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73–032 2001

S. HRG. 106–1052

AIRLINE COMPETITION: CLEAR SKIES OR

TURBULENCE AHEAD?

HEARING

BEFORE THE

SUBCOMMITTEE ON ANTITRUST,

BUSINESS RIGHTS, AND COMPETITION

OF THE

COMMITTEE ON THE JUDICIARY

UNITED STATES SENATE

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

MAY 2, 2000

Serial No. J–106–80

Printed for the use of the Committee on the Judiciary

(

(II)

COMMITTEE ON THE JUDICIARY

ORRIN G. HATCH, Utah, Chairman

STROM THURMOND, South Carolina

CHARLES E. GRASSLEY, Iowa

ARLEN SPECTER, Pennsylvania

JON KYL, Arizona

MIKE DEWINE, Ohio

JOHN ASHCROFT, Missouri

SPENCER ABRAHAM, Michigan

JEFF SESSIONS, Alabama

BOB SMITH, New Hampshire

PATRICK J. LEAHY, Vermont

EDWARD M. KENNEDY, Massachusetts

JOSEPH R. BIDEN, JR., Delaware

HERBERT KOHL, Wisconsin

DIANNE FEINSTEIN, California

RUSSELL D. FEINGOLD, Wisconsin

ROBERT G. TORRICELLI, New Jersey

CHARLES E. SCHUMER, New York

MANUS COONEY, Chief Counsel and Staff Director

BRUCE A. COHEN, Minority Chief Counsel

SUBCOMMITTEE ON ANTITRUST, BUSINESS RIGHTS, AND COMPETITION

MIKE DEWINE, Ohio, Chairman

ORRIN G. HATCH, Utah

ARLEN SPECTER, Pennsylvania

STROM THURMOND, South Carolina

HERBERT KOHL, Wisconsin

ROBERT G. TORRICELLI, New Jersey

PATRICK J. LEAHY, Vermont

PETE LEVITAS, Chief Counsel and Staff Director

JON LEIBOWITZ, Minority Chief Counsel and Staff Director

(III)

C O N T E N T S

STATEMENTS OF COMMITTEE MEMBERS

Page

DeWine, Hon. Mike, a U.S. Senator from the State of Ohio ................................ 1

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa ..................... 59

Kohl, Hon. Herbert, a U.S. Senator from the State of Wisconsin ....................... 2

CHRONOLOGICAL LIST OF WITNESSES

Panel consisting of Alfred E. Kahn, Professor Emeritus, Department of Economics, Cornell University, Ithaca, NY and Steven A. Morrison, Professor

of Economics, Northeastern University, Boston, MA ........................................ 4

Panel consisting of Robert Ferguson, President, Midway Airlines, RaleighDurham, NC; Donald J. Carty, Chairman and Chief Executive Officer,

American Airlines, Dallas, TX; and Bill La Macchia, Jr., President and

Chief Executive Officer, Sun Country Airlines, Mendota Heights, MN .......... 28

ALPHABETICAL LIST AND MATERIAL SUBMITTED

Carty, Donald J ........................................................................................................ 35

Prepared statement .......................................................................................... 38

Ferguson, Robert ...................................................................................................... 28

Prepared statement .......................................................................................... 31

Kahn, Alfred E ......................................................................................................... 4

Prepared statement .......................................................................................... 8

La Macchia, Bill, Jr ................................................................................................. 42

Prepared statement .......................................................................................... 46

Morrison, Steven A .................................................................................................. 11

Prepared statement .......................................................................................... 13

APPENDIX

ADDITION MATERIAL FOR THE RECORD

Edward P. Faberman, Air Carrier Association of America, prepared statement

and attachments ................................................................................................... 61

Paul M. Ruden, American Society of Travel Agents, letter and attachments .... 72

T. Allan McArtor, President and CEO, Legend Airlines, prepared statement ... 85

(1)

AIRLINE COMPETITION: CLEAR SKIES OR

TURBULENCE AHEAD?

TUESDAY, MAY 2, 2000

U.S. SENATE, SUBCOMMITTEE ON ANTITRUST, BUSINESS RIGHTS, AND COMPETITION, COMMITTEE ON THE JUDICIARY, Washington, DC.

The subcommittee met, pursuant to notice, at 2:04 p.m., in room

SD–226, Dirksen Senate Office Building, Hon. Mike DeWine (chairman of the subcommittee) presiding.

Also present: Senator Kohl.

OPENING STATEMENT OF HON. MIKE DeWINE, A U.S. SENATOR

FROM THE STATE OF OHIO

Senator DEWINE. Good afternoon. Two years ago, this subcommittee held hearings to examine the competitive structure and

activity of the aviation industry. We have been following the industry closely in the 2 years since those hearings, and aviation continues to be among the most difficult marketplaces to evaluate.

It is clear that competition has succeeded in improving service

and prices. In fact, since Congress deregulated the airline industry

in the 1970’s, passengers have flown far more, to a greater number

of destinations, and at a lower average price than ever before. The

hub and spoke system, from all reports, is responsible for a great

deal of that progress.

But despite the general improvements in service and price deregulation, we continue to hear complaints from consumers, complaints ranging from high prices for business travelers, to poor customer service for leisure travelers, particularly in hub cities. Possibly as a result of this dissatisfaction, start-up airlines continue to

enter the market. Despite their effort to meet customer demand,

however, most start-ups fail, often while complaining about the

anti-competitive tactics of the incumbent airlines, especially those

that are entrenched in hub airports.

In response to the failures of start-up airlines, Federal enforcement and regulatory agencies have increased the scrutiny of the industry. Specifically, the Department of Justice has investigated a

number of major carriers and has filed a case charging American

Airlines with predatory pricing. Further, in the last 2 years the Department of Transportation has issued and withdrawn draft competition guidelines and is now considering whether to issue new

guidelines. We will examine the implications of both of these Government actions in our hearing today.

2

Now, with regard specifically to the Department of Transportation and its guidelines, I would like to make a couple of points.

As most of you know, the draft guidelines that the Department of

Transportation issued 2 years ago met with a great deal of criticism, and I shared the concern of many of the critics, namely that

the draft guidelines were both too vague and too restrictive.

Now, I know that the Department of Transportation has received

a great number of comments on the guidelines, and I hope that if

the Department does reissue the guidelines that they took those

comments into account and produce a document that moves the debate forward.

More generally, however, I am still concerned about the notion

of Department of Transportation guidelines being used as a benchmark for enforcement policy. By their very nature, guidelines are

difficult to draft, and they run the risk of either over-regulating behavior, which is the last thing we should be doing in the aviation

industry, or not providing enough guidance to competitors.

Accordingly, at this point I continue to believe that the vigorous,

reasonable enforcement of the predatory pricing laws are a better

alternative. If correctly enforced, the predatory pricing laws should

enable the Government to punish illegal activity without chilling

the sort of tough competition that we want to encourage.

As I noted earlier, the Department of Justice is currently litigating its first predatory pricing case in years, and I think it

makes sense to await the outcome of that case before we consider

any different type of enforcement mechanism.

In the meantime, the industry continues to evolve. Perhaps one

of the most significant changes is the tremendous growth of regional jet service to provide direct, non-stop service to many new

cities. These jets are smaller and cheaper to fly than the traditional

jet airliner, but are much more popular than the turbo-prop planes

that they are replacing.

I am interested in hearing from our witnesses today in regard to

what impact the regional jet will have on the hub and spoke system. I would also like to discuss other aspects of the aviation industry which impact on competition, such as exclusive gate arrangements at many airports and the need to modernize our air

traffic control system.

Because of Government actions addressing competition and the

industry’s reaction to marketplace changes, this is an important

and an exciting time in the aviation industry. We have a very distinguished and experienced group of witnesses with us today to

help us analyze recent developments, and I look forward to hearing

from them as this subcommittee continues its work to increase

competition and to help consumers.

Let me turn now to the ranking minority member of the subcommittee, Senator Kohl.

STATEMENT OF HON. HERBERT KOHL, A U.S. SENATOR FROM

THE STATE OF WISCONSIN

Senator KOHL. Thank you, Senator DeWine.

To paraphrase Charles Dickens, in many respects airline competition today is a ‘‘tale of two cities.’’ Consumers in large markets

such as New York, Los Angeles or Washington, DC, traveling to

3

other large cities often benefit from vigorous price competition

among several choices in air carriers. Unfortunately, outside these

large markets, the picture is much bleaker. Travelers in smaller

and medium-size markets continue to have few alternatives to the

large incumbent carriers on many routes.

As a result, only some of the benefits promised during airline deregulation have been realized. Fares continue to be higher than

they should be, and choice continues to be limited. Moreover, startup carriers face serious obstacles in establishing service competing

with the incumbent carriers. And according to business writer

James Glassman, the established large airlines seem content to divide the country into separate fiefdoms defended by fortress hubs,

avoiding direct competition with each other and thereby ensuring

high fares and higher profits. That is why he advised investing in

their stock.

When a start-up does enter a new route dominated by a single

carrier, the results are dramatic. Indeed, after Sun Country Airlines recently began competing against Northwest from Milwaukee

to Minneapolis, prices dropped substantially, by as much as half,

according to our research, from the levels of just 2 years ago. The

findings reflected in the charts behind me demonstrate this dramatic change.

But the difficulty is not so much getting these start-ups into the

market, it is keeping them in the market in the face of relentless

and possibly predatory competition. Mr. La Macchia, the President

of Sun Country, will testify to the problems faced by new entrants

challenging large carriers in their fortress hubs; for example, difficulty in obtaining airport gates, huge increases of capacity by the

incumbent carrier, and large bonuses paid to travel agents for directing consumers to the dominant carrier. We invited the CEO of

Northwest to testify to give his side of the story, but he declined.

To be sure, there are no simple solutions to these problems, but

one answer may lie somewhere other than in antitrust enforcement. That is because the standards for predatory pricing are uncertain, making the large airlines’ behavior in many cases lawful

under prevailing antitrust laws. And antitrust enforcement almost

always leads to complicated, protracted, and lengthy proceedings.

However, it is clear that abuses exist, abuses that need to be corrected, and that in many places the competitive conditions in the

airline industry are far from ideal.

For this reason, today we are writing to the Secretary of Transportation to urge him to utilize his enforcement powers in an innovative and effective way. The Transportation Act authorizes the

Secretary to prevent ‘‘unfair, deceptive, predatory, or anti-competitive practices in air transportation.’’ We believe, and the weight of

authority is strongly on our side, that some conduct by airlines, although legal under antitrust law, is nonetheless unfair, unscrupulous, and anti-consumer, and clearly actionable under the DOT

statute.

Using this approach—that is, having the DOT bring an action

against an airline for unfairness rather than predatory pricing—

can avoid years and years of litigation about whether or not the

technical requirements of antitrust law have been met. In other

words, it will help consumers sooner rather than later, and it is

4

more fair to the airlines, who don’t deserve to be in legal limbo for

years and years and years.

Mr. Chairman, some of us may have different views about how

to promote competition, but all of us here today want to ensure

that the traveling public has the greatest possible number of

choices, the lowest possible prices, and the highest possible quality

of service and standards in air travel. So we are eager to hear what

our panelists think of these ideas and the state of airline competition today.

It is a terrific group of witnesses, and I especially want to thank

Professor Kahn, the father of airline deregulation, who is appearing

before this committee for the first time since 1987. We welcome you

all.

I return to you, Mr. Chairman.

Senator DEWINE. Senator Kohl, thank you very much.

Let me introduce our first panel. Alfred Kahn is Emeritus Professor of Political Economy at Cornell University and a special consultant to National Economic Research Associates. He is the former

Chairman of the Civil Aeronautics Board and is well known

throughout the industry as the father of airline deregulation.

Steven A. Morrison is Professor and Chair of the Department of

Economics at Northeastern University. During 1998 and 1999, he

was a member of the congressionally-mandated Transportation Research Board Committee for the Study of Competition in the U.S.

Airline Industry. Professor Morrison testified in front of this subcommittee about aviation competition about 2 years ago and we are

happy to have him back with us today.

Professor Kahn, we will start with you and we will take your

opening statement. Thank you for appearing, both of you.

PANEL CONSISTING OF ALFRED E. KAHN, PROFESSOR EMERITUS, DEPARTMENT OF ECONOMICS, CORNELL UNIVERSITY,

ITHACA, NY, AND STEVEN A. MORRISON, PROFESSOR OF ECONOMICS, NORTHEASTERN UNIVERSITY, BOSTON, MA

STATEMENT OF ALFRED E. KAHN

Mr. KAHN. Thank you, Mr. Chairman. One prefatory sentence.

While identifying me as the father of airline deregulation is an exaggeration of history, I do not demand a paternity test. I am honored by your invitation and hope I can be of some use to you.

Fortunately, I can leave to my colleague, Professor Morrison, who

is the coauthor of the really definitive studies of the effect of airline

deregulation, documentation of my firm opinion that deregulation

has been a great success, in particular by unleashing the forces of

competition and bringing air travel within reach of people of limited means without sacrifice of safety.

I had in my formal statement, which I will try quickly to summarize, a recognition of the fact that this has been accompanied with

a great deal of discomfort and congestion. In part, I want to point

out that was precisely our purpose. When we had planes flying half

full and half empty, it was nice to have an empty seat next to you.

Our purpose was to bring low-fare, lower-quality service, and

that inevitably meant letting the airlines compete to fill those

empty seats. So the congestion is part of a remedy; low-price and

5

greater congestion is part of what we were attempting to accomplish. But in addition, there has been a major failure, I think, of

Government institutions to provide the necessary infrastructure

and to price it correctly, and we can go into that, but it is not really

your subject today.

I don’t have to point out to this committee the truism that deregulation means increased reliance on competition, and increased

reliance on competition means greatly increased importance of vigilance on the part of the antitrust authority.

In these remarks, I want to concentrate on one aspect of antitrust policy as applied to this industry that has inspired the greatest amount of controversy in several years, namely the determination of what constitutes or should constitute unfairly exclusionary

policies—‘‘unfair, deceptive, predatory,’’ in the terms of the authority of the Department of Transportation.

Along with the reform of the arrangements for providing infrastructure and pricing it, and continuing to try to get rid of the barriers to competition at the international level, I can think of no

other aspect of Government policy with greater significance for the

preservation and expansion of the benefits of deregulation.

I therefore strongly endorse the proposition that DOT both has

and should have joint responsibility. It is the precise counterpart

of the statutory responsibility of the Federal Trade Commission to

prevent unfair methods of competition in industry generally, from

which airlines were exempted because historically they were subjected to direct regulation.

The basis for the increased concern about such assertedly exclusionary tactics as predatory pricing, interference with fair access to

airport facilities, refusal to interline or exchange luggage, or the

offer of special override commissions in the face of competitive

entry, is by now entirely familiar. And I just want to set it forth

in a series as quickly as I can of propositions.

Average yields per mile have declined some 40 percent, adjusted

for the Consumer Price Index, in real terms. But full fares, paid

by only about 6 percent of all traveled mileage, have apparently increased on the order of 70 percent; that is, adjusted for the CPI.

If you don’t adjust it for the CPI, they have increased five-fold. So

you have had this increased spread of fares.

Now, I think in large measure, maybe in major measure, that

spread has been beneficial for travelers, both those who pay the

low fares and those who pay the high fares. It reflects wide differences in costs, with length of route, with density of route, with

time of day. If you try to get discount fares between New York and

Washington at 8 a.m. on a Monday morning, you are not going to

get it. Obviously, you are paying more, but that is because congestion costs are higher at that time, and the cost of holding seats out

for last-minute availability, which is one of the things you pay a

lot for.

In the case of the fare quoted to me, Ithaca to Washington, 300

miles or less, round trip fare was $732. You could divide it by the

mileage. I don’t have any scientific basis for telling you that I find

that outrageous, but I do take comfort from the fact that if I can

stay over a weekend, I can get very good fares, and most people

do. So there is this increased spread.

6

I should point out that in some measure that spread is discriminatory. It clearly is charging travelers with a highly inelastic demand what that traffic will bear. But even discrimination, on balance, is beneficial. It is a way, for example, of filling seats that

would otherwise be empty, charging very low fares to discretionary

travelers. And as long as they cover the incremental costs of serving them, they contribute toward using bigger planes which are

more efficient, with an increased availability of routes to different

places, which is clearly a product of deregulation, and convenient

scheduling, all of which are particularly beneficial to business travelers.

At the same time, it has clearly raised legitimate concerns about

whether it represents also monopoly exploitation of the demand-inelastic travel, not just business travelers, but people traveling on

family business who can’t get a certificate from a crematorium that

they deserve a lower fare. I know about that; I have had that experience.

There are only two ways of preventing that exploitation, if it exists. One is, of course, the resumption of regulation. I don’t know

anybody—well, I know some who are in favor of it, but nobody I

respect. [Laughter.]

The only alternative is freedom of entry, and that, of course, is

exemplified by the increasing challenge to the sharp increases in

full fares by new entrants in the middle-1990’s. The Department of

Transportation has documented it. It estimates that they saved

travelers some $6 billion in 1996. That is how a deregulated, competitive industry is supposed to protect not really consumers generally, but any subgroup of consumers. If a small carrier says, I can

serve these people at lower cost and at a lower fare, free entry is

the way in which we rely for protection.

I won’t recite the pattern that is described by the Department of

Transportation, the pattern that is exemplified by this showing,

but certainly it has been found in case after case, a drastic reaction, very sharp price reductions, an enormous increase in the offer

of discount fares only on the particular routes where the challenge

occurs. When and if the entrant is driven out, fares go back up to

their previous level. And, of course, other carriers thinking about

entry, seeing what happened to the one before, are going to be hesitant about entering.

Now, I can’t even tell you that that is the typical scenario. It has

certainly happened many, many times. I have not been able to do

a continuing study, and I regret that the Department of Transportation doesn’t seem to have done so, to tell us whether that is the

typical picture or not.

But, interestingly, I came across my desk yesterday a monograph

by Professors Fred Allvine, of the Georgia Institute of Technology,

about whose work I have known in the past, and Ashutosh Dixit,

of the University of Georgia, which appears to document at length

and in great detail exactly the kind of scenario that is described

there and purporting to show a pattern of very great consistency.

And I urge you and the Department of Transportation to look at

it very carefully.

There is no question, according to the studies by Drs. Morrison

and Winston, that entry by more or less low-fare carriers, low-cost,

7

has made a disproportionately great contribution to the benefits of

price competition in the industry. And they have actually made estimates of that and they show that the contribution to savings from

reduced real fares by Southwest and other new entrants has been

more than twice as great as the competition supplied by incumbent

carriers. It plays an extremely important role in disciplining the industry.

Now, the industry is especially susceptible to predation because

you can move aircraft in and out, and that is an almost unusual

circumstance in this industry. The incumbents incur virtually no

additional sunk costs if they simply increase capacity on challenged

routes, and then they can readily take the capacity out. And that

also makes it easier for the people who are there to depart because

they don’t have major sunk costs. They can transfer their planes

out or be induced to do so.

Yield management techniques also increase the ability of the industry to practice predation. Because of that, it is extremely difficult to apply the test that has typically been adopted by the

courts in antitrust cases under the Sherman Act and under the

Clayton Act because the principal component of the average variable costs that supply the principal test under antitrust jurisprudence are not production costs, which are very, very low. They are

opportunity costs, the revenues that you sacrifice by transferring

capacity from one route to the challenged route, and what the Department of Transportation pointed out, the sacrifice of net revenues that you may be making if you had pursued a less aggressive

policy.

That immediately makes it clear how difficult that is to interpret

and to administer, and I am one of the first to recognize it. But,

in principle, I point out to you that the report of the National Research Committee, of which I was a member, that reported last

summer clearly recognizes the infirmity of simply using average

variable production cost. That reflects direct expenses, but it is an

unsatisfactory proxy—I am quoting them—for marginal costs because it doesn’t account for the more profitable opportunities that

are foregone.

Now, I should emphasize, in fairness, the overall profitability of

this industry is nothing to write home about. It seems over the

years clearly to fall somewhere below the average, and perhaps

markedly below the average, of industry generally.

On the other hand, that doesn’t mean that there is no room for

additional competition. If competitive entry were freer than it is

today of predatory responses, the intensified competition could be

associated with lower costs, both because of the increased pressures

that it would impose on the incumbent carriers to reduce their

costs and because a greater proportion of the traffic would be carried by low-cost carriers.

My last observation, and I will stop. There is always a danger

in proceeding more vigorously against what appear to be predatory

pricing responses of weakening competition itself. That is a legitimate concern that a more vigorous attack on these responses by labeling healthy consumer-benefitting responses as predatory could

outweigh the benefits.

8

On the other hand, some of the responses to the Department of

Transportation’s initiative to move against them on the ground

that it would suppress more competition than it would protect generally ignores the fact that the only circumstances under which

DOT would move under these would be when the incumbents were

not offering those low fares in such profusion until they were challenged, and then only in the particular routes on which they were

challenged.

The initiative has in almost all cases, almost invariably, come

from the entrants. So when one sheds tears about limiting the competitive response of the incumbents, it is important to bear it in the

context that they occur only when the initiative has come from

competitive entrants. And, of course, they are promptly withdrawn

when they succeed in driving competitors out.

On the third hand—you remember President Truman said he

used to go to bed at night praying for a one-handed economist—

there is the difficulty in enforcement actions of predicting which of

these vigorous competitive responses will have an ultimately anticompetitive effect and which will not, and in which markets, therefore, competition is likely to persist, to the lasting benefit of consumers.

I am sorry that I have left you with a three-handed dilemma. I

do want to present you, however, with the case for saying this is

a serious problem. There is serious basis for anger on the part of

the 6 percent of mileage, and that is all it is, who pay the full fare,

and all of them live in Ithaca. [Laughter.]

Therefore, I think DOT’s exercise of its independent authority

should be encouraged.

Thank you.

Senator DEWINE. Professor, thank you very much.

[The prepared statement of Mr. Kahn follows:]

PREPARED STATEMENT OF ALFRED E. KAHN

I am honored by the invitation to appear before you today, and hope I can be of

some assistance to you in your consideration of the state of competition in the deregulated airline industry and the application of the antitrust laws to it.

Fortunately, I can leave to my colleague, Professor Steven Morrison, co-author of

the definitive studies of the effects of airline deregulation, documentation of my firm

opinion, and his, that deregulation has been a great success—in particular, by

unleashing the forces of competition, bringing air travel within reach of people of

limited means, without sacrifice of safety.

There are, I think, two things to be said about the fact that it has also been accompanied by a marked increase in discomfort and congestion: first, that it was precisely the failure of regulation to offer travelers a low-cost/lower-quality product that

was its greatest failure; and, second, that this deterioration in the quality of the air

travel experience is a consequence, in important measure, of the failure of government to provide the optimal infrastructure—specifically, air traffic control and airport capacity—and to price it correctly.

I take it as a truism, which requires no explanation to this Committee, that the

withdrawal of direct regulation shifts the responsibility for protecting consumers to

competition and responsibility for preserving that competition to increased vigilance

in enforcing the antitrust laws.

In these remarks, I propose to concentrate my attention on the aspect of antitrust

policy, as applied to this industry, that has inspired the greatest amount of controversy in the last several years—namely, the determination of what constitutes or

should constitute unfairly exclusionary practices, such as the Department of Transportation is charged with preventing. While I have not been in a position to make

any direct assessment, on the basis of historical experience, of the importance of

such practices—and am not at all clear how it might be conducted—I have at least

9

1 I testified on the subject before the Aviation Subcommittee of the U.S. Senate Committee

on Commerce, Science, and Transportation approximately two years ago (April 22, 1998) and

before the Transportation Subcommittee of the same Committee on May 5, 1998, and published

a more formal statement, ‘‘Comments on Exclusionary Airline Pricing,’’ which was published in

the Journal of Air Transport Management in 1999.

the strong impression that the intense controversies engendered by DOT’s promulgation of proposed rules in fulfillment of that responsibility, in April of 1998, does

properly reflect their importance. Along with the reform of the arrangements for

providing and pricing access to infrastructure and our long-continuing efforts to lift

the governmentally imposed barriers to competition at the international level, I can

think of no other aspect of government policy with greater significance for the preservation and expansion of the benefits of deregulation—perhaps I should add, of

greater importance, for good or ill.

Consistently with that opinion, I strongly endorse the proposition that DOT both

has and should have that responsibility: it is the precise counterpart of the statutory

responsibility of the Federal Trade Commission to prevent unfair methods of competition—from which airlines were exempted because of their historical subjection

instead to direct regulation.

The basis for the heightened concern in recent years about such assertedly exclusionary tactics as predatory pricing, the interference with new entrants obtaining

fair access to airport facilities, refusals to interline or exchange luggage, and the

offer of special override commissions to travel agents targeted at markets subjected

to new competitive entry is by now entirely familiar.1

1. While average yields, per mile, have declined on the order of 40 percent in real

terms—i.e., adjusted for changes in the Consumer Price Index—since deregulation,

full fares, paid on only some 6 percent of total mileage, have apparently increased

on the order of 70 percent. That sharply increased spread has surely been in large— indeed, I offer the impression, major—measure beneficial to all travelers, for two

reasons. In part, it reflects wide differences in real costs as between long and short,

dense and thin routes and by hour of the day and day of the week, as well as of

holding seats open for last-minute availability. Moreover, to the extent that the fare

differentials are discriminatory, they make it possible to use larger, more efficient

planes and offer more convenient scheduling on a greater number of routes than

would have been possible if all fares had to be uniform. Within limits—of incremental costs at the bottom and stand-alone costs at the top—the offer of heavily discounted tickets to discretionary and/or leisure travelers, in order to fill seats that

would otherwise go empty, while charging higher fares to demand-inelastic travelers, is beneficial to both of them.

2. At the same time, this increased discrimination has also raised legitimate concerns about the likelihood that those full fares reflect also monopoly exploitation of

travelers who cannot make their reservations weeks in advance or stay over a weekend—the most familiar devices by which the airlines discriminate between demandelastic or discretionary travelers, on the one side, and demand-inelastic, exploitable

ones, on the other.

3. There are, effectively, only two ways of preventing exploitation of the demandinelastic travelers. One would be a resumption of regulation; since no economist I

know advocates this, it would be superfluous to expatiate on our reasons for not recommending it.

4. The only alternative protection, and the one completely consistent with deregulation, is competition. One important function of free competitive entry is to ensure

that no group of travelers is ever charged more than the costs of serving it alone.

This process was apparently exemplified by the increasing challenge to the sharp

increases in full fares by new entrants in the middle ’90s—documented by the Department of Transportation, along with an estimate that they saved travelers some

$6 billion in 1996. This is precisely the way in which a deregulated, competitive industry is supposed to protect not merely consumers generally but any smaller subgroup of them.

As I put it in my testimony on April 22, 1998,

The theoretically correct basis for . . . charges to subgroups of customers . . .

is stand-alone costs—the hypothetical cost of serving any partial grouping of

customers alone. That is the ceiling that would prevail if there were perfectly

free entry: . . . .

Clearly, the best way of ensuring that such a ceiling will prevail is free entry

itself; and it was indeed on freedom of competitive entry that we relied for the

protection of travelers when we deregulated the airlines. But what seems to

have occurred time and again in recent years has been: unrestricted fares are

jacked up and up; that induces entry of low-cost, more or less uniformly lowVerDate 11-MAY-2000 05:40 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00013 Fmt 6633 Sfmt 6621 E:\HR\OC\B032.XXX pfrm01 PsN: B032
10

2Special Report 255, National Academy Press, Washington, DC, 1999.

3 In their magisterial studies of airline deregulation, Winston and Morrison estimate that the

contribution to the savings from reduced real fares since deregulation by Southwest and other

new entrants has been more than twice as great as the ‘‘competition supplied by incumbent carriers,’’ with Southwest accounting for some three-quarters of the former. Winston, ‘‘U.S. Industry Adjustment to Economic Deregulation,’’ Journal of Economic Perspectives, summer 1998, p.

101. 4Despite the more or less even division of the members of the TRB Committee for the Study

of Competition in the U.S. Airline Industry on the issue of whether DOT should be encouraged

to proceed with its independent enforcement actions or defer to the Department of Justice, all

members recognized the critical relevance of opportunity costs in these circumstances (pp. 8, 86):

‘‘to the extent that AVC [average variable cost] mainly reflects the direct expenses incurred in

production, it is an unsatisfactory proxy for marginal cost—since it does not account for more

profitable opportunities foregone.’’ By emphasizing revenue ‘‘self-diversion,’’ DOT seemingly was

trying to incorporate opportunity costs into its method of detecting predation. 5 I have had time only to look at the industry’s ranking among the Fortune 500 only over the

last seven years: its median ranking was 21st out of 38 industries, reflecting rankings averaging

fare rivals, emulating Southwest, who can profitably serve those customers at

much lower fares; the incumbents then cut their fares deeply and sharply increase the number of low-fare seats they offer on the routes—and only on the

routes—on which they have been challenged; the new entrant departs; and fares

immediately go right back up, with no further challenge. That is the kind of

scenario that the Department of Transportation says it has seen played out

many times in the last few years and that it sees as crying out for remedy.

I should point out, at the same time, that the pattern I have just described is by

no means uniform and invariable. While the TRB Committee, of which I was a

member, that reported on Entry and Competition in the U.S. Airlines Industry last

summer,2 found some of the responses of incumbents to competitive entry ‘‘difficult

to reconcile with fair and efficient competition’’ (p. 6), it could find no uniform pattern in the instances of possibly exclusionary conduct presented to it by the Department of Transportation: while incumbent airlines typically reduced their fares

sharply in response to such entry, sometimes increasing capacity, sometimes not,

there is no clear and consistent relationship between those responses and either the

disappearance of the challengers or the restoration of fares to their previous level.

On the other hand, there has just come across my desk a monograph by Professors

Fred Allvine, of the Georgia Institute of Technology, and Ashutosh Dixit, of the University of Georgia, which appears to document, at length and in great detail, the

kind of scenario that I have just described, showing a pattern of great consistency;

it clearly deserves your careful attention and that of the Department of Transportation.

5. Market entry by low-cost, more or less uniformly low-fare-charging carriers has

made a grossly disproportionally great contribution to the benefits of price competition in the industry, according to the studies of Drs. Winston and Morrison.3

6. The airline industry is especially susceptible to predation, because of the mobility of aircraft and the consequent relatively small proportion of sunk costs in undertaking to serve and responding to competitive entry into individual markets: the incumbents need incur virtually no additional sunk costs when they increase capacity

on challenged routes and entrants can be readily induced to depart, because of their

ability correspondingly to move their equipment out.

7. The sophistication of the major airlines in practicing yield management, rationing the availability of deeply discounted tickets, makes it easy for them sharply to

increase the availability of such fares on individual routes in response to competitive challenge and to withdraw them when the challenge disappears.

8. This character of the industry and of its costs makes it extremely difficult to

apply the test of predation that has been most widely adopted by the courts—name- ly, pricing by the incumbent below their short-term marginal or average variable

production costs. In the circumstances that I have just described, the principal component of those average variable costs are not production costs but opportunity

costs—the revenue foregone elsewhere by transferring capacity to the contested

route and/or the revenue from undiscounted or only modestly discounted ticket sales

sacrified by the suddenly increased availability of deeply discounted ones. This is

the essence of the condition incorporated in all three indicators of ‘‘unfair exclusionary practices’’ proposed by the Department of Transportation: that ‘‘the ensuing

self-diversion of revenue results in lower local revenue than would a reasonable alternative response.’’ 4 (in Transportation Research Board, p. 166)

I must emphasize, in fairness, that the overall profitability of the airline industry

seems hardly reflective of what one would expect from a monopolist: overall, it apparently has, on average over the years, fallen well below the average of American

industries generally.5 This consideration does not, however, exclude the possibility

11

around 32 out of 35 in 1993–95 and a very satisfactory 12 out of some 38 in 1997–99; but one

need only dip back into the catastrophic losses the industry suffered in the 1990–92 period to

put the quite satisfactory showings over the last years in proper context.

of purchasers of unrestricted tickets having a legitimate complaint; and it by no

means follows that if unrestricted fares were to come down, discount fares would

inevitably have to go up. The industry is far from perfectly competitive, there is

therefore a wide range within which its rates of return can vary, not only from year

to year, but also in the long run, if only because its costs are not exogenously fixed

by perfectly competitive input markets but are themselves instead responsive in important measure to the intensity of competition in airline markets. If competitive

entry were freer than it is today of predatory responses, the intensified competition

that it could bring could clearly be associated with lower costs, the latter because

of both intensified downward pressures of competition on the costs of incumbents

and increase in the proportion of the traffic carried by the low-cost carriers.

There is always a danger, in proceeding more vigorously against what appear to

be predatory pricing responses by incumbent airlines to competitive entry of weakening competition itself. The concern is a legitimate one—that a more vigorous attack on responses by incumbent airlines to competitive entry may, by labeling

healthy and consumer-benefiting competitive responses by incumbents as predatory,

outweigh the benefits. On the other hand, some of the responses of the Department

of Transportation’s initiative to move against such responses, on the ground that it

would suppress more competition than it would protect, generally ignore the fact

that the only possible circumstances under which such a policy would discourage

such price reductions would be when the incumbents were not offering such low

fares in such profusion until they were challenged, offered them then only in direct

response to competitive entry and only on the particular routes affected, and—in

those instances in which the competitor had been driven out—promptly withdrew

them. On the third hand, however, there is the difficulty, in enforcement actions,

of predicting which of the vigorous competitive responses will have that ultimately

anti-competitive effect, which will not, and in which markets, therefore, competition

is likely to persist, to the lasting benefit of consumers.

Senator DEWINE. Professor Morrison.

STATEMENT OF STEVEN A. MORRISON

Mr. MORRISON. Thank you. It is a pleasure to be back today. My

remarks will be brief. There is more detail in my testimony and in

the sources that are referenced in the testimony.

What I would like to do is go through some points to provide my

answer to the question that is the theme or the title of these hearings: ‘‘Airline Competition: Clear Skies or Turbulence Ahead?’’ My

approach to this issue, as to all issues of this type, is empirical. I

look at the data.

What I am going to do in the next 5 minutes is, first, present

some aggregate figures that provide an overview of the extent of

competition in the airline industry, then present the results of

some statistical analyses that shed light on the factors that underlie those aggregate results, and then speculate on some possible

policy responses that may improve competition.

As for the overview, I would like to look at some key measures

of the extent of competition in the airline industry and its effects.

One of the most important measures of competition is the number

of carriers per route. And using that measure, competition has

been stable for the last 7 years, at a level some 30 percent higher

than it was before airlines were deregulated.

As, or more important than that simple measure of number of

carriers per route, as Professor Kahn indicated, is the presence of

low-fare carriers. And by that measure, low-fare carriers’ share of

passenger miles is now at an all-time high, at 12 percent. But the

influence of low-fare carriers goes beyond their own share of pasVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00015 Fmt 6633 Sfmt 6602 E:\HR\OC\B032.XXX pfrm01 PsN: B032
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senger traffic because they influence the fares of other carriers who

compete against them, as the chart illustrates.

If you look at the percentage of traffic that flies on routes with

low-fare competition, that measure, as well, is at an all-time high

of 42 percent.

Senator DEWINE. Forty-two?

Mr. MORRISON. Forty-two. I will add parenthetically that twothirds of both of those numbers is due to the premier low-fare carrier, Southwest.

Using an even broader definition of the influence of low-fare competition to include not just routes served but the effect of potential

competition, I have calculated the effect of Southwest Airlines

alone influences fares on 94 percent of passenger miles in the country, just Southwest Airlines.

These figures on the extent of competition are of interest because

we know both theoretically and empirically that more competition

leads to lower fares. But as Professor Kahn said, we can just look

at fares to see what has happened. Fare per mile adjusted for inflation is at a historical low of a little bit less than 14 cents a mile.

Indeed, there is a wide variation in fares. We documented that in

the report of the Transportation Research Board panel.

So adding in the service benefits and fare changes, travelers today are saving some $20 billion annually over what they would

have paid in the years of regulation. So, viewed in the aggregate,

airline markets are working. But aggregate statistics can hide

some details.

Although the average traveler is better off, our estimate is that

some 20 percent of travelers are paying higher fares, the 6 percent

that Professor Kahn indicated, but others as well. And what I want

to do in the second half of my testimony is talk about what factors

account for these winners and losers.

To address that, Cliff Winston and I performed some statistical

analyses. The original source is documented in the testimony. Some

of the findings—perhaps most of them are not surprising, but they

provide a useful quantification of conventional wisdom.

I have good news and bad news. The good news is competition

from Southwest Airlines saves travelers some $10 billion a year.

Competition from other low-fare carriers saves travelers some $1.5

billion a year. The bad news is the long-term exclusive use gates

at airports and other lease policies that make it difficult for airlines to acquire new gates, by our estimates, cost travelers $3.8 billion annually.

Slot restrictions at the slot-controlled airports, the high-density

rule, costs travelers $.6 billion annually. Hub dominance costs travelers $.4 billion annually, but this appears to be because, with a

few exceptions, Southwest Airlines does not operate from dominated hub airports.

What we have found is that fares at hubs are no higher than

fares elsewhere that Southwest doesn’t serve. Southwest has such

a huge impact on the outcomes in the marketplace that one needs

to in almost any analysis take their presence or absence into account when making comparisons.

Finally, in the bad news category, we were provided by the Department of Transportation a list of some 20-odd routes where

13

* Portions of this testimony rely on and are extracted from Steven A. Morrison and Clifford

Winston, ‘‘The Remaining Role of Government Policy in the Deregulated Airline Industry,’’ in

Sam Peltzman and Clifford Winston, eds., ‘‘Deregulation of Network Industries: What’s Next?,’’ Washington, DC: The Brookings Institution, 2000 (forthcoming). The paper is available in the

research section of my web site. 1The National Commission to Ensure a Strong Competitive Airline Industry, Change, Challenge and Competition: A Report to the President and the Congress, August 1993. 2 Because a simple count of carriers on a route would treat a carrier with a large market share

of equal importance as one with a small market share, a measure of competition that takes market share into account is appropriate. In particular, I use the inverse of the widely used

Herfindahl-Hirshman index (HHI), which equals the sum of the square of each firm’s market

share. Thus, if two carriers each had a 50 percent market share, the HHI would be

0.50 2+.050 2=0.50. Inverting gives two equal-sized competitors. The same result would occur

with three carriers with market shares of two-thirds, one-sixth, and one-sixth.

their unfair exclusionary practices criteria appeared to have been

violated. The routes on which those violations occurred cost travelers $20 million a year. So that is a rather small number compared to the billions that I have been referring to before.

What can we do about it? Low-fare competition, especially from

Southwest, has a powerful effect on fares. To increase the likelihood of the next Southwest coming on line, we could, and I think

we should, eliminate restrictions on foreigners owning and operating U.S.-based airlines.

We need to do something, and I am not entirely sure what, to

increase gate availability. From what I have read, it appears that

existing policies of the DOT or existing regulations of DOT and of

airport operators provide them with more leverage than they are

using to open up gates, but that is certainly an area that needs

some attention. Remove slots and replace them with congestionbased takeoff and landing fees. I am not up to date on exactly what

has happened, but I know some legislation has been passed in that

regard. Finally, I differ with Professor Kahn about the importance,

but more importantly about the avenue to take with alleged predatory behavior. I believe it should reside with the Department of

Justice.

To summarize, to answer the question: airline competition: clear

skies or turbulence ahead, I would say clear skies with a little light

chop.

[The prepared statement of Mr. Morrison follows:]

PREPARED STATEMENT OF STEVEN A. MORRISON*

INTRODUCTION

From time to time since airlines were deregulated over 20 years ago, the question

of the functioning of airline markets arises. For example, seven years ago, after four

years of staggering losses, a national commission was formed to investigate whether

the deregulated airline industry was capable of achieving financial viability.1 The

industry’s fortunes improved without any regulatory intervention and for the last

several years it has been recording record profitability. Recently, concern has shifted

from the plight of airlines to a concern for their passengers. This testimony summarizes recent empirical analyses I have undertaken to address the state of competition in the airline industry.

THE BIG PICTURE

Figure 1 shows the trend in the number of ‘‘effective competitors’’ 2 at the route

level from 1977, the year before formal deregulation, through 1999. The number of

carriers per route averaged about 1.7 in 1977 and rose to about 2.5 by 1986. Following the merger wave of the mid-1980s and bankruptcies in the early 1990s, the

number of effective competitors per route has been fairly constant since 1993 at 2.2,

an increase of more than 30 percent since 1977.

14

3 About two-thirds of the passenger miles flown by low-fare carriers are accounted for by

Southwest Airlines. Although the passenger miles of other low-fare carriers were at an all-time

high in 1999, their share of passenger miles (4.0%) was slightly less than in 1997 (4.1%) when

it reached an all-time high. 4 Again, about two-thirds of this is due to Southwest Airlines.

5See Steven A. Morrison, ‘‘Actual, Adjacent, and Potential Competition: Estimating the Full

Effect of Southwest Airlines,’’ unpublished manuscript (available in the research section of my

website). 6The estimate compares actual deregulated fares with an estimate of what fares would be if

they continued to be regulated. Of course, one has no way of knowing for sure what regulated

fares would be. However, a good guess can be made with an updated version of the fare formula

that the CAB used during the last few years of regulation. See Steven A. Morrison and Clifford

Winston, The Evolution of the Airline Industry, Washington, DC: The Brookings Institution,

1995. 7Steven A. Morrison and Clifford Winston, ‘‘The Evolution of the Airline Industry’’ provides

a detailed discussion of the findings reported in this paragraph. The benefits from increased frequency are nearly as important as the benefits from reduced fares, amounting to more than 80

percent of the benefits from lower fares.

In addition, however, to the number of carriers on a route, the identity and business models of those carriers are also important, especially if one’s ultimate interest

is the effect of competition on fares. Figure 2 shows two measures of the influence

of low-fare carriers. The first measure is the percentage of domestic passenger miles

flown by low-fare carriers. This measure increased steadily from 1978 until 1985,

declined in 1986 with the bankruptcy/merger of People Express and has grown

steadily since 1987. In 1999 low-fare carriers accounted for 12 percent of domestic

passenger miles, the highest percentage ever.3 The second measure, however, gives

a more accurate picture of the effect that low-fare carriers have on airline competition and fares. This measure takes into account that the influence of low-fare carriers is greater than their share of traffic because they influence fares of other carriers flying the same routes (in this case, the same city pair). In particular, it measures the percentage of domestic passenger miles flown (by all carriers) in city-pair

markets that are served by low-fare carriers. This measure follows the same pattern

as the previous one: increasing until 1985, declining until 1987 and increasing since

then. In 1999, low-fare carriers influenced fares on routes accounting for 42 percent

of domestic passenger miles, an all time high.4 In addition, using a broader measure

of the effect of low-fare carriers that incorporates the effect of actual route competition, competition on nearby routes, and the effect of potential competition, I have

found that Southwest Airlines alone affects airfares on routes that account for 94

percent of U.S. domestic passenger miles.5

Interest in the extent of competition in the industry stems from the observation

that more competition—especially from low-fare carriers—leads to lower fares. This

is addressed directly in Figure 3, which shows domestic airline yield (average fare

per mile) from 1970 to 1999. Fares, adjusted for inflation, have fluctuated, but followed a declining path since 1971. Compared with 1976, before the regulatory reform that preceded deregulation in 1978, fares have fallen 40 percent. In 1999, real

yield was a bit less then 14 cents, its lowest level ever. However, as shown in the

figure, fares were falling even before deregulation. How much of the decline in fares

is due to deregulation and how much would have happened anyway (due to factor

prices and technological change, for example)? This is addressed in Figure 4, which

shows a conservative estimate of how much lower fares are due to deregulation.6

For the last six years fares have been about 27 percent lower than they would have

been if they were regulated. (Thus, about two-thirds (27/40) of the fare decline since

1976 can be attributed to deregulation). Further investigation shows that 80 percent

of passengers, accounting for 85 percent of passenger miles, pay lower fares than

the estimate of regulated fares.

Deregulation has also affected service. Previous research has found that travelers

have gained substantially from the increase in flight frequency facilitated by the acceleration of hub-and-spoke operations.7 Because deregulation freed airlines to serve

all markets, travelers have also gained from having to make fewer connections that

require changing airlines. These gains have been partially offset by more crowded

flights, travel restrictions that are inconvenient for business travelers (especially the

required Saturday night stay), a few more connections, and slightly longer flight

times because of congestion. Accounting for fare and service quality changes, the annual net benefits to travelers from airline deregulation currently exceed $20 billion.

THE DETAILS

The results presented in the previous section indicate that, on average, travelers

have benefited from airline deregulation but that a small minority has not. In this

15

8Steven A. Morrison and Clifford Winston, ‘‘The Remaining Role of Government Policy in the

Deregulated Airline industry,’’ in Sam Pelzman and Clifford Winston, eds. ‘‘The Deregulation

of Network Industries: What’s Next?,’’ Washington, DC: The Brookings Institution, 2000 (forthcoming) (available in the research section of my web site). 9This comparison is potentially misleading because three of the concentrated airports are

served by Southwest (Salt Lake City, St. Louis, and Detroit). However, if these three airports

are eliminated from the analysis, fares at the nine remaining concentrated airports are 29 percent higher than at all other airports and 1 percent lower than the comparison group that excludes airports served by Southwest. 10FAA/OST Task Force, ‘‘Airport Business Practices and Their Impact on Airline Competition,’’ October 1999. 11Transportation Research Board, National Research Council, ‘‘Entry and Competition in the

U.S. Airline Industry,’’ Special Report 255, Washington, DC: National Academy Press, 1999.

section I take a more disaggregate view to try to identify those factors that distinguish the winners from the losers and to identify any trouble spots and possible policy remedies.

To address this question, my colleague Cliff Winston and I used regression analysis to examine the factors that influenced fare changes between 1978:4 and 1998:4

on the 1,000 most heavily traveled routes in 1998.8 We found that increased competition, especially from Southwest Airlines and other low-fare carriers leads to

lower fares. In particular, we found that competition from Southwest Airlines accounted for $9.7 billion of the fare savings since 1978:4. Competition from other lowfare carriers accounted for $1.5 billion, while additional competition from pre-deregulation carriers accounted for $0.4 billion.

In another regression we examined the factors that influence the level of fares

(rather than the change in fares) on the same set of routes used above. We found

that the most important factor that increases airfares to travelers was (lack of) gate

availability. In particular, we found that, other things equal, airports with a higher

fraction of gates available for use by other airlines (i.e., generally common use gates)

had lower fares. Quantitatively, if all airports had common use gates, or other arrangements that precluded exclusive use of gates by incumbent airlines, travelers

would save $3.8 billion annually.

Slots (at O’Hare and LaGuardia) raise fares by $0.6 billion annually. Domination of hub airports raises fares by $0.4 billion annually, other things

equal. Figure 5 sheds additional light on the hub premium issue. The figure shows

the percentage by which fares at 12 concentrated airports differ from fares at two

sets of control groups. Although the results differ from airport to airport, on average, fares at concentrated hub airports are 23 percent higher than at all other airports. But, as indicated above, the effect of Southwest Airlines on fares is so important, that when the comparison group excludes airports that Southwest serves, the

average concentrated airport has fares 6 percent lower than the comparison group.9

Thus, it appears that what looks like a hub premium is actually a ‘‘premium’’ that

airlines charge anywhere they can when they do not compete against Southwest.

On routes where carriers appear to have violated the Department of Transportation’s Unfair Exclusionary Practices criteria, fares are lower during the periods

when the alleged transgressions are occurring and return to their previous levels

after the episodes are over. We found that fares on these routes, before and after

the alleged predatory activity, are $20 million higher than on otherwise comparable

routes.

CONCLUSION AND POLICY RECOMMENDATIONS

By and large, airline markets are working and competition is healthy. There are

a few trouble spots, however. By far the most important is access to gates at airports. Slot restrictions are a distant second, followed by hub dominance. The quantitative importance of alleged predatory activity is quite small.

Although competition is robust, more competition would be better. The effect of

Southwest Airlines on competition and fares shows that just one airline can have

a large impact on competition and fares if it is well financed and well managed. The

likelihood of another Southwest entering the industry would be increased if federal

limits on foreigners owning and operating U.S.-based airlines were eliminated.

The FAA/OST Task Force 10 has recommended several policies to improve gate

availability at airports as has the TRB Committee for Study of Competition in the

U.S. Airline Industry.11 These range from using the AIP and PFC programs to improve gate availability to airport authorities buying back gates from dominant incumbents. Although I do not have a particular policy in mind, any policy that improves gate access should have a large impact on competition.

As for slots, I believe they should be eliminated and replaced with congestionbased takeoff and landing fees.

16

Although I have found that the likely effect of alleged predatory behavior is small,

it should not be ignored. In cases of alleged predatory behavior by airlines, I believe

the Department of Justice should investigate and take appropriate action, rather

than the Department of Transportation.

17

18

19

20

21

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Senator DEWINE. Good, very interesting.

Mr. Morrison, do you want to summarize for me in descending

order the items that are causing the problems as far as lack of

competition? Give me that again.

Mr. MORRISON. Gates.

Senator DEWINE. Gates, number one.

Mr. MORRISON. Number two is slots. Number three is hubs.

Senator DEWINE. Gates, slots, hubs.

Mr. MORRISON. Number four is alleged predatory behavior.

Senator DEWINE. OK, and that is the order?

Mr. MORRISON. Yes.

Senator DEWINE. Professor Kahn, you mention in your testimony

that having the Department of Transportation take action to prevent unfair exclusionary practices may actually weaken competition, and I agree that that is a concern. How would you protect

against that sort of unwanted result?

Mr. KAHN. I am not sure that I have an easy answer. We have

the experience of the Federal Trade Commission in dealing with

the entire economy. It has almost precisely the same authority

under Section 5 of the Federal Trade Commission Act. I have seen

many criticisms of the FTC, but I have never heard it seriously

maintained that, on balance, they have weakened competition.

One of my main reasons for wanting DOT to retain that concurrent authority is that the Supreme Court has virtually written predation out of the antitrust laws. They have expressed the opinion

time and again that predation is rarely tried and even more rarely

succeeds.

And by an interesting coincidence, the Supreme Court—I suppose it is not surprising, given the fact that they are lawyers—is

a victim of a perceptual lag. They are all trained by the University

of Chicago and the economics profession has moved about 15 years

past the University of Chicago on the question of whether predation is or is not a real problem. And since I have referred to myself

as a premature post-Chicagoan, I take enormous satisfaction from

that fact. And I would urge you to look at the Allvine-Dixit memorandum.

So it is a question of what your opinion is about the sufficiency

of the Sherman and Clayton Act prohibitions as they have been interpreted by the Supreme Court. I think there is an enormous lag

there, and I think that we should give DOT a chance. I think their

sensitivity to the danger of interfering with good competition is

very clear.

But the way I weigh the dangers, I weigh the danger much more

on the other side because, as I pointed out, they would never move

in a situation in which competition before the entry of the entrant

was effective. They would move only in those particular situations

in which somebody took the initiative to come in, cut fares sharply.

Then, of course, they are all in favor of competition, but only as

long as it is responsive and it is not initiating.

The only other point I would make and then I promise to stop

is that I have had correspondence with Professors Winston and

Morrison on this point. Their measure which demonstrates that

predation has cost consumers virtually nothing is a measure of the

extent to which, after assertedly predatory conduct, fares move up

23

beyond the entry at which they were before the competitor came

in.

In other words, if you have entry and fares go down 50 percent,

and then you have assertedly predatory tactics and fares just go

back up to the pre-entry level, their measure would say zero cost

to consumers. I think most of us would define predation as being

successful to the extent it restores fares to the previous level. I recognize that that might be an extreme the other way.

They have also introduced a second measure, which is, well, if it

restores fares to the previous level and those fares were unusually

high, that is compared with fares elsewhere, then to the extent

that they were unusually high, we will count that as a cost to consumers.

My concern is with the pattern of pricing in the industry all

through the industry that has these very high unrestricted fares.

So, again, these measures which they identify, I think, minimize

the costs of what many of us would feel were the costs of predation.

Mr. MORRISON. May I follow up?

Senator DEWINE. Absolutely.

Mr. KAHN. As he has in writing.

Mr. MORRISON. Indeed, what we found was that, of course, while

these alleged predatory activities are going on, fares are lower, and

that when they are finished, fares go up to the level that they were

before, not higher, but that those fares before and after were some

$20 million, the number I mentioned before, on the aggregate higher than on otherwise comparable routes.

As far as the notion that predation in one market spreads to others, I suspect that is true, but there is no way that I can figure

out to measure it, so the extent of it is speculative.

Mr. KAHN. Yes. That was the other point I made in my letter to

them that one of the main bases for the post-Chicago view of predation is that engaging in this kind of tactic protects the price level

all over your network because it deters future entry. And, of

course, Professors Winston and Morrison are absolutely right.

There is no way of measuring it, but, of course, the fact that something can’t be measured doesn’t mean it doesn’t exist.

Senator DEWINE. Senator Kohl?

Senator KOHL. Thank you, Mr. Chairman.

Professor Kahn, we have heard from several start-up airlines

that they find it very difficult to compete with the established airlines at their hubs where the incumbents dominate the market.

Northwest in Minneapolis, US Air in Pittsburgh, and Delta in Atlanta are just a few examples, although there are many others.

When a new airline comes into a market, the established airline

can and oftentimes does drastically cut its fares to undersell the

entrant and can add vastly more capacity. Some airline critics and

consumer advocates call these tactics predatory and say that they

ought to be illegal under antitrust law.

Do you have a view on that, Mr. Kahn?

Mr. KAHN. Well, my view is that some of those are almost certainly predatory, sufficient even to deter a Southwest Airlines from

challenging the incumbent hub-dominating carriers.

Now, there are two reasons why Southwest stays out. Partly,

when the hubs are congested, they can’t engage in their really effiVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00027 Fmt 6633 Sfmt 6602 E:\HR\OC\B032.XXX pfrm01 PsN: B032
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cient, rapid turnaround operations. But the other reason, I know,

is that if they were to try to come into Minneapolis to remedy the

situation that you described, they would run into a buzz saw.

Now, it is generally understood in the industry that you don’t

really take on Southwest. They have a very great longevity. But it

is also understood that Southwest doesn’t go into Boston, A, for the

perfectly good reason that I have mentioned, but, B, because it is

already dominated and it would start this kind of major price war.

So, of course, they locate at Providence and Manchester, which is

great, and at Baltimore, which is again great.

I mean, they are public benefactors, there is no question about

it. But I think that even they are deterred from challenging directly—and I have heard this example—specifically in Minneapolis

because of what they know the response is likely to be.

Senator KOHL. Professor Morrison, are you concerned that these

types of tactics practiced by some of the airlines will harm consumers by driving competition out of the market or preventing

them from getting into the market in the first place? Doesn’t it

bother you?

Mr. MORRISON. Yes. My problem is what to do about it.

Senator KOHL. Well, what about this DOT authority to commence an action?

Mr. MORRISON. Well, the DOT authority, in my view, is fairly

vague, these best alternative responses, and depending on where

these data would come from, it might be 6 months after an action

that you knew whether it was legal or illegal.

As was mentioned by Senator DeWine and as everybody knows,

there is currently a Department of Justice case against American

Airlines. I know that American Airlines and its allies say that the

Justice Department wants to create new law. And I gather what

they mean by that is a different definition of cost, and time will

tell.

Senator KOHL. Well, in the case of Minneapolis, for example, if

they called in Northwest and said, you know, we are watching this

very carefully, and detailed what they are observing and how important it was, in their opinion, to keep a competitor fairly in business or not to drive them out of business unfairly, and that, you

know, while they are not going to commence an antitrust action,

they have the authority to take a careful look at this and bring to

bear some very serious consequences, don’t you think that that provides them with the ability to do what you are concerned about?

Mr. MORRISON. Yes. As I recall, they did that without these new

guidelines under Secretary Pena when Reno Air entered into their

markets. And they responded very aggressively, as I recall, with a

phone call, or maybe it was more than that, from the Secretary.

They moderated their response.

Senator KOHL. Professor Kahn, I believe that all American consumers owe you a debt of gratitude for the ground-breaking work

you have done to promote airline deregulation. Sitting here today

in 2000, I wonder how you would assess the state of airline competition today. More specifically, has deregulation brought about

lower fares and increased consumer choice, as you imagined, and

what are the biggest competitive problems that we are looking at

20 years after deregulation?

25

Mr. KAHN. I have no disagreement at all with the general conclusions of Drs. Winston and Morrison. The benefits to travelers, the

$20 billion that they estimate—you understand these estimates are

very difficult because you have to know what fares would have

been in the last 20 years and what regulatory policies would have

been adopted and changed if we hadn’t deregulated.

But I don’t even have to look at their estimates. I can look

around me and I see that last year 94 percent of all mileage was

at discount fares, and that the average discount from the, I say,

perhaps outrageous full fare is 69 percent. And I see the behavior

of carriers. There couldn’t have been more than 15 percent of all

mileage at discount fares when it was regulated, and once we gave

them freedom, they clearly competitively were pricing down. I

would say that deregulation has exceeded my timid expectations by

far.

Senator KOHL. Are there some major problems that you think

need to be addressed?

Mr. KAHN. Well, I think that, number one, clearly the infrastructure. I mean, the system that we have for providing air traffic control and airports could only have been designed by a sadist. The

pricing of access to airports, particularly at times of congestion,

and to air traffic controls systems is insane.

When we had all those delays last summer and the airlines responded, well, we schedule our flights when the travelers want to

travel—and they are absolutely right, but if you charged for paintings the way you charge for landings at airports, so much per

pound, regardless of the day of the week, regardless of the amount

of congestion, regardless of the week of the year, you would have

riots where Van Gogh paintings were for sale.

I mean, a market system would permit those rates at those airports and access to air traffic control to be much higher, and then

use those surplus revenues to subsidize use of the air traffic control

system and access to those airports off-peak or at feeder airports,

and we might get some redistribution of the traffic.

And that is what we did when I was chairman of the New York

Commission. When I came, rates on Long Island were 5 cents a kilowatt hour, morning, afternoon, evening, summer, winter, spring

and autumn. By the time I left, rates to big users, for whom alone

you could have the necessary meters, were 31⁄2 cents, 3 cents, 21⁄2

cents, and in the summer, when the temperature got above 84 degrees, 30 cents. That is sensible pricing.

So the Government is simply not following elementary economic

advice, A, in the way it finances investment in air traffic control,

the fact that it is subject to the budgetary process. There has got

to be some sort of separate corporatization where it can raise its

own capital and then can price intelligently. That is one.

The second is the international, including the one that Steven

mentioned, the prohibition of foreign ownership. I want Richard

Branson to come in here with Virgin Airlines. And the third, I

think, is this threat to independent entry of the kind of violent

competitive response that many of them can tell you they encountered, temporary violent response, when they dare to come in and

bring in competition.

26

Senator KOHL. Just to finish my questioning with that line, in

this specific case, Minneapolis-Milwaukee, Sun Country Airlines, is

clearly beneficial to consumers. Mr. La Macchia testifies that they

are going to put them out of business. He doesn’t have much longer

to go.

If he would suggest that that is what is happening, what can we

do, what should we do, either one of you?

Mr. KAHN. I have been in communication with the Department

of Transportation trying to see if we could devise a test that would

not be, I think, as impossible to administer, for the reasons that

Professor Morrison has mentioned. Was there a more profitable

course that they have abandoned, and in abandoning it, they have

taken losses; that is, they are pursuing a less profitable course

than otherwise. That is an acid test of predation, and I find it extraordinarily difficult to do so.

I find myself attracted, as other economists have been, to the notion that if an incumbent carrier responds in this way, with sharp

reductions in rates and increasing in the offer of discount seats and

capacity, and the entrant is driven out, then the incumbent should

be required to stay there to retain those offerings for something

like 2 years. That would be a real test of whether they really

thought that they were taking the most profitable course or whether they were designedly taking losses which could be explained

only in the expectation of succeeding in predation.

Senator KOHL. Ok. Mr. Morrison.

Mr. MORRISON. I agree with Professor Kahn that it is difficult.

As to the 2-year idea, it is an intriguing idea. I don’t know how

easy even that would be to enforce, what with the fare structures

the way they are with quite variable fares. I really don’t have an

answer. It is a difficult question because of the structure of airline

costs, and it will be interesting to see what the outcome of this

American Airlines case is.

Mr. KAHN. I think it is partly like pornography. I can’t define it,

but I know it when I see it. I am quoting a very distinguished predecessor.

Senator KOHL. I will just end with this observation. In a sense,

with great respect and deference to what you are saying, it is pretty basic to this hearing. What do you do in those situations where

you do have clearly, or apparently, some predatory situation that

is going to drive out a competitor we don’t want to drive out. I don’t

have an easy answer either, but that is why we are here today.

And I am somewhat troubled by your suggesting that you don’t

have any remedy that you would——

Mr. MORRISON. Well, my remedy is the Department of Justice.

Senator KOHL. Antitrust?

Mr. MORRISON. Yes.

Senator KOHL. Long, drawn-out?

Mr. MORRISON. It is better than the alternative.

Senator KOHL. By that time, somebody like Sun Country might

be long gone.

Mr. MORRISON. Might be.

Senator DEWINE. Let me ask both of you this question. One of

the advantages of the hub and spoke system is that it allows the

27

airline to serve a number of markets that would not economically

be feasible using the point-to-point system.

With the increasing use of regional jets which are cheaper and

smaller than conventional domestic jets, some of those markets

may now be able to support point-to-point service. Will regional jet

service, in your opinion, decrease the economic value of hubs? How

will that impact all that?

Mr. KAHN. My crystal ball on this is going to be much poorer

than Mr. Carty, who will follow me and who kind of instructed me

many years ago on the benefits of hub and spoke in very lucid testimony that he gave.

Certainly, the availability of regional jets is a very hopeful development. There are, I understand, major difficulties in getting the

unions to accept them, and I hope that those can be worked out because there are point-to-point markets that it appears could economically be served. That would tend to encourage the possibility

of entry and avoiding the congestion at hubs, which is another very

important consideration.

I seriously doubt that it will diminish in a major way the importance of hub and spoke. I mean, the market has told us what we

had great difficulty in predicting when we were trying to regulate,

that hub and spoke is an extraordinarily efficient way of providing

improved service. And whether or not there is a hub premium, if

you leave out Southwest from the control group or you do not, it

is a wonderful place to live in terms of convenience of service.

Senator DEWINE. Professor.

Mr. MORRISON. I agree with Professor Kahn. I think that there

are obviously markets where the regional jet can and does and will

operate, but to expect it to have a significant effect to dismantle

hubs, I don’t think is going to happen.

Senator DEWINE. Let me ask another question. Both of you have

talked about and stressed improved access to airports as an important way to increase competition. Do you want to share with us any

specific suggestions as to how to improve this access?

Mr. MORRISON. As I said, I am not an expert on this, but various

things I have read recently indicate that the Secretary of Transportation, FAA, and airport operators have authority unused at this

time that can be used to free up even gates that are under exclusive-use, long-term leases.

The passenger facility charge, PFC program, appears to be or has

the potential to be a way to increase the number of gates. An aspect of that program is that gates constructed under it cannot be

exclusive-use, long-term gates. So that is something that the evidence isn’t in yet. One can be hopeful about.

But as I said, I think there is enough on the books already if it

were utilized, taken seriously, and used aggressively to free up airports at these hubs that are where the gates are scarce.

Senator DEWINE. Professor.

Mr. KAHN. I am sorry. I don’t have anything more to add to that.

We have a very large number of assertions to that effect, and the

staff of the national research committee looked at that and felt that

there was substance to it. Clearly, it is a carryover of the method

by which airport construction was financed in the past, and that

carryover has simply got to be eliminated.

28

Senator DEWINE. We want to thank both of you very much. It

has been very helpful. Thank you for coming.

Let me invite our second panel to come up, and as you are coming up, I will introduce you.

Donald J. Carty became Chairman, President, and Chief Executive Officer of American Airlines in 1998, after having served as

President of AMR Airline Group and American Airlines since 1995.

He also serves as Chairman and interim Chief Executive of Sabre.

Robert Ferguson III has served as Chairman of the Board, President, and Chief Executive Officer of Midway Airlines since February 1997. Mr. Ferguson also sits on the board of directors of Capital Cargo International Airlines, an air freight company, and in

the past has served as CEO of Continental Airlines.

Bill La Macchia has been President and Chief Executive Officer

of Sun Country Airlines since 1998, and has been an instrumental

part of Sun Country’s success and growth into a $250 million company.

Mr. Ferguson, we will start with you. Thank you all for coming.

PANEL CONSISTING OF ROBERT FERGUSON, PRESIDENT, MIDWAY AIRLINES, RALEIGH-DURHAM, NC; DONALD J. CARTY,

CHAIRMAN AND CHIEF EXECUTIVE OFFICER, AMERICAN

AIRLINES, DALLAS, TX; AND BILL La MACCHIA, JR., PRESIDENT AND CHIEF EXECUTIVE OFFICER, SUN COUNTRY AIRLINES, MENDOTA HEIGHTS, MN

STATEMENT OF ROBERT FERGUSON

Mr. FERGUSON. Thank you very much. Mr. Chairman, Senator

Kohl, committee members, thank you for the opportunity to speak

with you today. I am the President of Midway Airlines. It is the

only airline in America named for an airport it doesn’t serve. We

are presently based in Raleigh-Durham, NC.

I have been involved in the aviation business now for some 20

years, and I think it is fair to say I have seen a number of boomand-bust cycles through the course of that period. In 1993, when

I was the President of Continental Airlines, I had the opportunity

to testify before a commission established by President Clinton,

and one fact struck me as rather remarkable.

Since 1978, at the inception of deregulation, some 119 airlines

have been started, and 117 of them had failed. That didn’t seem

like a very auspicious beginning. They failed for bankruptcies, they

failed for mergers, they failed because of bad business plans. The

chances of success in this business, in fairness, if you are a little

guy, are very small.

I would like to tell you, however, that I do think it can be done.

There are ingredients, and I guess I would like to tell you a little

bit about Midway Airlines. In our case, we believe that you can

succeed in this business by beginning with a business plan that is

not premised on skimming the cream of the major air carriers and

their established routes.

Rather, an airline needs to find a growing market, an economically vibrant city, perhaps one that is not an existing hub, and it

is located in our case in Raleigh-Durham. Challenging a major carVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00032 Fmt 6633 Sfmt 6602 E:\HR\OC\B032.XXX pfrm01 PsN: B032
29

rier directly by initiating service into their hubs on the first day

of business is not a recipe for success.

Two, the carrier must be well financed. He must have patient investors. We have had both. We appreciate it.

Three, the product being sold, airline seats, must absolutely be

priced for profitability, not market share. Many of the new entrant

carriers over the years have priced for market share and not profitability.

Four, you must place an emphasis on safety, dependability, low

fares, and hopefully, if you are lucky, financial stability. We need

a loyal workforce and, in fact, ultimately we need some support

from the Government. We need access to airports, we need access

to slots and gates. We need a fair hearing before Federal regulatory

agencies.

And, in fairness, it would be good if we had an air traffic control

system that we could fly around with. In our little case, in the

month of April, 58 percent of the delays we experienced were attributable to the air traffic control system.

Of the six elements that I have mentioned, we have tried to

apply all of them at Midway, and we have applied one additional

one. We have applied regional jets, 50-seat aircraft, allowing us to

size the capacity of our equipment for the size of the markets in

which we participate.

Raleigh-Durham was not the most auspicious place for a hub. I

will point out that American Airlines had a little experience in Raleigh-Durham. In our opinion, part of the reason they were not successful was that the average aircraft size was too large for the market. Raleigh-Durham is, after all, the 50th largest market in the

United States. I don’t believe there is another hub that is in a city

that is less than the 30th largest.

Midway’s story, like so many other start-ups, began trying to

carve a niche in Chicago. We were unsuccessful. We were unable

to compete with the dominant carriers, even though we carried the

name of the city. Unlike Chicago, Raleigh-Durham presented us

with a great opportunity, and opportunity, in fact, carved for us by

American Airlines. They built the gates, they built the infrastructure, they built the maintenance facilities.

We seek to serve our customers. We have created a unique product. We serve our customers with only technologically advanced

equipment. It is environmentally-friendly, it meets all existing

noise standards. We have some 32 aircraft with an average age of

2.3 years. Of those aircraft, 22 are regional jets. We have 17 new

737’s on order, 2 of which have been delivered.

In fact, over the course of the last 3 years, we have the highest

on-time performance in the industry, although I speak in that respect only in regard to the 10 carriers who publish their statistics

because I can’t know about the others. Our baggage statistics routinely beat the major carriers, although, as I mentioned, we are

once again too small.

We have more leg room than our typical competitors, although

I have to say Mr. Carty is about to one-up us in that respect. We

have leather seats. We think we have friendly and professional

service and, of course, we focus on safety.

30

Finally, we do offer fares that are lower than those of our major

competitors. We are, however, not a low-fare carrier. We are a

lower-fare carrier and much higher quality. After an initial period

of unprofitability, we have been profitable now for 13 consecutive

quarters, and we take some pride in that and the fact that we have

built a business plan that actually works.

The most important factor for us, however, is we are in the midst

of a growing city. Raleigh-Durham grew 24 percent last year. It is

growing at 35 percent presently. There is robust competition in Raleigh-Durham. We have Southwest Airlines and we had MetroJet.

We have American Airlines and, in fact, we have every other major

air carrier.

We have been successful and we intend to continue being successful. We have done that partly by avoiding picking fights with

the major air carriers. We avoid picking major fights with them because it is simply a fact of life in the airline industry and any industry in which there is very little margin that if you try and skim

another guy’s passengers, he is going to react strongly and aggressively.

We are beginning to feel that we are part of a hub. We are finally achieving that status. We have grown from 47 flights 4 years

ago to 236 flights a day. We would react aggressively and affirmatively. At some point in the future, we are going to have to fly into

somebody else’s hub, however. We tried it once. We flew into another carrier’s hub in a market that hadn’t been served in at least

the prior 10 years, and immediately we were matched with overlaying services.

The Government can play a role; they can be a help. Little guys

do have a difficult time. Next time we go into a hub, we will go

with a much more aggressive posture. We will serve it as completely as we can and we will be prepared to take the losses necessary to sustain those services.

The other item I would like to mention here briefly is—and I

know my time is up and I apologize for that. Air 21, when you pass

that bill, is going to be extremely helpful to small carriers like ourselves. In the case of LaGuardia, one of the major carriers withdrew two slots from us, coincidentally at about the time we started

service into one of their hubs.

In any event, we are going to operate into and out of LaGuardia

now under the security of having slots available to us, and we

thank you for that. We are also thanking you for the help you are

going to give us in DCA. At least we are going to get a chance to

compete for some slots on the same basis as the other carriers

achieved them.

I believe, in the end, the Government can play a role. The role,

however, is not the one that I heard mention of a moment ago. I

do not believe the Justice Department is the right place for this to

reside. I got a $12 million education earlier in the 1990’s. I do not

believe that the competition we see in the airline business is

against the law. I do think, however, it is fair to say it is probably

predatory.

And I was very disappointed that one of your prior witnesses

took away my final line. I don’t know whether, ‘‘I know it when I

see it’’ is basically the bottom line on predation. There are clear exVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00034 Fmt 6633 Sfmt 6602 E:\HR\OC\B032.XXX pfrm01 PsN: B032
31

amples in our business of people going out of their way to ensure

that other guys don’t succeed. I do not in any respect believe those

are against the law. I simply do not believe the laws in this country

have been set up to address our business, and that is a public policy question. It is one for you to answer.

If we are going to have a standard of predation, it is not one that

applies to the bread makers or the steel mills or the oil businesses

of the 1920’s and 1930’s. We are in a very different world and we

need to have a lot of debate before we decide.

I will make one suggestion. The Department of Transportation,

with one phone call, or perhaps a bit more, managed to get my two

slots back from the very same guy who took them away, and in

that respect I am very thankful and very appreciative of the efforts

made on our behalf.

Senator DEWINE. Mr. Ferguson, thank you very much.

[The prepared statement of Mr. Ferguson follows:]

PREPARED STATEMENT OF ROBERT FERGUSON

Mr. Chairman, Senator Kohl and Committee Members, I would like to thank you

for the opportunity to testify today. I am the President of Midway Airlines based

in Raleigh Durham, North Carolina. I have spent over 20 years in the aviation industry and have enjoyed the considerable challenges it has presented. During this

time, I have seen many cycles of boom and bust.

In 1993, as President of Continental Airlines, I testified before a Commission appointed by President Clinton and charged with examining the Aviation industry. I

was stuck by one stark fact. Following airline deregulation 119 airlines had been

started and 117 had failed. Since 1993, there have been additional bankruptcies and

failures. The chances of success in this business are small, but still some airlines

do succeed and many others will continue to try. I would like to tell you what I

think are the critical ingredients to success, describe how Midway has applied those

lessons, and finally address briefly the question of the intense competition that exists in this industry and what others might call predation.

It is my belief that in order to start—and perhaps more important, to survive—

in this industry, an airline must:

One, build a business plan that is not premised upon cream skimming the routes

of the major carriers. Rather, the airline needs to find a growing, economically vibrant city that is not an existing hub and is located in an area of unserved and underserved cities. Challenging a major carrier directly by initiating service into one

of their hubs on the first day of business is a recipe for failure.

Two, the carrier must be well financed by patient investors who understand that

they are likely to sustain significant losses before reaching profitability.

Three, the product being sold—airline seats—must be priced for profitability not

market share.

Four, the carrier must place an emphasis upon the basics: safety, dependability,

low fares, and financial stability.

Five, build a loyal workforce that enjoys the airline business, conveying confidence

and placing the customer first.

Six, obtain government support for equal access to airports, slots, gates and a fair

hearing before federal regulatory agencies.

These six elements constitute a yard stick that has been successfully applied at

Midway, but can also be used by other new entrant airlines. They are borne out

in part by recent market research conducted by Harris Interactive Inc. and reported

in the Wall Street Journal last Thursday April 27th. Mr. Chairman with your permission, I would like to submit the article for the permanent record and a copy has

been provided to you as the last page of my statement.

Midway’s story, like so many other new start ups, began with an effort to carve

out a niche in a major market, Chicago. In part due to restraints on access to gates

and to intensified competition from other airlines at Chicago’s Midway airport, the

airline moved its hub and headquarters to Raleigh Durham in early 1995.

Unlike Chicago, Raleigh Durham presented Midway with an ideal platform to relaunch itself. American Airlines had decided to withdraw from Raleigh-Durham,

leaving no dominant competitor in place. Indeed, American left an excellent infrastructure of gates, baggage handling facilities and maintenance equipment essential

32

to our making a solid beginning. Raleigh Durham, as many of you know, is one of

the fastest growing communities on the East Coast. Our target was to focus on the

business customer traveling to and from this high growth area.

To serve our customers, Midway created a product that is unique for new entrant

carriers. We use only new, technologically advanced and environmentally friendly

aircraft that exceed all existing noise standards. We are an all jet airline with 32

aircraft having an average age of 2.3 years. Midway has on order 17 new Boeing

737–700’s, two of which have already been delivered. We have the best on time performance of any airline in the U.S. over the past three years. Baggage handling,

which is frequently a source of endless complaints, is also among the best in the

U.S. Midway is too small, however, to be reported with the large incumbent airlines

and is, thus not in Department of Transportation’s (DOT) rankings. Further, we

offer leather seating with extended leg room to all of our passengers on our larger

aircraft and professional and friendly service coupled with an attention to safety.

Finally, we offer fares that are generally lower than our competitors. We are not,

however, a low fare airline; rather, we are a high quality, lower fare carrier.

After an initial start up period of unprofitability following our move to Raleigh,

we have been profitable for the last 13 quarters. This is a significant accomplishment as many other new airlines remain unprofitable. The single most important

factor in this success has been the fact that we are based in a growing city where

we have been able to build our hub without the need to challenge from the first day

of business any large incumbent carrier. Rather, we have taken the infrastructure

left by American Airlines and built a hub that has grown from 42 daily flights to

7 states in 1995 to 236 daily flights to 25 destinations in 14 states. We now have

a solid base of loyal customers who know our airline and appreciate our attention

to detail.

There is robust competition in Raleigh Durham, however, from both Southwest

Airlines and USAIR. Other major carriers, including American Airlines, are also

providing service to Raleigh Durham. Indeed, we were able to survive Southwest’s entry into Raleigh Durham market, an event that has precipitated the exit of many

other large and small carriers in other markets, because we have been able to quietly build a strong hub that serves a somewhat different passenger than Southwest.

We have consciously avoided picking fights with the major airlines by flying directly into their hubs. This strategy has avoided the bruising battles that your Committee has heard about repeatedly from new airlines, which some call predation. I

would call it the ‘‘facts of life’’ in the airline industry. It is a simple fact that no

airline, whether it is American, United, or anyone else, can be expected to allow a

new carrier to begin operating out of their hub without mounting a robust and vigorous response. Midway would do the same. Margins in this business are very small

and a few passengers each day siphoned off by another carrier mean the difference

between profitability and a loss.

At some point in the future, Midway will have to fly into some of the major carriers’ hubs. In one instance, we tried it and had to withdraw in the face of an intense competitive response. We learned valuable lessons from this experience. What

I am seeking is to build Midway into a strong, profitable competitor. When we make

our next foray into a major carrier’s hub, I will do it on the basis that I have the

financial resources and passenger base necessary to stay.

The Government does have an important role to play in this next competitive

phase. First, to succeed, Midway and other new entrants need access to slots, gates

and other airport infrastructure on the same terms as the incumbents. In the case

of landing slots (an issue Mr. Chairman that you know about in depth from your

experience with the Cleveland/London route), the recently passed Wendell Ford

Aviation Act, known as ‘‘Air 21’’, will give Midway 9 slots at LaGuardia airport,

which we currently lease from a major carrier for $1.88 million per year. We are

also now able to apply for ‘‘in perimeter’’ slots at National Airport. The avoidance

of these lease costs will be one of the most important things I can do to increase

our profitability. In the future, as airports are expanded with the new airport construction funds made available by Air 21, the government needs to ensure that some

gates are reserve for small carriers.

The Government also can play an important role in tempering the most outrageous behavior by competitors. Every airline needs help from DoT. It is critical

that DoT use its oversight role to keep the competition within bounds. I do not believe that it requires antitrust action by the Justice Department. Indeed, from my

own experience at Continental, it is very hard, if not impossible, to prove an antitrust case. What I expect is for the Department of Transportation to simply call the

incumbent carrier and make it clear that their behavior is unacceptable. In the case

of Midway, I know that DoT’s own actions had such a positive result with one of

our competitors. This does not mean re-regulation of the industry, rather I view it

33

as the carrot and stick approach. If you want our help, then stop engaging in unfair

competition against the other smaller guy. What is the standard to be applied? I

think it is imprudent to try and put it on paper. This only creates controversy, like

when DoT issued its competition guidelines. To paraphrase the Supreme Court, addressing another issue, we know unfair competition when we see it.

Mr. Chairman, I want to thank you for this opportunity and I would be happy

to answer your questions.

34

35

Senator DEWINE. Mr. Carty.

STATEMENT OF DONALD J. CARTY

Mr. CARTY. Mr. Chairman, Senator Kohl, before I begin, I have

to confess that some of the folks on my legal staff were very nervous about my agreement to testify today. So I resolved it by asking

them for a list of the pros and cons of testifying. They came up

with 100 for and 87 against. Now, I am confused; 100 to 87 was

the score of last night’s Bucks’ win over the Pacers. Did I mention

that I was rooting for the Bucks? [Laughter.]

Actually, I confess I told my staff if the Bucks win, I am testifying for sure. If they lose, I suddenly have a bad throat coming

on.

Despite years of study by economists and volumes of published

reports, competition in the airline industry is still widely misunderstood by the general public, and obviously by the popular media.

In the next couple of minutes, I am going to address two of the

most enduring myths in airline competition: first, that hub and

spoke systems are anticompetitive, and, second, that airfares are

too high because of a lack of competition. In addition, I would like

to talk briefly about the subject of predation in the airline industry.

Now, the hub and spoke system really is, as Dr. Kahn pointed

out, very efficient. It allows a carrier to offer far more frequent

service to a lot more places than could be achieved with the very

same assets flying only point to point by simply combining the traffic from various points onto each hub route.

That exhibit that I have got up there explains the concept. The

top diagram shows the linear or point-to-point service with five aircraft flying between five points in the West and five in the East.

Now, with point-to-point service, as you can see, the carrier can

only serve five routes.

In the bottom diagram, you have got an airline that is open to

hub between the eastern and the western cities. Now, using virtually the same five airplanes, the carrier can link each western

city with every eastern city and, of course, vice versa. In addition

to that, he creates service between the hub itself and each of the

other 10 cities. As a result now, the carrier offers service in essentially 35 markets, which is a seven-fold increase in the destinations

using virtually the same number of aircraft.

So I guess the question is, does the tremendous deficiency of

hubs lead to dominant airlines that are harmful to consumers.

Well, obviously, for consumers living in a spoke city, the answer is

clearly no. Because of competition between the networks of different carriers, a spoke passenger, or at least most spoke passengers, enjoy frequent, one-stop service through a hub to nearly

anywhere in the world. And in most spoke cities, passengers get to

choose from several different airlines, each serving that particular

spoke to a different hub and then on to many of the same destinations.

Now, that brings you to the question of passengers living in the

hub cities. The hub and spoke system provides non-stop service to

scores of destinations; in fact, far more service than the local population of the hub city could support without the feed traffic from

36

all those other cities. So for all the talk of the alleged evils of hubs,

what has happened is nearly every city in America wants to be one.

Now, despite the rhetoric, most hubs, and certainly American

hubs, are very competitive. There is a constant competitive pressure, and that pressure can come from four different sources. The

first is direct competition from another airline. Passengers that at

least live in our two major domestic hubs, Dallas/Ft. Worth and

Chicago, have not one, but two established hub carriers battling for

their business.

At O’Hare, United Airlines is significantly larger than American,

and Delta Airlines operates a large hub at Dallas/Ft. Worth. So

this creates substantial direct competition on many routes. And beyond the routes where there actually is competition, when there is

a second hub carrier, you have the threat of potential entry on the

routes where that carrier doesn’t yet operate.

Second, in addition to the direct competition that you can have

from major carriers, established low-fare carriers like Southwest

offer tremendous competitive pressure using alternative airports; in

the case of Dallas/Ft. Worth, Love Field, and in the case of Chicago, Midway. And those airports and that particular carrier in

this instance competes for the same hub-originating passengers

that DFW and O’Hare do.

Third, the longest established low-fare carriers are not alone.

New entrants continue to begin new service on Dallas/Ft. Worth

routes, and some have operated successfully there for a number of

years now.

And, last, because most hubs are also spokes from every other

hub, large or small, the most heavily traveled routes across the

United States really have become the battle ground on which the

competitive skills of one hub carrier are pitted against another.

Now, these sources of competition combine to challenge at least

our carrier’s every move, and this intense competitive pressure has

had the desired effect. At the same time, American tries to remain

price-competitive in our hubs and across our system. But we also

spend a lot of other money on competition. We will invest over $2

billion in ground facilities in the next several years. We have on

firm order about $6.7 billion worth of new aircraft, and in 1999

spent more than $800 million on on-board catering, more per passenger than any other major carrier in the United States. And we

have begun a $400 million program to refurbish the interiors of our

existing fleet, including the program that Bob Ferguson mentioned

to create more room throughout all our coach cabins.

Now, these aren’t the steps that you would expect of a dominant

hub monopolist. These are investments that we need to make in

product and service because we are engaged in very vigorous competition.

Now, let me turn to the topic of air fares, perhaps the most complicated and misunderstood aspect of airline competition. The various public reports of trends in air fares seem always to conflict

with one another. The industry reports declining prices and yields,

and has year after year after year. In the meantime, the media reports trumpet periodic fare increases and high business fares.

Well, who is right? Well, it turns out, as Dr. Kahn said, both are.

When adjusted for inflation, average fares have fallen almost 39

37

percent since deregulation. And while it is true that full, unrestricted fares have gone up over the last 10 years, even those fares

have increased only slightly more than the rate of inflation.

Now, what is happening is the fare structures, the difference between the lowest fare and the highest, are being stretched. The

highest fares are a little higher, but the lowest fares are much

lower. And in the end, a large majority of our customers are paying

less and traveling more, just what you would expect in a healthy,

competitive industry.

I will turn now to a few comments about predation in the airline

industry, and I have to point out that this subject is somewhat sensitive because, as Senator DeWine observed, we are currently engaged in litigation with the Government, and I might add a host

of private claimants as a result of that Government claim, over allegations of predatory conduct at our DFW hub. Accordingly, my

comments are going to be limited to a very few general observations.

Most importantly, American Airlines is an outstanding airline,

and quite frankly I cannot imagine why anyone would ever want

to fly on any other airline if you can get there on American. Nevertheless, there are some people who still seem to want to fly on a

variety of other airlines, and competition is very brisk.

In that context, I would like to address some assertions of predation at DFW which I find particularly difficult to fathom because

DFW may represent the single most competitive hub in America.

It has two major carriers, American and Delta, both operating hubs

there, and we battle it out everyday. The Nation’s most profitable

airline, Southwest, is in its backyard at Love Field, along with

Continental, and I might add start-up carrier Legend Airlines. And

DFW has no slots, no limits on gates, no other facility constraints

that would be a barrier to new entry.

Not surprisingly, Dallas/Ft. Worth has attracted start-up carriers

over the years. Some who entered this competitive environment

tried to serve DFW with various combinations of point-to-point, single low-fare strategies, infrequent service, few on-board amenities,

no frequent flyer programs, and/or small networks that were unable to sustain profitable service. Other start-ups, as in the case of

carriers like Bob Ferguson referred to, have found better business

strategies and have successfully operated DFW routes for years.

And Dallas/Ft. Worth continues to attract new entry even today.

I think it would turn the antitrust laws completely on their head

to interpret them to limit the kind of price and service competition

that we have got in a market like DFW. Virtually all airlines

match low prices that are launched by their competitors. We didn’t

undercut competitive prices at DFW, nor did we ever pursue a

strategy to operate a route at prices below our variable costs,

which, as several people have testified, is the well accepted measure of predatory pricing under the law of the United States.

In some cases, we did add seats to a route if we thought additional capacity was needed because of the increased demand that

was stimulated by lower fares. That just makes good business

sense. We are a formidable competitor. We strive to provide our

customers the service they want at a reasonable price, and we invest tremendous resources to improve our ability to serve our cusVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00041 Fmt 6633 Sfmt 6602 E:\HR\OC\B032.XXX pfrm01 PsN: B032
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tomers today and win more customers tomorrow. That, in our view,

is what competition really is all about.

Senator DEWINE. Mr. Carty, thank you very much.

[The prepared statement of Mr. Carty follows:]

PREPARED STATEMENT OF DONALD J. CARTY

I would like to thank Chairman DeWine, Ranking Member Kohl and the other

members of the Committee for inviting me here today. Despite years of study by

economists and volumes of published reports, competition in the airline industry is

still widely misunderstood by the general public and the popular media. This level

of misunderstanding is one of the primary reasons I greatly appreciate the opportunity to speak with you today.

In the next few minutes, I will address two of the most enduring myths in airline

competition: First, that hub and spoke systems are anticompetitive, and second that

airfares are too high because of a lack of competition. In addition, I will talk briefly

about the subject of predation in the airline industry.

One of the most dramatic results of deregulation has been the formation of hub

and spoke route networks. Started in the United States, the hub and spoke system

is now the most common model for successful aviation operations world-wide—and

with good reason. A hub and spoke system is very efficient. It enables a carrier to

serve many routes with frequent flights by combining traffic from various points

onto each hub route.

The exhibit I have brought today explains the concept. The top diagram shows

linear or point-to-point service with five aircraft flying between five points in the

west and five in the east. With point-to-point service, the carrier can serve only five

routes. In the bottom diagram, the airline has opened a hub between the eastern

and western cities. Now, using the same five aircraft, the carrier can link each western city with every eastern city and vice versa, plus create service between the hub

itself and each city. As a result, the carrier can now offer a total of 35 routes—25

between the eastern and western cities and 10 more between each city and the hub.

This result—35 routes as opposed to 5—is a seven-fold increase in destinations

using the same number of airplanes.

In addition to their efficiency, hubs also permit service to much smaller communities than linear service could ever support. Suppose in our example that Western

City Number 1 had only 10 passengers for each departing flight bound for Eastern

City Number 1. That would never be enough to support daily nonstop service. But

when combined with other passengers originating in Western City Number 1, bound

for each of the other eastern cities, plus the hub, the route becomes commercially

viable.

This ability to concentrate traffic at a hub that is bound for different destinations

allows a hub and spoke carrier to serve each spoke city with greater frequency than

could be achieved without the combination of passengers from the other spoke

points.

Thus, a hub and spoke system affords tremendous efficiency. It allows more frequent service to more places than could be achieved with the same assets flying only

point-to-point. But does it lead to dominant airlines that are harmful to consumers?

To consumers living in a spoke city, the answer is clearly no. Because of competition between the networks of different carriers, spoke passengers enjoy frequent,

one-stop service through a hub to nearly anywhere in the world. In most spoke cities, passengers can choose from several different airlines each serving the spoke to

a different, competing hub and then on to many of the same destinations. For example, a passenger in Columbus, Ohio flying to Los Angeles can travel with a single

connection on Southwest through Nashville, on America West through Phoenix, on

Northwest through Memphis, on TWA through St. Louis, on United through Chicago or Denver, or on American through Chicago or Dallas/Ft. Worth. The Official

Airline Guide shows dozens of daily flights via several hubs for this route.

For passengers living in hub cities, the hub and spoke system provides frequent

service, numerous nonstop destinations and vigorous competition. For all the talk

about the alleged evils of hubs, nearly every city in America would love to be one.

Hub-originating passengers enjoy non-stop service to scores of destinations—far

more service in terms of both frequency and destinations than the local population

could support without the ‘‘feed’’ traffic from other cities.

Despite the rhetoric, most hubs, and certainly American’s hubs, are very competitive. There is constant competitive pressure from four sources. The first is direct

competition from another major airline. Passengers living in American’s two largest

hubs, Dallas/Ft. Worth and Chicago, have not one, but two established hub carriers

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battling for their business. At O’Hare, United Air Lines is significantly larger in

scope and scale than American—a fact we are working very hard to change. Delta

Air Lines operates a hub at Dallas/Ft. Worth—a hub where Delta enplanes more

passengers than Northwest at its Memphis hub, Continental at its Cleveland hub

or Southwest at its hub in Phoenix. And Delta has promised to expand its presence

at DFW in its recently announced growth plan. This creates substantial direct competition on many routes and the threat of potential entry on the rest.

In addition to direct competition from other major carriers, well-established low

fare carriers like Southwest offer tremendous competitive pressure using alternative

airports like Love Field and Midway to compete for hub originating passengers at

DFW and O’Hare.

The long-established low fare carriers are not alone. New entrants continue to

begin new service on Dallas/Ft. Worth routes, and some have operated successfully

for several years.

Last, because most hubs are served as spokes from every other hub, large or

small, the most heavily traveled routes across the U.S. are the battlegrounds on

which the competitive skills of one hub carrier are pitted against another.

These sources of competition combine to challenge American Airlines’ every move

and this intense competitive pressure has had the desired effect. At the same time

American tries to remain price competitive in our hubs and across our system, we

will also invest over $2 billion in ground facilities improvements in the next several

years—including more than $500 million in the near term at DFW alone. We have on firm order about $6.7 billion worth of new aircraft, in 1999 spent more than $800

million for onboard catering—more per passenger than any other major carrier, and have begun a $400 million program to refurbish the interiors of our existing fleet,

including our program to remove two rows of seats from every aircraft to create

more room throughout our coach cabins. These are not the steps one would expect

of a dominant hub monopolist. These are investments in product and service made

by a company engaged in vigorous competition.

Let me now turn to the topic of airfares—perhaps the most complicated and misunderstood aspect of airline competition. For years, the fact that on any given route,

most carriers charge the same fares has been misunderstood as evidence of collusion. Nothing could be more wrong. The reason fares are often the same is that passengers have taught us that they shop for air transportation based on price. That

fact, coupled with computer systems that allow the whole world to see every available fare, means that we can and must match most fares to ensure that we do not

lose passengers. The fares are the same for the same reason you often see identical

gasoline prices between gas stations on the same corner. Our passengers will rarely

pay more for American than for United, Delta, Continental or any other airline. So

if we want to keep our customers flying on us, we have to meet the market price.

What about the reports of ever increasing airfares? The various public reports of

trends in airfares seem always to conflict with one another. The industry reports

declining prices and yields, while media reports trumpet periodic fare increases and

high business fares. Who is right? Well, it turns out both are. When adjusted for

inflation, average fares have fallen almost 39 percent since deregulation according

to Air Transport Association statistics. However, while it is true that full, unrestricted fares have gone up in recent years, over the last ten years even those fares

have increased only slightly faster than inflation. What is happening is that the fare

structures—the difference between the lowest fare available on a route, and the

highest—are being stretched. The highest fares are a little higher, but the lowest

fares are much lower. Most importantly, the number of people enjoying deeply discounted fares has soared while the number of those buying the full fares has decreased to less than 7 percent of all tickets sold. In the end, a large majority of our

customers are paying less and traveling more—just what you would expect in a

healthy, competitive industry.

As the fare structure gets stretched, the art and science of revenue management

becomes more important. Offering the right number of seats at various price points

in this range of fares is one of the most complex challenges to successful commercial

operations. The key is to achieve an optimum ‘‘mix’’ of high fare passengers and low

fare, typically leisure passengers. Often in this industry, start up airline managers

are tempted to try to sell every seat at one low fare for simplicity. Because of the

low variable costs in the airline industry, they cover short-term costs and appear

to be making money. However, the revenue generated from those fares must not

only cover short run variable costs, but must eventually, over the long term, cover

the much higher long-run fixed costs of operations as well—a business reality that

is often miscalculated by start up carriers.

A single fixed price would not be good news for travelers or airlines. If airlines

sold all of their seats at a single price and that price was high enough to cover variVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00043 Fmt 6633 Sfmt 6621 E:\HR\OC\B032.XXX pfrm01 PsN: B032
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able and long term fixed costs, that average price would be higher than many deep

discount fares available today. So instead, airlines use a wide variety of prices, associated with various fare restrictions to achieve a balance that offers enough flexible

fares at a higher price for business travelers, combined with many deeply discounted seats available for leisure travelers. And all of our fares are constantly reevaluated based on competition and market pressures.

The discussion of single-price efforts by start up carriers leads naturally into a

discussion of predation in the airline industry. I must point out that this subject

is very sensitive because we are currently engaged in litigation with the government

and a host of private claimants over allegations of predatory conduct at our DFW

hub. Accordingly, my comments are going to be limited to a few general observations.

First and most importantly, American Airlines is an outstanding airline that offers its customers one of the best route networks in the world, the best frequent

flyer program, terrific customer service agents at our gates, ticket counters and reservation offices, proficient, well-trained pilots, mechanics and flight attendants and

now even the most comfortable, spacious interiors in our aircraft. In short, I cannot

imagine why anyone would ever want to fly on any other airline if we can get you

there.

Nevertheless, there are some people who still seem to want to fly on a variety

of other airlines, which leads me to my second point about predation. Assertions of

predation at DFW are particularly difficult to fathom, because DFW may represent

the single most competitive hub in America. It has two major carriers operating

hubs there and battling it out every day. It has the nation’s most profitable airline,

Southwest, in its backyard at Love Field, along with continental and start up carrier

Legend Airlines. DFW has no slots, gates or other facility constraints that would

be a barrier to new entry. Not surprisingly, Dallas/Fort Worth has attracted start

up carriers over the years. Some who entered this competitive environment tried to

serve Dallas/Fort Worth with various combinations of point-to-point, single low-fare

strategies, infrequent service, few on-board amenities, no frequent flyer programs

and/or small networks and were unable to sustain profitable service. Other start ups

have found better business strategies and have successfully operated DFW routes

for years. Dallas/Fort Worth continues to attract new entry even today.

It would turn the antitrust laws completely on their head to interpret them to

limit the kind of price and service competition I have just described at DFW, rather

than to promote it. Virtually all airlines match low prices launched by their competitors. American did not undercut the competitive prices at DFW, nor did we ever

pursue a strategy to operate a route at prices below our variable costs—the wellaccepted measure of predatory pricing. In some cases we added seats to a route if

we thought additional capacity was needed because of increased demand stimulated

by lower fares. If, at the same price, more people want to fly on American Airlines

than on another airline, its because every single day our employees get up in the

morning and go to work to make exactly that happen. We are a formidable competitor because we strive to provide our customers the services they want at a reasonable price. We work hard and invest tremendous resources to improve our ability

to serve our customers today and to win over more customers tomorrow. That, in

our view, is what competition is all about.

I would like to conclude with an observation on an emerging competitive issue—

global competition. Aviation is a network business. The U.S. Government, through

its approval and endorsement of immunized alliances has created an environment

in which U.S. carriers have formed partnerships with other airlines throughout the

world.

In a world of alliances, it is particularly important for the government to foster

an atmosphere of healthy competition. That means no one alliance should be favored

or disfavored by government policy. Just as the networks of the hub and spoke carriers in the U.S. overlap and compete with one another for domestic passengers, it

is important that the international networks of the global alliances overlap and thus

spur robust competition. Accordingly, we were very pleased when Dr. Kahn agreed

to support American’s application in the China route case. As Dr. Kahn pointed out

to the Department of Transportation, it is essential that a decision in that case take

into consideration the need to balance competitive opportunities among alliances.

The Department has an opportunity to achieve this balance by awarding the available route rights to a U.S. passenger carrier in a global alliance that will compete

with the incumbent airline alliances that have held historic rights to serve China

for many years. We are hopeful that the Department will act favorably on this opportunity.

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42

AMERICAN AIRLINES,

Dallas/Fort Worth Airport, TX, June 15, 2000.

Hon. MICHAEL DEWINE,

Chairman, Senate Antitrust Subcommittee, U.S. Senate, Washington, DC.

DEAR CHAIRMAN DEWINE: On May 2, 2000, I testified at the Subcommittee’s hearing on competition in the airline industry. As part of that testimony, I responded

to your question concerning T2, the website being developed jointly by several of the

major airlines, including American. I have since learned that my answer is being

misconstrued by competitors of T2 in an attempt to mislead policymakers. T2’s competitors would like policymakers to believe that there is some kind of improper

agreement among the equity owners of T2. I am writing to you to ensure that my

answer is properly understood. I would very much appreciate it if this letter could

become a part of the official record of the hearing so that I may stop the improper

use of my earlier testimony.

At the hearing, you asked a question about exclusivity provisions in the T2 agreement. There has been an extraordinary amount of false and misleading information

spread about T2 on this point, so it is important for me to be very succinct. There

are no agreements, tacit or express, among the T2 equity holders or participants,

to make any fares available exclusively on T2. In fact, the written agreements state

precisely the opposite. Pursuant to the express terms of the equity and charter associate agreements, any carrier may make available any fare offered on T2 to any,

or every, travel agency whether online or traditional bricks and mortar.

What I said at the hearing was that there is an expectation that some fares may

appear on T2 and not on other sites. The point is that carriers are likely to independently choose to make some deeply discounted fares available on T2 and their

own airline site, but not on the other online travel agency sites. This is not because

of any illicit, exclusive agreement among the airlines, but because of simple economics. Every airline has a strong incentive to sell its service through the least costly

distribution channel. For some very deeply discounted fares, a low-cost distribution

mechanism may be an essential means of preserving a thin margin above variable

costs.

The market-leading structure of T2 is expected to operate at lower distribution

costs for every airline that uses it to sell air transportation services—lower than any

other online travel agency site such as Travelocity or Expedia. Accordingly, every

airline will have an economic incentive to make the deepest discounted tickets available through T2 because it is the least expensive distribution channel, other than

a carrier’s own website. The attractive economics of T2 are even slightly better for

the equity holders who have the added desire to see their investment in T2 succeed.

T2 is an innovative response to the very serious problem of distribution costs for

the airline industry. For some time, the four computerized reservation systems have

operated largely free of price competition for the services they provide to the airline

industry. Accordingly, the fee paid by every airline to a CRS for each booking made

by travel agencies or over the Internet has increased at a rate of about 7 percent

every year since 1994, despite declining computing and telecommunications costs.

T2’s innovative pricing has made the first small dent of competition in this area of

airline costs. We are hopeful that T2 will afford the technological foundation for

much greater costs savings in the future. Quite frankly, it is time for the CRS owners and the largest online travel agencies to respond to the T2 challenge with new

innovation and price competition, not misinformation and aggressive lobbying.

I would be happy to provide you or your staff with additional information on this

subject, if you wish. Thank you for the opportunity to respond to the misuse of my

earlier testimony.

Sincerely,

D.J. CARTY,

Chairman, President, and CEO.

Senator DEWINE. Mr. La Macchia.

STATEMENT OF BILL La MACCHIA, JR.

Mr. LA MACCHIA. Thank you, Chairman DeWine, Senator Kohl.

Senator DEWINE. As you can tell by the bell, we have a vote that

has just started, but we will proceed with your statement.

Mr. LA MACCHIA. OK, thank you. I couldn’t tell because I didn’t

know what that was, but I am new to this. I am just a small-town

kid from Wisconsin, so bear with me.

43

Senator DEWINE. We have heard that before. [Laughter.]

Mr. LA MACCHIA. Thank you, Mr. Chairman, Senator Kohl, for

your attention to the issue of airline competition and the antitrust

concerns associated with market dominance from mega airlines.

We are a different story. We started as a charter airline in 1983.

We continue to this day to operate on behalf of tour operators, not

only that we own, but others that have utilized our service through

the years. Let me emphasize we are not in favor of re-regulation.

We are in favor of being given the opportunity to compete in a fair

and open marketplace, and provide choices for the traveling public.

The major airlines will argue that Government should not play

a role in promoting competition. Clearly, the major airlines have a

double standard. They want Government assistance when it benefits them internationally, but cry foul when new entrants and lowcost carriers ask for the same consideration to promote domestic

competition.

Today, I will argue that promoting domestic competition is necessary. Predation does occur. Northwest Airlines, the fourth largest

airline, but arguably the most predatory and anticompetitive of the

majors, is employing a variety of tactics that are questionable

under the Sherman Antitrust Act and threaten to drive us out of

the market. We are based in Minneapolis. We had options when we

bought this airline to do other things, but we felt we were committed to the community, and we knew what we were getting into

and we believe our business plan is just.

According to third quarter 1999 DOT figures, as you will see in

this chart, Northwest Airlines and its affiliates comprised 68.5 percent of the market share in the Twin Cities, their partners being

Continental, America West, and Mesaba. That doesn’t even take

into account its charter subsidiary, Champion Airlines, which is not

required to report to the Department of Transportation.

Competition is good, but it is the intent of the carrier’s aggressive action which must be called into question. We believe it is

Northwest’s intent to drive us from the market and achieve an

even greater level of monopolization.

History shows that Northwest’s strategy of predation has worked

before and, left unchecked, will probably work again. We are all

aware of what happened in 1993 when Reno Air entered the Minneapolis market to provide 3 daily non-stop trips between Reno and

Minneapolis, with connecting service to West Coast cities. Northwest then increased its service, actually announced service, as they

were not flying that market, and it added service from Reno to Los

Angeles, Seattle and San Diego.

Northwest, utilizing its tactics of perks such as frequent flyer

miles, had targeted the residents of Reno, and at the end of the day

had really called for Reno to make a business, which was to withdraw from the market. Today, a 7-day advance fare from Minneapolis to Reno is $1,026.

By driving Reno Air out of the Minneapolis market and raising

its fares, it is believed Northwest was able to recoup the investment it made in below-cost pricing. Again, this disproves conventional wisdom and contestability theories on predation.

Now, flash forward 5 years to September 1998. The Northwest

pilots go on strike and the Minneapolis-St. Paul market is held

44

hostage without sufficient choices for air transportation. We had

made a decision based on our market strategies and the manner

of the business that we were anticipating losing by not flying for

one of Northwest’s subsidiaries, MLT Vacations, and we saw an opportunity in the marketplace that that market was indeed deserving of an alternative.

Studies by the Department of Transportation and the Minnesota

Planning Commission showed that Minnesotans were paying higher than average fares compared to other cities of comparable distances, costing them an additional $500 million per year.

This graph was created by Dr. Paul Stephen Dempsey, a renowned expert on airline competition from the University of Denver. As you can see the pink line—this goes back to the first quarter of 1990, over 10 years, and the pink line with the box represents Minneapolis-St. Paul. And you will see in some cases where

there are dramatic decreases on the other markets where low-fare

competition had come into play.

As with Reno, Northwest responded vigorously to Sun Country’s

announcement when we began scheduled service on June 1, 1999.

There is a chart which shows exactly the fare decreases which complements that of Senator Kohl about the Minneapolis-Milwaukee

market, and we knew this going into it. We knew that the prices

would be matched. Our business strategy and our marketing strategy was such that we felt we were going to be able to create our

niche in the marketplace. In addition to the fare matches, there

were also those of capacity increases.

In the chart on the bottom which shows the history in markets

where we are currently flying, you will see by the jagged red line

at the top what happened when, in 1996, we had entered the Minneapolis-St. Paul market on a scheduled charter basis. Northwest

completely matched fares and increased capacity. We pulled that

down and the rates went back up. Then you will see how they operate with the thick dotted line as to the non-Sun Country markets,

non-low-cost competition.

What constitutes fair competition? Well, what a difference a few

years makes. In 1992, Northwest said the pricing behavior we just

described was unfair and even illegal, which points out another

glaring double standard by Northwest. After sustaining enormous

losses from an extended price war with American, Northwest filed

a predatory pricing lawsuit against American. Northwest said that

American was offering discounts for a greater number of passengers and incurring substantial revenue losses itself.

Northwest also alleged that American engaged in illegal anticompetitive and monopolistic activities which were intended to further eliminate competition. In fact, Northwest Chairman Gary Wilson referred to American’s then CEO, Bob Crandall. ‘‘It is not fair,

it is time that the bully in the schoolyard got punched.’’ Well, after

their unsuccessful lawsuit, a new and even more forceful bully

came into the schoolyard, that being Northwest Airlines.

In addition to its own fleet of 428 aircraft, Northwest is utilizing

its tour operator, MLT Vacations, which is 100-percent owned by

Northwest, and its charter affiliate airline, Champion Airlines,

which is owned 40 percent by Northwest. The other individual that

owns the airline is Carl Poulad, who is a major stockholder in

45

Mesaba Airlines. MLT’s reservation center has also recently introduced their air outlet center to introduce drastically discounted

fares on Sun Country routes, not only to come after us, but another

travel company in the Twin Cities.

This combination of Northwest, MLT, and Champion is so unique

in the industry it does not even show up on the radar screens of

Federal regulators. Together, MLT and Champion have been able

to aggressively compete with Sun Country without Department of

Transportation, Department of Justice, or congressional scrutiny.

This relationship is an anomaly in the industry, but a significant

competitive advantage and one that this committee should be very

focused on for possible antitrust implications.

No other major airline in the United States has Northwest’s ability to dominate a market for both scheduled and charter flights.

Northwest has used MLT to add low-fare capacity on our common

routes. They have also utilized MLT and its charter airline, Champion, to add frequency on common routes.

The Minnesota Attorney General asked the DOT to investigate

their behavior and wrote, ‘‘It is not difficult to conclude that the

use of this three-front attack by Northwest creates a climate of expanded seating, reduced prices, and scheduling conflicts designed

to push an emerging competitor out of the marketplace.’’ Northwest has recently announced service on routes that they

had not flown, which is two flights a day to New York’s JFK and

also two flights a day to San Antonio. These are the only new domestic routes announced by Northwest this year in their Minneapolis or Detroit hubs.

In cities where Sun Country has two flights a day, Milwaukee

and Detroit, Northwest has added two to three times the number

of discount seats. Clearly, it was not their benevolence which

provided—— Senator DEWINE. Mr. La Macchia, I have to interrupt you. We

are now down to 5 minutes in the vote. We only have about 5 minutes to get there, so we will have to—— Mr. LA MACCHIA. Very well. I will end at this moment.

Senator DEWINE. We will be back in approximately 15 minutes.

Thank you very much.

[The subcommittee stood in recess from 3:25 p.m. to 3:44 p.m.]

Senator DEWINE. Mr. La Macchia, you wanted to finish?

Mr. LA MACCHIA. I will just finish.

Senator DEWINE. Yes, sir, proceed.

Mr. LA MACCHIA. In a hearing before this committee on April 1,

entitled ‘‘Airline Hubs: Fair Competition or Predatory Pricing,’’

then Northwest Senior Vice President of Corporate Affairs, Richard

Hirst, had testified, ‘‘We sublease gates at Detroit and Minneapolis

to numerous of our competitors, including Southwest Airlines,

America West, and new entrants such as Vanguard and Frontier.

In addition, we provide ground handling services at Detroit, such

as Spirit and Reno Air, as well as maintenance services to our

other competitors. Frankly, it is in Northwest’s best economic interests to do so.’’ If sharing facilities and other services is in Northwest’s best economic interests and they utilize this as a statement as to how anticompetitive behavior in the fortress hubs does not exist, then why

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shortly after his testimony did Northwest cancel our agreements

for a ground handling office and ticket counter space in Boston,

preferring to leave the space vacant rather than leasing to us? And

1 month later, we received notice of the same in Los Angeles.

In June 1999, 6 days after we began scheduled service, Northwest canceled our part sharing and purchase agreement. And if it

is in their best economic interests to provide maintenance service

to competitors, why is it that we are not allowed to purchase unwanted and excess parts from their surplus parts listing which is

used by all other airlines, which is industry standard in the best

interests of this industry to provide support for other airlines, if

needed?

In order for competition to work, it must be fair. The charts that

I have here show that major airlines operate differently when they

are competing against another major airline, versus Southwest Airlines, and a new entrant. The strategy of a large, high-cost, mega

carrier is clear. They will sacrifice short-term profitability with opportunity costs in order to reestablish monopoly power. In the end,

the consumer is going to lose and pay higher fares.

Again, as part of their suit against American, John Dasburg,

CEO of Northwest Airlines, said, ‘‘In the long run, predatory pricing will reduce the number of airlines, ultimately cutting the number of flights and choices available, particularly in smaller markets.

This will leave the few surviving airlines free to price just as high

as they want to for just as long as they want.’’ We thank him for

making our point so well.

Over the last decade, major airlines have created a reputation of

predation that, left unchecked, will end the emergence of low-fare

carriers in large hub markets, and send a message to the community that if Southwest Airlines isn’t there, you don’t have competition in a low-fare category.

In conclusion, our mission today was to inform you of our situation, as it is unique. What you choose to do with this information

is entirely up to you. We have chosen to compete for the customer

and will do so and continue to do so in a fair and honorable manner.

Thank you.

[The prepared statement of Mr. La Macchia follows:]

PREPARED STATEMENT OF BILL LA MACCHIA, JR.

Thank you, Chairman DeWine, ranking member Senator Kohl, distinguished

members of this subcommittee, for your attention to the issue of airline competition

and the anti-trust concerns associated with the market dominance of mega airlines.

Let me begin by thanking Alfred Kahn, the father of deregulation, for his testimony today. Now is the time to take his efforts to the next level. To truly promote

competition, more must be done to level the playing field.

Let me emphasize: we are not in favor of re-regulation. We are in favor of being

given the opportunity to compete in a fair and open marketplace and provide choices

for the traveling public. We are against predatory behavior designed to protect monopolies and cartels.

The major airlines will argue that the government should not play a role in promoting competition and that, left alone, competition will flourish. Why is it then

that the majors continue to come before Congress and the Department of Transportation (DOT) and beg for government intervention for open skies agreements and

access to international airports? And further, why do they request antitrust exemptions for their alliances?

Clearly, the major airlines want to promote a double standard. They want government assistance when it benefits them internationally but cry foul when new enVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00050 Fmt 6633 Sfmt 6621 E:\HR\OC\B032.XXX pfrm01 PsN: B032
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trants and low cost carriers ask for the same considerations to promote domestic

competition.

For this hearing, let me also debunk conventional wisdom and contestability theory that predation is ‘‘implausible’’ and therefore, does not occur. The argument that

companies rarely engage in predatory conduct because of the prohibitive upfront

costs and the notion that the attempt by the predator to ‘‘recoup’’ the financial

losses will not be successful is proven incorrect in several instances in this testimony.

Further, the argument that the predators would not engage in this behavior because a stream of new entrants would come after the previous one driven from the

market is also incorrect, as airlines establish a dominance in their hubs and a reputation for predation that deters new entrants from coming in and competing.

For our testimony today, we will argue that promoting domestic competition is

necessary, predation does occur, and how Northwest Airlines (the fourth largest airline, but arguable the most predatory and anticompetitive of the majors) is employing a variety of tactics that are questionable under the Sherman Antitrust Act and

threaten to drive us out of the market.

NORTHWEST’S STRATEGY FOR MARKET CONTROL AND DOMINATION

According to 3rd quarter 1999 DOT figures, Northwest alone control 62 percent

of the market share in Minneapolis/St. Paul (MSP) compared to Sun Country 8 percent. With it’s alliance partners, Continental, Mesaba America West, Northwest’s

combined market dominance exceeds 70 percent. That doesn’t even take into account its charter subsidiary, Champion, which is not required to report to the DOT.

With this level of domination, why is it that Northwest continues to aggressively

attack Sun Country via fare actions, capacity increases and control of facilities?

Again, competition is good—but it is the ‘‘intent’’ of the carrier’s aggressive action

which must be called into question. We believe it is Northwest’s intent to drive us

from the market and achieve an even greater level of monopolization.

History shows that Northwest’s strategy of predation has worked before, and left

unchecked, will probably work again.

RENO AIR VS. NORTHWEST AIRLINES

Northwest’s predatory conduct against Sun Country replicates predatory conduct

by Northwest that drove a low cost competitor, Reno Air, from the MSP market in

1993.

In April 1991, Northwest canceled service between MSP and Reno, Nevada, because that route was not sufficiently profitable.

In February 1993, seeing a niche that was not being served, Reno Air announced

that it would begin three daily non-stop trips between Reno and MSP.

NWA’s new Reno service

Northwest retaliated and announced it would also begin three daily MSP/Reno

non-stop flights. In addition, Northwest said it would begin daily roundtrips from

Reno to Reno Air’s destination cities of Los Angeles, Seattle and San Diego.

NWA adds flights, perks for Reno

To further squeeze the Reno market, Northwest then announced on May 1, 1993,

it would begin a second daily flight from Reno to both Los Angeles and Seattle. In

addition, Northwest announced special ‘‘World Perks’’ (i.e. frequent flyer) bonus

miles for Reno residents in an effort to control that market.

NWA slashes fare, adds capacity

to further secure their dominance, Northwest matched Reno Air’s low fares on the

Reno/MSP route and also matched or undercut their fares on their other common

routes. In addition, Northwest offered more seats than Reno Air and provided additional seats at these low prices.

This predatory combination of reducing price and adding capacity forced Reno Air

to abandon the market.

Predation returns NWA to profits

In June 1993, after Reno Air’s withdrawal from the market, Northwest’s lowest

fare increased from $86.36 to $135.46 to $149.09. Its lowest refundable fare increased from $136.36 to $454.55. Today, a seven-day advance fare from MSP to

Reno is $1,026.

Reno Air did sue Northwest for its predatory practices in 1997. That lawsuit was

dropped when Reno Air was bought by American Airlines.

48

By driving Reno Air out of MSP and then raising its fares, Northwest was able

to recoup the investment it made in below-cost pricing. Northwest’s predation and

intent to dominate the Reno routes worked, disproving again conventional wisdom

and contestability theories on predation.

ENTER SUN COUNTRY

Flash forward now five years to September 1998, the Northwest pilots go on

strike and the MSP market is held hostage without sufficient choices for air transportation.

Studies completed by the U.S. Department of Transportation and State of Minnesota Planning Commission, showed that Minnesotans were paying higher than

average fares compared to other cities for comparable distances—costing them an

additional $500 million per year due to a lack of competition.

This graph and the other airfare comparison charts I will be showing you today

were created by Dr. Paul Stephen Dempsey, a renowned expert on airline competition and the Director of the Transportation Law program at the University of Denver. As you can clearly see, Minneapolis/St. Paul has historically the highest airfares compared to other hub cities.

Sun Country saw an opportunity to provide an affordable choice for air travel and

announced it would begin scheduled service on June 1, 1999.

NWA’S PREDATION: SAME SONG, SECOND VERSE

As with Reno, Northwest responded vigorously to Sun Country’s announcement

and promptly slashed fares. Compare the following, seven-day advance purchase

fares on flights from MSP in the summer of 1998, before Sun Country began scheduled service to summer of 1999, when Sun Country inaugurated scheduled service.

1998 1999

Northwest fares to:

Boston ..................................................................................................................................... $814 $298

New York ................................................................................................................................. 750 $298

Washington, DC ...................................................................................................................... 675 $298

Seattle ..................................................................................................................................... 628 318

Detroit ..................................................................................................................................... 634 218

Milwaukee ............................................................................................................................... 427 128

In addition to fare matches, Northwest has added capacity on routes flown by Sun

Country, including both additional flights and larger aircraft. For example:

August 1998

(per week)

August 1999

(per week)

Northwest flights to:

Anchorage ................................................. 3 planes/570 seats ........................................... 5 planes/950 seats.

Phoenix ..................................................... 5 planes/750 seats ........................................... 6 planes/940 seats.

The public has benefited since Sun Country entered the market. Consumers are

expected to save an average of $120 million in the first year of our scheduled service.

NWA’S DOUBLE STANDARD

Now, you may ask, what is fair competition? What a difference a few years makes.

In their 1992 lawsuit against American, Northwest contended that this type of pricing behavior was unfair and even illegal, which points out another glaring double

standard by Northwest.

In 1992, after sustaining enormous losses from an extended price war with American Airlines, Northwest filed a predatory pricing lawsuit contending that American

had dropped fares to drive them out of business.

Northwest said that American was ‘‘offering discounts for a far greater number

of passengers and incurring substantial revenue losses to itself.’’ Northwest also alleged that American engaged in ‘‘illegal, anticompetitive and monopolistic activities’’

which were ‘‘intended to further its goal of eliminating competition.’’

Northwest Chairman Gary Wilson also implied that American Airlines was trying

to ground Northwest with below-cost pricing. Referring to American’s CEO Bob

Crandall, Wilson said, ‘‘It’s not fair . . . It’s time the bully in the schoolyard got

punched.’’

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After their unsuccessful lawsuit, a new and even more forceful bully came into

the schoolyard . . . Northwest Airlines.

ENFORCEMENT OF THE SHERMAN ANTITRUST ACT

While Northwest may have been unsuccessful in suing American, in current there

does exist remedy for this anticompetitive behavior.

The Sherman Act outlaws all contracts, combinations, and conspiracies that unreasonably restrain interstate trade. This includes agreements among competitors

to fix prices, rig bids and allocate customers. The Sherman Act also makes it a

crime to monopolize any part of interstate commerce.

Under the Sherman Act, an unlawful monopoly exists when only one firm provides a product or service, and it has become the only supplier not because its product or service is superior to others, but by suppressing competition with anticompetitive conduct.

Joel Klein, Assistant Attorney General for the U.S. Department of Justice’s (DOJ)

antitrust division appeared before the Senate Judiciary Committee on March 22,

2000.

Klein said that, under the Sherman Act, DOJ had identified predatory pricing and

monopolization practices by American Airlines.

On March 22, 2000, Klein testified:

[First let me say a few words about our pending case against American Airlines under section 2 of the Sherman Act for monopolizing airline passenger

service on routes emanating from its hub at Dallas/Ft. Worth International Airport. As the complaint we filed sets forth in detail, American repeatedly sought

to drive small, start-up airlines out of DFW by saturating their routes with additional flights and cut-rate fares. After it succeeded in driving out the new entrant, American would re-establish high fares and reduce service. Passenger

traffic surged when the low-cost airline began operations and more people could

afford to fly, and then fell back dramatically after American had driven out the

upstart and resumed monopoly pricing. American knew this strategy was a

money-loser in the short term, but expected to make that up by preserving its

ability to set fares at monopoly levels.

American, like anyone else in our capitalist economy, is free to compete, and

compete aggressively. But it crossed a fundamental line into predation. This is

the first predation case brought against an airline by the Antitrust Division

since the industry was deregulated in 1979. I think it will be tremendously important for our traveling public throughout the country, who deserve the lower

fares and expanded choices available in a competitive airline marketplace.]

As with the recent government break-up of AT&T and the proposed break-up of

Microsoft, the federal government has the authority and responsibility to break up

other monopolies. The major airlines, each monopoly in their fortress hubs but collectively a giant cartel, may be the next target for such action.

Examine how Northwest uses a wholly-owned tour operator, charter airline affiliate and discount ‘‘Air Outlet Center’’ to create a mini-monopoly and control the

Minneapolis/St. Paul market.

NWA MARKET DOMINANCE AND MONOPOLIZATION

MLT Vacations (100 percent NWA owned); Champion Airlines (40 percent NWA

owned); and Air Outlet Center (a division of MLT’s Reservation Center).

In addition to its own fleet of 428 aircraft, Northwest is also using its tour operator MLT Vacations (100 percent owned by Northwest) and its charter-affiliate airline, Champion Airlines (40 percent owned by Northwest) to go after Sun Country.

MLT’s reservation center has also recently introduced their ‘‘Air Outlet Center’’ to

drastically discount fares on Sun Country routes.

Let me first explain: the combination of Northwest, MLT and Champion is so

unique in the industry that it does not even show up on the radar screen of federal

regulators. Together, MLT and Champion have been able to aggressively compete

with Sun Country, without DOT, DOJ or Congressional scrutiny.

This relationship is an anomaly in the industry but a significant competitive advantage and one that this committee should be most interested in for possible Sherman antitrust implications.

No other major airline in the United States has Northwest’s ability to dominate

a market for both scheduled and charter flights.

Northwest has used MLT to add low-fare capacity on Sun Country common

routes. Compare their service before and after we began scheduled service.

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August 1998 August 1999

Northwest/MLT to:

Las Vegas ................................................. 680 seats .......................................................... 920 seats.

Los Angeles .............................................. 1,650 seats ....................................................... 2,170 seats.

Orlando ..................................................... 560 seats .......................................................... 1,030 seats.

Northwest has used MLT and it’s charter airline Champion to add frequency on

common routes with Sun Country. Compare before and after we announced scheduled service.

Summer 1998 Summer 1999

Northwest’s MLT/Champion to:

MSP/Las Vegas ......................................... 2x/week since 1985 .......................................... Daily.

MSP/Orlando ............................................. 2x/week since 1985 .......................................... Daily.

What is surprising is that many of these increases are on routes that Northwest

was already experiencing its lowest operating profits. MLT’s own employees have

questioned why Northwest is asking them to do this.

History has shown, as with Reno Air, that Northwest is willing to suffer slim margins and even losses in the short-term to drive a competitor from the market and

recoup profits later by restoring the routes to higher fares.

Left unchecked, this predatory behavior will again drive competition from the

MSP market. You’ll recall from an earlier chart that the cost of air travel in MSP

is among the highest for consumers. Why? Because of the dominance and control

of Northwest Airlines.

The Minnesota Attorney General has asked the DOT to investigate Northwest’s

behavior and wrote, ‘‘It is not difficult to conclude that the use of a three-front attack by Northwest (through Champion, MLT and its own carriers) creates a climate

of expanded seating, reduced prices, and scheduling conflicts designed to push an

emerging competitor out of this marketplace.’’

NEW NWA ROUTES VS. SUN COUNTRY

Northwest has recently employed a new, more aggressive strategy of going after

Sun Country on routes they were not serving and Sun Country had a niche. In

March, Northwest announced new twice daily nonstop service to New York-JFK and

new nonstop service to San Antonio.

We have to question why—after all the years of careful market analysis—would

Northwest suddenly decide to begin new service to those routes. Again, it is important to question their ‘‘intent.’’

Did Northwest see a market opportunity because Sun Country had expanded the

market on these routes? Or, do they want to establish control of the route, drive

Sun Country away, and then raise fares when competition no longer exists? As

you’ll recall, a similar thing happened when Northwest went after Reno Air’s other

destination cities.

ADDED CAPACITY WHERE SUN COUNTRY HAS MORE FREQUENCY

Northwest has also acted very aggressively in key markets where Sun Country

has frequency.

In the markets where Sun Country has two flights per day, Milwaukee and Detroit, Northwest has added 2.5 to 3 times the number of discount seats that Sun

Country has. Northwest has also added 2.5 to 3 times the number of discount seats

that Sun Country has to Boston, where it previously had no other competition.

This aggressive, predatory behavior is of grave concern to us.

As every airline knows, the best assurance of profitability is to add frequency to

your routes and attract more frequent or business travelers. If Northwest acts in

this kind of predatory manner for every route that Sun Country has more than one

flight per day, Sun Country may not be able to build a profitable hub.

SHERMAN ACT: SUPPRESSING COMPETITION BY ANTICOMPETITIVE CONDUCT

Beyond pricing, the Sherman Act also says that an unlawful monopoly exists

when one supplier is able to suppress competition with anticompetitive conduct.

While the mega carriers will say they do not engage in anticompetitive behavior in

their fortress hubs, this is another example of saying one thing and doing another.

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In a hearing before this committee on April 1, 1998, entitled ‘‘Airline Hubs: Fair

Competition or Predatory Pricing?’’ Northwest’s Senior Vice President of Corporate

Affairs, Richard B. Hirst, testified:

[On a related point, unfounded claims have been made that major network

carriers engage in anticompetitive practices to preserve their dominant position

at hub airports. These charges are wholly without merit. Detroit, for instance,

is a facility constrained airport and all airlines are similarly constrained in

their growth, most significantly Northwest. Nonetheless, we sublease gates at

Detroit and Minneapolis to numerous of our competitors, including Southwest

Airlines and America West and new entrants such as Vanguard and Frontier.

(Northwest Deck, page 62) In addition, we provide ground handling services to

competitors at Detroit such as Spirit Airlines and Reno Air, as well as maintenance services to other competitors. (Northwest Deck, page 62) Frankly, it is in

Northwest’s best economic interest to do so.]

If sharing gates, facilities and other services is in Northwest’s best economic interest, why then, shortly after Mr. Hirst’s testimony, did Northwest do the following?

In October 1998, Northwest canceled our agreements for groundhandling, office

and ticket counter space in Boston, preferring to leave the space vacant rather than

lease to Sun Country. One month later, they did the same in Los Angeles.

In June 1999, six days after we began scheduled service, Northwest canceled our

part sharing agreement and posted a large sign in Detroit saying ‘‘no parts to Sun

Country.’’

If it is Northwest’s best economic interest to provide maintenance services to competitors, why is it that Northwest even refuses to sell Sun Country its unwanted

and excess parts from their surplus parts listing service, which is used by all other

airlines?

With regard to gates, Sun Country has repeatedly asked Northwest to sublease

us gates at the Main passenger terminal. Repeatedly, they ignored or refused our

request.

VARYING DEGREES OF COMPETITION

Let us reiterate: competition is a good thing. But in order for competition to work,

it must be fair. Our concern, and the concern of other new entrants and low-cost

carriers is the severity of competing methods employed by mega carriers against low

cost carriers.

Compare the fare histories of the following charts and see the differing degrees

of how a major competes with a major; major competes with Southwest; and a major

competes with a new entrant.

FAIR AND EQUAL ACCESS TO COMPETITION

The strategy of the large high-cost mega carriers is clear. They will sacrifice

short-term profitability in order to re-establish monopoly power in the market place.

In the end, the consumer . . . your constituents . . . lose and pay higher fares.

Again, as part of their suit against American, John Dasburg, CEO of Northwest

Airlines said, ‘‘In the long run, predatory pricing will reduce the number of airlines,

ultimately cutting the number of flights and choices available, particularly in smaller markets. This will leave the few surviving airlines free to price just as high as

they want for just as long as they want.’’

We thank him for making our point so well.

While the mega carriers can shift their vast resources to cover routes where they

are being extra-competitive and operating at or below costs, the new entrant cannot.

We need prompt action by the DOT and DOJ to take action against the predatory

behaviors I’ve outlined today.

Beyond that, if new entrants and low-cost carriers are to survive we need:

Fair and Equal Access to Airport Facilities. The major carrier in the market, who

dominates that hub, should not be allowed to dictate policy and bully the airport

commissions and local governing bodies into submission—thereby, squelching competition. New entrants, who are able to bring value to the community should have

access to gates and facilities.

Fair and Equal Access to the Most Profitable Routes. Particularly, we need open

access to slot-controlled airports, where the major airlines have a lock on the airports and refuse to allow new competition in. This is an areas where Congress has

provided some relief through the FAA Reauthorization bill, but more must be done

to open up these markets.

We are not asking for special treatment, we are only asking you for the same

things that the major airlines ask you for in opening up international skies and airVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00055 Fmt 6633 Sfmt 6621 E:\HR\OC\B032.XXX pfrm01 PsN: B032
52

ports: for fair and open access. When you are considering their requests, we only

ask that you hold them to the same standard to promote domestic competition.

Thank you.

Senator DEWINE. Mr. La Macchia, thank you very much. Mr.

Ferguson has stated that he expects a competitor to react if somebody invades his hub, and therefore will not enter a hub unless he

has the financial resources to handle that reaction. That was at

least a summary of what he had to say. Is that the right way to

approach a competitor’s hub, in your opinion?

Mr. LA MACCHIA. Well, we were already there. We have been

based in Minneapolis since our beginning, and it is just as much,

we feel, our hub and our operation as it is anyone else’s.

Senator DEWINE. How about a general question, though? My

question was general.

Mr. LA MACCHIA. We look at the opportunity and our balance of

our marketing approach is that there was an opportunity to utilize

our aircraft. And there were individuals who did not have the ability to fly, and we recognized that and we feel we are providing that

benefit to customers and we are providing individuals a choice and

we are ensuring that there is competition. Ultimately, at the end

of the day it is up to the customer to make that choice, but we have

a very good product.

Senator DEWINE. Mr. Carty, in your testimony you note that despite the complaints about hub service, cities seem to want to host

airline hubs in their airports. However, based on some press reports at least, a few mid-size cities such as Kansas City, Jacksonville, and Indianapolis appear to think they are better off maybe

without hubs because of the broad range of competition they have

been able to attract to their airports.

Is this type of reaction common, and what do you think is its significance?

Mr. CARTY. Well, I think it is less than common. I have been approached by at least two of those three cities in the last 10 years

urging exactly the opposite. So I guess my instinct is to question

the sincerity of it. The fact of the matter is cities that are hubs get

a lot more non-stop flights to more destinations than any other city

of comparable size.

Senator DEWINE. There is, as you have already pointed out in

your testimony, quite a tradeoff, though. I mean, there is a tradeoff. That is the good news.

Mr. CARTY. Well, if you are a spoke, you get all the advantages

of being a spoke.

Senator DEWINE. I understand.

Mr. CARTY. But as I said in my testimony, every hub is also a

spoke, so every hub is the winner of deregulation. They get to be

a spoke to every other hub, so they have got that same competition

for one-stop service everywhere in the world. In addition to that,

they have the premium product of non-stop service to almost everywhere in the world with high frequency. So they are the true winners.

There are very few people and very few cities that I am aware

of that wouldn’t prefer their cities to be hubs. The reason the hub

cities have done so well in terms of economic development is they

are a magnet for business and business growth.

53

Senator DEWINE. Mr. Carty, I do not question what you are saying, but I can take you to some cities and show you a lot of consumers who would vehemently disagree with what you are saying.

And I am not going to get into specifics today, but we could cite

some hubs and we could give you some examples on pricing, and

I think you know what I mean. So I don’t think it is quite as clearcut as you have outlined.

I understand what you are saying, and I think most cities by and

large historically have said, sure, they would like to be a hub. I

also think that once you get beyond some of the business leadership in the community, you will find other consumers who will say,

my Lord, why am I paying so much to fly there? And when they

look into it, they find out why they are paying that much to fly

there because there isn’t any competition.

Mr. CARTY. Well, you know, again I would say to you that the

evidence is not at all clear to me. I know the average consumer in

Dallas/Ft. Worth has the availability of these same highly discounted seats that Dr. Kahn referred to on more flights to more

places than any other community in the world.

He also has a full-fare ticket that is, as Dr. Kahn represented,

more fully priced. The very limited number of people that are paying full-fare ticket—and I think Dr. Kahn cited a number of 7 percent—are paying very much what they paid prior to deregulation.

But the average fare in all markets across the United States is

down literally almost 40 percent.

Now, would consumers like more service and even lower fares?

Of course, they would. That is true in almost every product in the

United States today. But the transparency of pricing in our business for the last 20 years has been like no other business in the

world. The rest of the businesses in the world are starting to see

it with Internet, but we have essentially had the transparency of

fare information in our business for 20 years that most other businesses are beginning to see.

Senator DEWINE. Mr. Carty, I don’t question what you are saying. My only point is a very simple point, and I think you are candidly maybe overreacting to what I am saying. I want to make sure

you understand what I am saying. All I am saying is that there are

pros and cons to being a hub. That is all. There is good and bad,

and as you pointed out, most people think that the good outweighs

the bad. But we can take you to some communities where the pricing structure is pretty rough if you live in a hub city.

American has recently announced that it will be a part of a joint

venture with Continental, Northwest, United, and Delta to create

an Internet reservation site called T2. This joint venture purportedly will include a large number of other carriers, and has raised

some concerns among competing reservation services.

There are contradictory reports about how exactly this is going

to work, so I would like maybe if you could take a moment to briefly explain what T2 will do. Specifically, will it be an exclusive system that does not allow the participants to post their fare information on other reservation services?

Mr. CARTY. T2 is a business concept that involves, as you say,

providing an Internet access capability to as much of the industry’s

fare and schedule information as we can possibly attract to the

54

site. It was originally started by the other carriers. We were recently invited to become an equity holder in that company and accepted that invitation. We had not been invited before because we

were a very large holder in a competing reservation system,

Travelocity, that is owned by Sabre.

I think what you are seeing with the advent of the Internet is

airlines and other travel providers trying to put their product in

every conceivable Internet shelf that is developed, whether it is

Microsoft’s Expedia, whether it is Travelocity, whether it is their

own airline sites, or whether it is this combined site or the hundreds of others, the priceline.coms, and so on.

It is envisaged by this particular site that some offerings will be

made on this site that won’t be made on other sites, at least by the

equity owners of the airlines. That is not necessarily true of other

airlines. It is sort of up to them, just as it is also true today that

we offer and other airlines offer on their own sites some offerings

that aren’t offered on the broader travel agency sites.

I think the reason for this development, Senator, is the concern

by the airlines and other travel providers that a very small number

of so-called electronic travel agents, Travelocity and Microsoft’s

Expedia in particular, were in danger of completely dominating

this space, to the detriment of the travel providers themselves. So

I think this is one of the strategies that the airlines have used in

response to that.

Senator DEWINE. Mr. Ferguson, in your testimony you seem willing to rely upon the Department of Transportation to put pressure

on incumbent carriers to basically just behave themselves. Some

would argue that the Department does that now without much success. Let me just ask you if you agree with that, and if so, what

else should the Department of Transportation be doing?

Mr. FERGUSON. The reason I find that the proper venue is be- cause I had a little education, to the tune of $12 million and David

Boyce’s representation—and he has been representing the Government recently—on sort of what the antitrust laws are in the United

States. And I don’t believe the competition offered by Mr. Carty, or

frankly the other major airlines, generally fits in the category of

predatory. I do think there are instances in which behavior appears

predatory, and certainly looks that way.

I do think from time to time the Department has stepped in. I

think there are some clear examples of that. I think they have done

that on our behalf. I think the efforts in rules that were passed

some years ago were an attempt. In all honesty, I am not sure that

we have a position as a public policy matter about where we want

to get to that lets the Department, whether it be Justice or Transportation, take a real position.

I mean, it is not that fares in the industry are too high. They

are not. If they were too high, we would all make money, and we

don’t; we make a little bit. I think the question that needs to be

answered is the disparity, the widening that Mr. Carty has described. Is that unfair? And if it is, then we need a policy that espouses some way to make that close.

But I don’t think the rules that were authored in the 1930’s, I

guess it was, are going to address that problem in our business. I

just don’t think that is the place to look, and so I think you have

55

to look to the Department. I think they have tried to do a good job.

I don’t think they have always been perfect, but they have tried.

Senator DEWINE. Senator Kohl.

Senator KOHL. Mr. La Macchia, in that route, Minneapolis to

Milwaukee, what are the two or three most egregious things that

they have done to hurt you?

Mr. LA MACCHIA. Well, one issue is because of the fact that we

are in the same area for gates. We have asked the airport to step

up and get involved because they were literally blocking the area

for our aircraft to come in. We had shared the bag room and there

were contentious relationships with their baggage handlers and the

group that we had utilized.

Clearly, they have opened the inventory and the bucket of lower

priced seats in that route that were never there before. It used to

cost $600, as it says there, in order to continue to provide them

with, well, you can get the same price by flying on us.

And, lastly, I would say in that route our job is to take care of

the customers, and it is interesting to note that in situations where

the other airline may have canceled a flight or were delayed or

what have you, most airlines have agreements for passenger protection. There have been days when they would—in fact, they have

never walked their customers down to us and have said, here is an

option. That is their choice, and the customer’s. But yet it goes to

another standpoint when they tell a customer, no, there are no

other flights, Sun Country’s flight has already left, when, in fact,

it hasn’t. So it is really up to the customer’s issue.

Senator KOHL. These are the most egregious things they have

done?

Mr. LA MACCHIA. Well, it is like the bully in a schoolyard. I can

go on and on. There are issues where when we have to move a part

on an aircraft, it mistakenly or seemingly gets lost.

Senator KOHL. Let me just stop there. What would you have the

Government do about these things?

Mr. LA MACCHIA. Well, it is not just that route, but there are

issues in other routes; for example, the squeezing of travel agents

to apply pressure in order to ensure that they are not losing market share and forcing the agents to operate at a certain increased

level of market share, which is a distribution arm.

From our perspective, we have solutions. We are not coming here

saying we need you to protect us. We are saying we have these

facts of how difficult it is to compete in some of these markets.

Some of the solutions that we have put into place—I agree with Alfred Kahn’s issue of ensuring that the other airline stays in the

market with the prices and the inventory levels for a few number

of years.

I also believe that we should put the onus on the other airlines

to explain and prove that their actions did not remove the new entrant from a marketplace. Everybody looks at us saying prove it.

Well, you know, no one has put the onus on the other airlines and

said, all right, be accountable for these actions.

We talk about limiting the impact and the squeezing of the travel agents. It is also the issue of other assets and resources that are

available, and I think it is important that we review the relationships and partnerships of the airlines, not only with the technology

56

arm, but also now performing a relationship with purchasing and

buying of parts and sharing of that. We will be applying to have

entry into T2. We will see if we are denied.

We also believe that a solution is to hold airports accountable

and make them show how they have spent money, and does it benefit the community or does it benefit a certain airport. And, lastly,

maybe we need to come up with a better term than ‘‘predatory.’’ I

think that is a term that everybody is so hung up on. We have

talked about, well, you know it when you see it, but from our perspective it is about the people.

My father and I entered into the Minneapolis market because we

had a belief in a strategy. Can we move our assets elsewhere? Yes,

we can, but we believe—— Senator KOHL. How long have you been in that market?

Mr. LA MACCHIA. Milwaukee-Minneapolis we initiated a year

ago.

Senator KOHL. How many flights do you have a week?

Mr. LA MACCHIA. Well, we have two flights a day. Last fall, we

initiated connecting service from Milwaukee to Minneapolis which

would then connect to Seattle, San Francisco, and Los Angeles.

Senator KOHL. You have been doing it for how long, a year?

Mr. LA MACCHIA. A year, and we are continuing to see our

loads—— Senator KOHL. But you are continuing those flights from Milwaukee to Minneapolis?

Mr. LA MACCHIA. Pardon me?

Senator KOHL. Those flights continue to operate twice a day?

Mr. LA MACCHIA. Yes, they do, and we recognize that that route,

Minneapolis to Milwaukee, would not be successful down the road

if we do not ensure that there is connecting traffic to broaden that

base of business. We do the same out of Detroit.

My father and I continue to invest in the organization. We are

not profitable. We have a strategy in place that we think we can

be profitable. The scheduled service of our business is not the only

part of our business. We still operate on behalf of the tour operators which allows that balance.

Senator KOHL. Mr. Carty, you have been listening to a little guy

talk about his business and some of the problems he has competing

with some of the big guys. What would you say to Mr. La Macchia?

Mr. CARTY. Well, Senator, listening to both Mr. La Macchia and

Mr. Ferguson, and the previous testimony, I guess the question is

where are the impediments to competition and how can we remove

them, on the one hand. I think the gate issue is a very interesting

issue.

I am not experienced in most of my route network in a shortage

of gates, but I have seen reports in markets that are not as much

interesting to me where there are gate shortages. The one market

where I am experiencing gate shortages is Los Angeles. You can’t

get gates in Los Angeles. I think the financing of gates which the

expanded PFC’s will allow us to do should begin to alleviate that

issue.

I might add that the FAA already has power to force a local airport to take underutilized gates and allocate them to carriers that

want them, as opposed to those that aren’t using them properly.

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That power exists and that should happen. And, in fact, if that

process is taking too long—and it may take too long; there are very

few examples of it being tested—then it needs to be accelerated.

I am a great believer in getting rid of those impediments. I think

we ought to get rid of those impediments. I think we have made

some real progress on the slots. We are obviously not finished. We

have still got slots left in the country, but we have made some

progress. I think the air traffic control issues that Dr. Kahn referred to are critical. In fact, the removal of slots is going to aggravate them and the air traffic control problem in the short term. We

need to fix that.

But in terms of the antitrust laws themselves, I think we really

do need to be very careful with them. I don’t disagree with the conclusion that laws that were written in the 1930’s for steel companies may or may not be appropriate to today’s marketplace, but I

don’t think that is a unique phenomenon to the airline business.

When there is a price war on the corner of a street where there

are two gas stations, does the guy that matched, if the other guy

goes out of business, have to keep his gas price at $.90 for 2 years

afterwards? The answer is no. When MCI undercuts AT&T in the

long-distance market and AT&T matches them, when AT&T finds

that their lines are ringing busy because they don’t have enough

capacity and adds capacity, isn’t that really very much a parallel

to what we are talking about here in the airline business?

So I think there is a valid question of whether it is time we revisit as a country our antitrust laws. I think we ought to be very

careful of treating the airlines uniquely. This is a business like

every other business; in fact, as Bob Ferguson pointed out, substantially less profitable than most other business. Our price earning

multiple in the airline business is in sort of the single-digit range

for most of us.

And this wonderful public beneficiary that we refer to as Southwest Airlines is the only guy that has got a 20 multiple and, in

fact, is returning more to his shareholders than any of us. So, you

know, he is also a beneficiary of his shareholders. I just think we

need to be very careful as we massage these antitrust laws that we

don’t invent solutions for airlines that are sort of quick-fix answers

without thinking through the implications for our total economy.

Senator KOHL. OK.

Mr. CARTY. But I would support revisitation of those antitrust

laws.

Senator KOHL. Mr. Ferguson, do you have something to say to

Mr. La Macchia?

Mr. FERGUSON. I guess the only thing I would have to say to him

is I wish him extremely good luck, and if he is going to make the

service survive, he is going to have to do it premised on connecting

passengers. I don’t believe you can win a point-to-point war with

a major air carrier in a straight-out fight.

I don’t know how wealthy Mr. La Macchia and his family are, but the carrier they are fighting is probably worth $5 billion, $10

billion, I don’t know. If they apply that capital, he cannot win. So,

you know, he is going to have to do it by carrying people connecting

through that network, but that is a business recommendation. I am

not sure I see sort of how else you win that fight.

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Senator KOHL. And neither one of you, Mr. Carty or Mr. Ferguson, have any quarrel with one strategy that Northwest employs,

which is to price that flight between those two cities really low? I

mean, you don’t have a quarrel with that in terms of a business

practice that is accepted in combatting competitors in this country?

Mr. CARTY. Again, I think that is the kind of business practice

you would expect to see in any business. When you have got a

product that is closer to a commodity than we would like it to be,

if you don’t match price, particularly with the transparency of pricing that I referred to a moment ago where everybody knows what

everybody charges, you are just not going to have any business.

So if you have got a lot of loyal passengers in a market—and I

know nothing about the Minneapolis-St. Paul to Milwaukee market, to be perfectly honest with you—you are either going to lose

those passengers to price or you are going to match the price. It

is as simple as that. And if you match the price and the price is

significantly lower than the price that has been in the market, you

are going to genuinely generate new demand.

And if you want to accommodate that demand, if you want to accommodate your loyal passenger, you have got to have enough capacity so that when he phones up and says, I want to go to Milwaukee, you have got a seat for him. So on that pure piece of it,

I think that is not unique to the airline business. You know, the

analogy with the communications companies is obvious. The analogy to almost every business—whether you are a gas station, a car

manufacturer, a grocery store, or a communications company, I

think that strategy would be common.

Now, the courts have defined a standard of predation, one that

at least Dr. Kahn is uncomfortable with, and that is if you price

below your variable cost, maybe we are in the situation where the

person is clearly engaged in predation. But when you start redefining average variable cost to include things like opportunity cost,

what you are saying to a company is you must optimize profits in

the short term. Don’t worry about your customers in the long term,

don’t worry about your business plan in the long term, don’t worry

about what happens in the long term. You have to deploy your assets and price them more to maximize profit tomorrow. If you don’t,

you are predator. That is not a standard that is going to hold up

in very many industries in the United States. And I don’t mean to

suggest anybody here suggested it, but it is a very difficult question. Very few companies manage for the short term.

Senator KOHL. But you would also concede, would you not, that

there is a public policy question here just in terms of that route

that if you don’t have a competitor like Sun Country, again, just

business being what it is, and if they are the only carrier, Northwest is likely to be charging consumers a lot more than they would

like to be charged?

Mr. CARTY. That tends to be the nature of business. I would

agree.

Senator KOHL. So there are other considerations here—— Mr. CARTY. I would agree.

Senator KOHL [continuing]. That we weigh when we consider

what you are saying and we consider his situation.

Mr. CARTY. I would agree with that.

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Senator KOHL. Thank you.

Senator DEWINE. Senator Kohl, thank you very much.

I have a statement from Senator Grassley that I will make a part

of the record at this point.

[The prepared statement of Senator Grassley follows:]

PREPARED STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S. SENATOR FROM THE

STATE OF IOWA

Good afternoon, Mr. Chairman. I commend you for calling another in your series

of hearings on the important subject of airline competition. You and Senator Kohl

have shown leadership in bringing to light many of the problems surrounding true

airline competition. The traveling public owes you a debt of thanks and a vote of

confidence for your efforts.

You have assembled two very distinguished panels this afternoon. Everyone is familiar with Dr. Alfred Kahn and his pioneering work on the deregulation of the airline industry. We all look forward to his comments on where we are now, and if

this is the actual point that he expected the airline industry to be at this time. Similarly, we look forward to the comments of his colleague, Dr. Morrison, from Northeastern University.

I am also pleased to join you in welcoming Donald Carty, the Chairman, President, and CEO of American Airlines and AMR Corporation. Mr. Carty, I would like

to personally thank you and your staff for the help that you provided me during

the debate on AIR–21. This is truly a landmark piece of legislation that will hopefully benefit states like Iowa which lack a major hub airport. I know that increasing

competition was our joint goal as we worked together to phase-out the antiquated

slot-control system at Chicago’s O’Hare and New York’s LaGuardia and Kennedy

airports. Your support of the phase-out, with its help for turbo-prop and regional

jet aircraft, is key to helping several smaller communities in Iowa. You have been

very sensitive to our needs.

Welcome also to Robert Ferguson, Chairman, President and CEO of Midway Airlines, and to Bill La Macchia, President and CEO of Sun Country Airlines. I am

aware of your concerns about competition and look forward to what you have to say.

We are currently blessed with the longest peace-time economic expansion in the

history of our great country. Access to economical, reliable air service is key for communities to be able to participate equally and fully in this economic boom. Trustworthy air service at economical fares is essential if businesses are to enter the national and international marketplace. If good service and fares are not available at

their current business location, some businesses move to cities that can provide

them. This is unfair to underserved communities.

AIR–21 seeks to bring about more airline competition. As a conferee, I successfully fought for a phase-out of the out-dated slot-control system. Why? Because I

fear that an abrupt end to the slot system would only benefit large hub airports,

to the exclusion of medium, small and non-hub airports. This would in turn, further

skew an already skewed competition system. Looking at airline ads in the newspaper, large airport to large airport traffic already enjoy many favorable schedule

and low airfare advantages. But just try to fly out of Sioux City or other Iowa regional airports and see how much you have to pay and how difficult it is to reach

some locations.

The phase-out of the slot rule favors turbo-prop and regional jet aircraft that will

serve small and non-hub airports.

Air–21 also provides much-needed funds for necessary infrastructure improvements at all levels of airports. These funds will help build new runways, taxiways,

aprons, ramps, additional gates and terminals. This will help to ease congestion and

allow airlines to either begin new service or expand existing service to reach more

places and increase competition.

Also, there are new programs to directly assist small communities. One of the

most important is a pilot project that allows small communities to apply for up to

$500,000 in direct financial assistance to attract or improve new commercial air

service. There is also a regional jet purchase loan program that will be closely followed.

Importantly, Section 155 of AIR–21 found that ‘‘15 large hub airports today are

each dominated by one air carrier, with each such carrier controlling more than 50

percent of the traffic at the hub.’’ It further states, ‘‘the General Accounting Office

has found that such levels of concentration lead to higher airfares.’’ Section 155 requires that these airports submit a written competition plan to the Secretary of

Transportation before they can increase their passenger facility charge.

60

The competition plan is required to include the following information: availability

of airport gates and related facilities, leasing and sub-leasing arrangements, gateuse requirements, patterns of air service, gate-assignment policy, financial constraints, and other pertinent data.

This is a very important provision that neither the airlines nor the affected airports should take lightly.

I have not talked about AIR–21 to say that the Congress has done its job with

regard to airline competition and it is time to move on to other issues. To the contrary, we still have a job to do. We have made a good first step. That is why I comment you, Mr. Chairman, for holding this hearing. We must continue to send a message to the airline industry that there is still work to do to bring about increased

competition and that we are watching. The traveling public expects no less. It will

take time for some of the provisions of AIR–21 to fully mature and have their effects

felt and understood. But in the interim, we must not relax our vigilance on airline

competition. Oversight is the name of the game.

Senator DEWINE. Let me thank our witnesses from this panel

and the previous panel for their testimony today. I think this hearing was very helpful in bringing us up to date on a wide variety

of competition issues affecting the aviation industry.

As I mentioned earlier, the aviation industry is a very complex

and difficult industry to analyze. It is very important that we continue to hear from the experts, both those who study aviation and

the industry and those who work in the industry.

For our part, this subcommittee will continue to promote competition for large and small airlines alike. We will closely monitor

developments in the next few months, with particular focus on the

Justice Department litigation against American Airlines and any

enforcement policy decisions made by the Department of Transportation.

This is an important time for the industry, and it is important

that we take the right steps to promote competition. Today’s testimony will help us do that, and I look forward to continuing to work

with Senator Kohl, the other members of this subcommittee, the

enforcement agencies, representatives of the industry, and the experts to ensure that consumers have the full benefits of vigorous

competition in this industry.

I want to thank again this panel and our previous panel, an exceptional group of witnesses. Your testimony has been very helpful.

Thank you very much.

[Whereupon, at 4:11 p.m., the subcommittee was adjourned.]

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A P P E N D I X

ADDITIONAL SUBMISSIONS FOR THE RECORD

PREPARED STATEMENT OF EDWARD P. FABERMAN, ON BEHALF OF AIR CARRIER

ASSOCIATION OF AMERICA

DEAR CHAIRMAN DEWINE AND SENATOR KOHL: On behalf of travelers and communities from throughout the country, we thank you for again holding a hearing to review airline competition. As we move into the new millennium, 20 years since deregulation, we face a system in which: • hub concentration is increasing (In some markets, the largest hub carrier has

85 to 90 percent market share. This is unheard of in any other industry.); • there are fewer air carriers than at any time since deregulation; • consolidation continues; • larger carriers continue to expand their international alliances and partnerships

providing them with additional resources; • more new entrants have stopped operations or filed for bankruptcy than have

started service; • barriers to entry still exist; and • anti-competitive behavior continues.

We have just passed the second anniversary since the Department issued draft

anti-competitive guidelines. Although some carriers act as if there are no limits on

actions they can take to attack new entrant competitors (they don’t take similar actions in response to large carriers or even Southwest), the guidelines have not yet

been finalized.

When Secretary Slater announced his intention to issue guidelines he stated: ‘‘Our

responsibility at the Department of Transportation is to ensure that every airline— large or small, new or established—has the opportunity compete freely. That is what

deregulation is supposed to be all about—a fair chance to compete.’’ When the Department issued the ‘‘Proposed Guidelines on Unfair Competitive

Practices in the Airline Industry,’’ the Secretary stated:

The purpose of deregulation was to make the airline industry competitive and

make air travel affordable. But competition only works if it exists.

There is growing concern that major carriers are willing to lose money—lots

of it—in the short run to drive off competition.

This policy is not intended to ensure the success of any start-up carrier, but

rather to ensure a level playing field. Consumers deserve a pro-competitive

standard that helps ensure affordable airfares and accessible service. To provide

a level playing field, we must preserve vigorous competition and prohibit unfair

exclusionary practices meant solely to eliminate that competition.

Our common goal is to expand the pie, to provide opportunity for all, and prepare the aviation industry for the challenges of the 21st century.

While some smaller carriers have been able to grow and compete, pressures continue. Midway Airlines, one of the carriers represented at your hearing, is an example of how one carrier has survived without offering low-cost service or competing

directly with large carriers. After Midway went through bankruptcy and moved to

Raleigh Durham where it took over American’s facilities, it signed a marketing

agreement with American. It apparently has decided that it will not compete on

American’s routes. It does not operate to Miami or Dallas—markets served by American. Even more surprisingly, it does not operate to Chicago, where it started. American operates to Chicago, Miami and Dallas from Raleigh Durham. Midway has

been able to survive in part because it has avoided serving some of the most congested hubs and was able to serve the critical markets of LaGuardia and National

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1 Another successful new carrier—Midwest Express—also has obtained high density slots.

Would Midwest Express still be in existence if it didn’t obtain access to National and

LaGuardia?

because American provided slots to them.1 Under deregulation, each carrier should

be able to serve the markets it elects to enter and at the fares it wants to charge.

Nevertheless those carriers that elect to take a different approach than Midway and

service a concentrated large hub airport, competing directly with a major carrier,

should be able to take that approach and not face predatory behavior.

As to the approach that large carriers take to combat competition and their views

of the competitive environment, I refer you to the following comments.

Former American Airlines Chairman and Chief Executive Officer Robert Crandall,

speaking at a November 1997 National Press Club luncheon, made comments that

demonstrate the need for the very action he denounced. He stated:

Unfortunately, the byproducts of our cost control efforts have all too often

been long and bitter labor disputes and customers upset by things like smaller

seats, fewer closets and reduced food service.

Losing a small percentage of the people on each plane to a startup will take

away the profit of any airline. We want to keep all those passengers. Any airline that sustains losses for the purpose of damaging competitors is not going

to stay around very long. That is not to say an airline won’t cut fares or lose

money for awhile to defend market share at an airport where it cannot afford

to lose. When somebody challenges us in a market where we must prevail, we

will compete. If that competition costs us money, we are prepared to do it. [Airline Financial News, November 17, 1997, p. 3.]

The following statement by Gordon Bethune, President and CEO of Continental

Airlines, best summarizes what large carriers will do to force competitors out of

markets:

Last year, because we [Continental] were able to offer better discounts than

United for Newark to San Francisco and Newark to Los Angeles, and because

we were able to offer those discounts to the people in Boston, United put in a

four jet operation, four times a day from Boston to Newark. We said, ‘‘Boston

to Newark?’’

‘‘What the heck’s United coming in for—we ran USAir out of there some years

ago.’’ So we put four flights between L.A. and San Francisco. Get that? You do

that stuff to us, we do that stuff to you. Now they’re [United] down to one flight

and I think we’ll pull out.

When you have 20 percent of the market [Continental and Northwest combined], United will say, ‘‘You know what, between those two guys they might

put 100 flights into L.A. Screwing with one might be the same as screwing with

the other.’’ Now, as a joined-at-the-hip partner with Northwest, you better

watch out if we do get upset. We have a lot of different ways that we can pay

you back. [Business Travel News, February 23, 1998.]

The following article from the May 1998 issue of Air Transport World describes

the type of actions taken by large carriers:

In testimony before Congress last fall, Reno Air VP/General Counsel Bob

Rowen said that when Reno entered the Detroit-Reno city-pair with nonstop

service, Northwest, which did not offer a nonstop in the market, inaugurated

its own nonstops and flooded the route with capacity. ‘‘A market that Reno entered with fewer than 4,000 seats per month soon had over 24,000 seats per

month,’’ said Rowen. Northwest also offered nonstop fares that were lower than

its previous one-stop fares, he said. Rowen alleged that Northwest was guilty

of predatory pricing in another instance. When Detroit-based start-up Spirit

Airlines entered the Detroit-Boston market, a market heavily served by NWA,

‘‘Northwest dropped its fares by over 50%.’’

Major airlines are unapologetic about these actions. ‘‘The imperative to defend

. . . core markets means that when challenged, we will compete aggressively

with whoever challenges us,’’ says Crandall. [Bob Crandall, former CEO of

American Airlines.] Matching fares and boosting capacity in the face of a challenge are ‘‘only natural,’’ since ‘‘every consumer’s first concern is price,’’ while

adding service ‘‘enhance[s] the quality of its product offering.’’

It is clear that some large carrier continue to engage in actions to discourage competition. The following statement from a Hoover Institute essay, ‘‘A Fair Fight’’ explains the likely motive behind this behavior:

In the late 1970’s and early ’80s, the dominant view among economists was

that so-called predatory pricing—pricing below your firm’s own costs with the

purpose of driving your competitors out of business—was not a profitable stratVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00066 Fmt 6601 Sfmt 6621 E:\HR\OC\B032.XXX pfrm01 PsN: B032
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egy. The reason was simple: If you price below cost, you lose money. And if you

win market share from your competitors, you lose even more money.

For predatory pricing to be worthwhile, the ‘‘predator’’ must more than make

up such losses by charging a higher price once all its competitors drop out. But

there’s a problem: Once the predator raises prices above what they were when

competitors were present, other firms will be tempted to enter the market.

Some resourceful competitor might even buy the assets of the ‘‘victim’’ at firesale prices.

American judges who are asked to rule on antitrust matters have, by and

large, agreed with this economic reasoning. But in the past 10 years or so, some

economists, particularly those who employ game theory, have revived the idea

of predatory pricing. They argue that if the predator can convince his prey (i.e.,

potential entrants) that he’s serious—or ‘‘committed’’—he can deter entry after

he raises his price. Who, after all, wants to be the next sucker to lose his shirt?

[David R. Henderson, Viewpoints, Stanford University.]

To demonstrate the significant advantages held by the nation’s largest carriers,

I have attached a number of charts that highlight advantages held by those carriers

and the status of a new entry. As new entrants are driven out of markets and fares

increase, the impacts are enormous:

Business travelers have been forced in recent years to bear the brunt of higher fares in markets where network carriers aren’t exposed to low-fare competition, and business fares continue to rise. [Department of Transportation ‘‘Competition in the U.S. Domestic Airline Industry: The Need for a Policy to Prevent

Unfair Practices’’, July, 1998.]

In describing the impact of predatory behavior, in its comments to the Department’s proposed Policy, the National Business Travel Association stated:

Characteristically, corporations bear a disproportionate financial burden for

air travel by their employees when contrasted to the amount that leisure travelers pay for their airline tickets. Often business travel fares are four times as

much as leisure fares because of the price of the airline ticket and the accompanying federal passenger taxes.

To a great extent, we have arrived at the current dilemma because the Departments have not acted. They have allowed the situation to drift, with no enforcement or clearly defined rules of the game spelling out for airlines and consumers alike what acceptable competitive behavior is under deregulation. The

Departments have not defined what constitutes predatory pricing or unfair competitive practices and have not, until recently, shown much inclination to act

on those practices.

The need to move forward was emphasized by an editorial in Business Week (Airlines Should Reform Themselves,’’ February 16, 1998.):

Consider some recent trends: Price-gouging of business customers. Virtual

monopolies on certain routes. Neglect of small markets. Now, Washington is on

the case, with the Transportation Department and Congress mulling some

moves.

Of all the reforms being contemplated, Transportation’s is the most worthwhile. Defining predatory behavior and setting up a mechanism by which airlines can be monitored and complaints promptly adjudicated would go a long

way toward countering the most flagrant anticompetitive acts—like when

Northwest Airlines Inc. pulled out all the stops in 1993 to outsell Reno Air Inc.’s

new route between Reno and Detroit, going so far as to establish a mini-hub

in Reno, a city it had never before served.

On some business routes, the big airlines have stopped competing on price.

At some airports, they have a lock on slots. The upshot: New competitors can’t

even get to the gate, and underserved markets remain so.

Total deregulation is fully supported by small carriers. For a competitive air system to survive, we must have a level playing field and open markets. It is essential

for this Committee to urge the Departments of Transportation and Justice to ensure

the future of airline competition. Without it, business will be impaired and travelers

will not be able to visit friends, relatives, take vacations and important business

trips. Deregulation should not only exist in certain markets and for certain carriers.

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1 64 Fed. Reg. 54483, 54489, October 6, 1999.

2 Id. at 54487. 3 United also operates the Web-site for the nine-carrier Star Alliance at www.star-alliance.com.

AMERICAN SOCIETY OF TRAVEL AGENTS,

Alexandria, VA, May 2, 2000.

Hon. MIKE DEWINE,

Chair, Senate Subcommittee on Antitrust, Business Rights and Competition, Dirksen

Senate Office Building, Washington, DC.

DEAR SENATOR DEWINE: The American Society of Travel Agents (ASTA) applauds

your efforts to continue monitoring competition in the aviation industry. As a proponent of airline deregulation and an advocate of the traveling consumer, ASTA is

deeply concerned with the rising tide of consumer dissatisfaction with air transportation which reflects a lack of effective industry competition.

Although there are many complex issues facing the airline industry today, ASTA

submits for the hearing record on Airline Competition the attached filing with the

Department of Justice (DOJ) on the proposed operation of a joint airline web site.

Our filing requests the DOJ to investigate and undertake enforcement action with

respect to the stated plan of the major United States and foreign airlines to create

a joint Internet Web-site to monopolize the provision of retail travel services on the

Internet and, ultimately, in all markets. Most recently, American Airlines joined the

site as the fifth equity owner. No other industry of which ASTA is aware has attempted such a frontal assault on the competitive process.

ASTA encourages the Subcommittee to closely follow the developments of this web

site as it reviews all the current aspects of competition in the aviation industry.

Sincerely,

PAUL M. RUDEN,

Senior Vice President, Legal & Industry Affairs.

Attachment.

AMERICAN SOCIETY OF TRAVEL AGENTS,

Alexandria, VA, February 16, 2000.

Hon. JOEL I. KLEIN,

Assistant Attorney General, Antitrust Division, Department of Justice, Washington,

DC.

DEAR MR. KLEIN: The American Society of Travel Agents, Inc. (‘‘ASTA’’) respectfully requests the Department of Justice to investigate and undertake enforcement

action with respect to the stated plan of the major United States and foreign airlines to create a joint Internet Web-site to monopolize the provision of retail travel

services on the Internet and, ultimately, in all markets.

The agreements of which we complain, will, in the words of the recently, published Draft Antitrust Guidelines for Collaborations Among Competitors,1

‘‘involve agreements on price, output or other competitively significant variables, or on the use of competitively significant assets, such as an extensive distribution network, that can result in anticompetitive harm. Such agreements

can create or increase market power or facilitate its exercise by limiting independent decision making; by combining in the collaboration, or in certain participants, control over competitively significant assets or decisions about competitively significant variables that otherwise would be controlled independently; or by combining financial interests in ways that undermine incentives to

compete independently.’’

Whatever limited efficiency-enhancing integration of activity may be plausibly

claimed for the joint Web-site cannot overcome the fact that all such benefits can

be achieved ‘‘through practical, significantly less restrictive means.’’ Consequently,

these agreements are not ‘‘reasonably necessary,’’ as defined in the Guidelines, to

achieve any procompetitive benefits.2 For example, United Airlines, the largest of

the partners in this venture, has created a new company to continue operating its

own Web-site, www.ual.com, which already offers booking services for over 500 airlines, 45 car rental firms, and 30,000 hotels worldwide.3 The joint Web-site will add

nothing that cannot be achieved through independent action by these giant corporations.

We believe that the proposed arrangements must inevitably lead to price fixing

and on their face involve a concerted refusal to deal with travel agencies, both per

se violations of the antitrust laws. For example, United owns 17 percent of Galileo,

the Computer Reservation System, and is funding $5 million in advertising and promotion for a new Galileo Web-site that will undercut existing commission rates paid

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4 ‘‘Pirates, Snoops, Monopolists: Why the Net Needs Some Cops,’’ Robert Kuttner, Business

Week, February 21, 2000, at 24. 5 Joint Press Release of United, Delta, Northwest and Continental, November 9, 1999.

6 Id.

7 Attributed to Ben Burnett, Vice President of Boston Consulting Group, a firm retained to

act as ‘‘temporary launch manager.’’ ‘‘Nearly Two Dozen Airlines Will Join Planned Web Site

of Four Big Carriers,’’ Susan Carey, Wall Street Journal, February, 2000.

to online travel agencies to induce listing of fares that also undercut the prices that

United provides to those agencies for resale to the public. The new joint Web-site

appears to contemplate similar arrangements from which travel agents will be excluded. How can the airlines make joint claims for what this Web-site will offer

without exchanging and committing to future price understandings and policies?

The desire to make this partnership, involving a huge segment of the airline industry’s assets, a success at its stated goals will undermine incentives to compete vigorously and heighten the already pronounced tendency of the airlines to copy each

other in almost everything they do.

In practical effect, the United States airline industry has begun to operate as a

single enterprise, of which the joint Web-site is just the most recent manifestation.

A graphic illustration of the extraordinary network of commercial relationships that

have developed between the domestic carriers (and many of their foreign counterparts), involving most of the major industry assets devoted to the production and

sale of domestic and foreign air transportation, is set out in Attachment A to this

letter. It is doubtful that any industry in this country, or the world, exhibits such

incestuous interconnectedness among firms that are supposed to be full-fledged competitors.

While there are still some signs of competitive life left in the industry, the opportunities for their long-term survival are quickly diminishing. If the Department of

Justice does not intervene immediately to stop the unification of the competitive assets and the destruction of the competitive spirit of this industry, it may be too late

to do so later when the damage caused by these amalgamations is more obvious.

We leave this introduction with this non-legal but insightful commentary:

A century-old principle of antitrust is that when the same company controls

both content and the carriage of content, anticompetitive abuses arise. The gate

keeper (such as a railroad) can overcharge users, keep out competitors, and

frustrate technological advance. This led the government to insist that companies must choose between being common carriers or providers of content. You

could be railroad or shipper that uses railroads, not both, and as railroad you

had to treat shippers equally. You could control the TV network, but not the

production companies. If you were the phone company, you had to connect all

calls.

The Internet has different technologies, but similar economies principles.

There is the same temptation to combine and dominate, less to achieve economies of scale than to achieve market power . . . Far from being scrapped, antitrust policy needs to be brought into the Internet Age.4

BACKGROUND

On November 9, 1999, four major airlines, United, Delta, Northwest and Continental, together representing more than 45 percent of the passengers carried in domestic air transportation (more than 11,482, daily flights), announced a ‘‘partnership’’ to operate a ‘‘multi-airline travel portal’’ that was self-proclaimed to ‘‘offer the

most comprehensive selection of online airfares and other travel information available anywhere on the World Wide Web,’’ a site ‘‘superior to all travel sites,’’ a site

with ‘‘the best of everything.’’ 5

It is important to understand the significance in this claim of the phrase ‘‘online

airfares.’’ This does not refer merely to the publication on the Internet of otherwise

generally available airfares. It refers instead to the publication of fares not available

anywhere but the Internet, and thus leads to the additional claim that ‘‘for the first

time, online travel consumers will be able to compare and purchase the Internet

fares offered by several airlines . . . by visiting just one site.’’ 6 ‘‘It would support

our business model if they supplied special Internet-only capacity.’’ 7

This, then, is the real goal of this venture: to combine in one retail location owned

and controlled by the airlines the Internet-only fares offered to consumers and not

available for sale by the independent travel agency community whose members are,

in every other respect, the full and unqualified agents for these airlines for the retail sale of air transportation. The joint announcement makes clear, moreover, that

this new joint site is not in lieu of the individual Web-sites provided by the particiVerDate 11-MAY-2000 04:31 Sep 08, 2001 Jkt 073032 PO 00000 Frm 00077 Fmt 6601 Sfmt 6621 E:\HR\OC\B032.XXX pfrm01 PsN: B032
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8 Id. 9Those same airlines are parties to a proposal to assign common identified numbers to corporate clients so that, among other things, airline alliances can ‘‘track corporate business across

several airlines.’’ See Application for Approval of Agreements by the International Air Transport

Association, Docket OST–99–6694–1, filed December 21, 1999. 10See http://biz.yahoo.com/prnews/000203/ma_gomez_o_l.html. 11 Id. 12Traditional travel agencies are declining in number in the face of the combined onslaught

of reduced commissions (50% in four years) and numerous other marketing practices calculated

to raise agency costs and impair their competitive flexibility. See ASTA’s Complaint in ‘‘In the

Matter of American Society of Travel Agents, Inc.’’, Docket OST–99–6410, U.S. Department of

Transportation.

pating carriers—those will continue to operate and will continue to offer Internetonly fares also.8

The joint announcement refers also to ‘‘unique travel packages’’ that will be offered through ‘‘combined product offerings of our [non-airline] partners.’’ Predictably, and in keeping with the airline industry’s history of advance announcements to their competitors of business intentions, additional airlines have

stated their plans to join the pack, yielding a total, to date, of 27 airlines, including

American and US Airways. These new airlines are called ‘‘Charter Associates,’’ but

the exact nature of their relationship to the four ‘‘founders’’ has never been made

clear. The added participation of the new US airlines brings the combined market

share of the partners to more than 68 percent of domestic passenger traffic. The

other participants include some smaller U.S. airlines plus Air Canada (the monopoly

route carrier in Canada), Alitalia, KLM Royal Dutch Airlines and other major foreign carriers. Press reports indicate that other participants are expected.

The latest press report is that many of the participating European carriers are

now discussing a joint Web-site of their own, involving virtually all of the principal

U.S.-Europe foreign airlines (including Air France, British Airways, Lufthansa, Iberia, Swissair, and Sabena. Air France has stated that its marketing alliance will

also have a joint Web-site. Most of these carriers have marketing alliances and/or

code-share agreements with the partners in the US carrier Web-site. How long will

it be before these sites are merged? 9

Any hopes that anyone had that the Internet would remain a vigorous and open

competitive marketplace are about to be dashed on the rocks of consolidated market

power in the hands of a few industry giants. For example only, research released

on February 3 by Gomez Advisors states that three ‘‘dominant online travel firms

. . . now take in over 40 percent of all online travel bookings.’’ 10 One of these firms,

Preview, is about to merge into one of the others, so there will two firms with a

40 percent share.

The Gomez report states that: ‘‘the real leaders are solidifying their dominant positions . . . the online travel giants are gobbling up as many niche companies as possible in an effort to

dwarf any smaller competitors. This amount of consolidation taking place in the

market is making it nearly impossible for any but the top three online travel

sites to earn significant revenues.’’ 11

The airlines’ collective attempt to cut off the online agencies at the pass may or

may not ultimately leave a survivor or two. Perhaps the best outcome that can now

be foreseen for retail travel completion on the Web is one in which two or three consolidated sites compete for almost all the business. All others will be shut out.

More likely, however, is the prospect that the airlines, by combining assets and

special fares not available to their competitors, will succeed eventually (and in the

Internet world ‘‘eventually’’ is not far off) in destroying all their competition online

as well as offline.12 After all, once allowed to establish themselves collectively on

the Internet, what is there to stop the airlines from completely terminating the compensation they pay to their online competitors? This will leave the airlines in sole

control of the supply of information on which consumers must rely to make comparisons among competing choices.

Such an outcome has no precedent. Since the earliest days of commercial aviation,

there has been an independent presence in the market, offering consumers an alternative to dealing directly with the airlines for information and transactions. It may

be hard to conceive that it could happen so swiftly, given the short life of the Internet, but all signs now point to the complete domination of the Internet by a handful

of firms.

All of this is occurring just when traditional travel agencies are extending their

customer outreach to and through the Internet. One example, previously brought to

the department’s attention, is Act Travel at www.actdc.com which maintains a traditional brick-and-mortar agency as well as a booking engine online. Today’s travel

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agencies are rapidly adapting to new means of commerce like the Internet and to

hybrid business models that encompass electronic communications and booking

services in a diverse array of service packages. All of these agencies, newcomers and

traditional agencies, that use or will use the Internet for booking travel are considered ‘‘online agencies’’ for purposes of this complaint.

Both the fully online agencies and the ‘‘traditional’’ agents who have embraced

this technology provide an efficient means to deliver the one-stop, accurate, and unbiased comparative travel information and advice that consumers value. This avenue has become increasingly important to agents as airlines’ reductions in compensation to non-compensatory levels place them in a profit squeeze and threaten

to deprive the public of the access that travel agents uniquely provide to comparative price information.

The airlines are not content to compete with these firms for consumer patronage.

They are intent now upon massing their forces so as to dominate the medium and

thereby control the message.

If the airlines can divert any meaningful amount of this business to their individual Web sites while deterring travel agencies from reaching consumers through

the Web, the potential gain to them is enormous, not merely in commissions avoided, but in the higher overall prices that consumers will pay for air travel. Deprived

of easy access to independent sources of comparative price and service information,

consumers inevitably will end up paying more, on average, even if the airlines never

raise another fare.

Clearly, the airlines would like customers to make their reservations directly on

the carriers’ own Web sites. Standing alone, that objective does not necessarily offend competition policy. But the airlines have gone well beyond merely luring consumers with ‘‘better deals.’’ They have implemented commission policies and other

restrictions with respect to Internet-based bookings by travel agencies that are designed to thwart travel agency use of the Internet to communicate and book travel.

The more successful they are in this approach, the fewer practical options consumers will have for comparing prices and purchasing travel, leading to less competition in travel services and higher prices for consumers. We have attached to this

letter a copy of ASTA’s complaint to the Department of Transportation in Docket

OST–99–6410, wherein we detail other competitive abuses directed at the independent travel retailer by the major US airlines.

CONCLUSION

No other industry of which we are aware has attempted such a frontal assault

on the competitive process. Time is running out. The expansion of the joint Website is well-advanced.

The Department should issue a Civil Investigative Demand upon all the partners

in the proposed Web-site to obtain inspection of the underlying agreements and

marketing plans. That is the only way anyone can be satisfied that this scheme is

not what we have alleged it is: the finishing blow in a campaign calculated to destroy public access to comparative information about air travel services and to end

once and for all the hope for a vigorous competitive industry that was the promise

of airline deregulation in 1978.

ASTA would be pleased to meet with representatives of the Antitrust Division to

discuss this matter further.

Respectfully submitted,

AMERICAN SOCIETY OF TRAVEL AGENTS, INC.

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1 An example of American’s misinformation campaign: ‘‘Because more than 90% of Dallasites

and more than 50% of Metroplex residents live closer to Love Field than DFW, airlines will add

service at Love and reduce it at DFW. With fewer local customers, in the long term DFW will

not compete with hubs like O’Hare, Atlanta, and Denver. DFW will become a second-tier hub.’’

[Dear Colleague Letter from American Chairman, Don Carty, July 6, 1998.] 2The following news reports describe a series of actions taken by American to drive Continental Express out of Love Field:

Continued

PREPARED STATEMENT OF T. ALLAN MCARTOR, PRESIDENT AND CEO, ON BEHALF OF

LEGEND AIRLINES

On behalf of Legend Airlines, I would like to thank you for holding this hearing

and addressing airline competition issues. We appreciate the opportunity to provide

the information on the status of competition in the airline industry from a new entrant’s perspective. Let me begin by stating that I thought that my prior experiences

as a combat pilot, head of Federal Express Airline and Administrator of the FAA

had prepared me for my current assignment. Well, I can now assure you that nothing prepares one for attempting to start a new entrant airline carrier, particularly

in a city dominated by one of the world’s largest air carriers. We never could have

imagined that a carrier that fought so hard against us and our right to fly under

federal laws in multiple forums would then turn around and duplicate our premium

service at Love Field and nowhere else. American continually switches its positions—one day arguing that it and DFW Airport would be destroyed and that it

would be best if the Supreme Court blocked flights out of Love Field, the next day

arguing that they owe it to the people of Dallas to offer service at Love Field. It

would not be surprising if American changes its story again tomorrow. The bottom

line is, if a carrier is allowed to go to such extremes to drive a new entrant out of

business, the future of competition indeed looks bleak.

Legend Airlines is a new entrant carrier operating out of Dallas Love Field that

started service on April 5 to Washington Dulles, Los Angeles, and Las Vegas. We

fly jet aircraft reconfigured to hold only 56 seats (consistent with federal law), offering premium service at coach fares. Since Legend was founded in 1996, American

Airlines and its surrogates have been waging a multi-million dollar litigation and

media campaign to put us out of business. It is difficult enough to start out in a

market where the incumbent carrier has a 75 percent market share, but Legend

was willing to compete in accordance with federal law and DOT orders. From the

sheer magnitude of American’s response, you would have thought Legend was a 400

aircraft operation with multiple alliances—certainly not what it is, a four aircraft

startup with jets limited to 56 passengers. (For comparison’s sake, American has 32

alliance partners, a 641 aircraft fleet and approximately 1,000 slots at O’Hare Airport.)

When Legend and Continental Express first announced plans to fly out of Love

Field—consistent with federal law known as the Wright Amendment, American’s

CEO Robert Crandall announced that ‘‘if the Wright Amendment is ever changed,

we’ll sue everybody in America to close Love Field.’’ The headline in the October

4, 1996 Dallas business Journal stated, ‘‘AMR chief promises to fight to the death

on Love Field.’’ They were not exaggerating. Before Legend even filed for DOT certification, American was intent on destroying it. In October 1997, Congress passed

the Shelby Amendment, which amended the Wright Amendment expressly allowing

jets reconfigured to carry no more than 56 passengers to any destination. Before the

President had signed the Shelby Amendment into law, American sued Legend, Continental Express and the City of Dallas in Texas state court to prevent us and Continental Express from operating out of Love Field.

While many cities throughout this country—including Houston, New York, Washington, D.C., Los Angeles, Miami—have many multiple airports that compete, as a

part of American’s campaign, it spread misleading information throughout the Dallas area that American and its DFW hub would be destroyed by any level of competition introduced at Love Field.1 American opposed allowing nonstop flights to

Mississippi, Alabama and Kansas and use of 56-seat aircraft to any destination.

Such oppressive restrictions exist nowhere else in the country. Such restrictions

exist nowhere else in the world.

To demonstrate that it is not just a one-carrier predator, American also challenged Continental Express’ right to fly 50-seat regional jets from Love Field to

Cleveland. It announced that it would use 12 LGA commuter slots to serve

LaGuardia-Cleveland—one of Continental’s hubs, a market where Continental already operated six daily roundtrips.2

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American said Monday that it is starting service from Austin to Houston’s Hobby Airport on

September 9, the same day American also plans to launch three daily flights from Hobby to New

York’s LaGuardia Airport.

The new service comes as Continental presses its own plans to fly from Dallas Love Field to

Continental’s hub in Cleveland. A state district judge in Fort Worth has blocked that service

at the request of Fort Worth and Dallas/Fort Worth International Airport board.

Analysts said American’s new Houston Service appears to be simply retaliation against Continental’s Love field plans.

‘‘It’s spite,’’ said Joseph Berman, senior aviation analyst at Avmark Inc. ‘‘They’re saying, ‘If

you’re going to go into our market and do that, we’re going to go into your market and do this.’ ’’

[Dallas Morning News, Tuesday, July 21, 1998.]

In commenting on American’s action to stop Continental Express’ proposed flights at Love

Field, David Siegel, President of Continental Express, Inc., stated in Commuter/Regional Airlines News (July 20, 1998): ‘‘It is refreshing to see new leadership at DFW’s flagship airline.

Many hoped that with the easing of the dress code at American Airlines would be more than

symbolic. But whether dressed up or dressed down, the same old anticompetitive, protectionist

actions continue to thrive and deny consumers their rights to choice convenience and reasonable

fares.’’ Analysis of American’s Houston-LaGuardia service is similarly enlightening: ‘‘. . . but Carty

is ‘no pushover by a long shot,’ the [American] official said, describing him as tough and aggressive, particularly when it comes to competitive response. ‘Don [Carty] doesn’t like to sit there

and take it,’ he said, ‘He wants to retaliate’ . . . its unusual for us to fly nonhub-to-nonhub

routes,’ an official said. ‘It’s a signal to anyone who comes messing around with our market.’ ’’

[‘‘American Builds on Crandall’s Legacy,’’ Aviation Week & Space Technology, August 24, 1998.] 3 American spent close to $100 million to block the use of certain passenger facilities at Love

Field, claiming that they would use the facilities for office space. In 1997, American entered a

25-year lease for ‘‘office space’’ in a former Love Field terminal at an annual lease price of $3.5

million. The facility needs approximately $8.5 million in asbestos work and several million dollars worth of general renovations.

Because these were federal issues and impacted the national aviation system and

interstate commerce, DOT tried to resolve the conflict by instituting an Interpretive

Proceeding wherein it considered whether federal law permits Legend’s proposed operations. On December 23, 1998, DOT issued a Declaratory Order finding that Legend’s proposed service is authorized under federal law. American and its partners

appealed that decision to the Fifth Circuit Court of Appeals. On February 1, 2000,

the Fifth Circuit rendered a decision affirming DOT’s Orders and upholding Legend’s authority under federal law to operate at Love Field. (Fort Worth has petitioned to bring this case before the Supreme Court. It is expected that American

will file as well.

Within two hours of the Fifth Circuit decision, American announced plans to reconfigure Fokker 100 jets and MD–80 jets (normally seating 135 passengers) to combat Legend. As reported by the February 2 Dallas Morning Star, ‘‘American’s plan

is to create a special fleet of jets that will be used at Love Field only.’’ Therefore,

in its effort to copy Legend, American is spending millions of dollars to reconfigure

each of the aircraft it will utilize at Love Field (this is in addition to the expenses

it will incur at Love Field to build and upgrade facilities,3 add personnel, build catering facilities, and create a specialized marketing program) in Legend’s markets

with the sole intent of driving Legend out of Love Field.

American has admitted that it will not use these aircraft in other markets. If

American were to utilize these aircraft elsewhere in this system or halt this service,

they would again reconfigure these aircraft to restore the original interiors. Although this would add millions of additional dollars to its costs, American is prepared to do so.

American has made it very clear that it would prefer that all service from Love

Field to destinations beyond the four border states be prevented, regardless of the

million they are spending.

American’s spokesman explained its actions in the Dallas Morning News:

‘‘If Legend is allowed to fly out of Love Field, we will also fly out of Love

Field, and we will fly in competitive markets and at competitive fares,’’ said

American spokesman Tim Doke, adding that American can offer more flights

than Legend to the same destinations.

‘‘We are confident that a court will step in and enjoin Legend from selling

tickets,’’ Mr. Doke said.

Fort Worth has appealed a lower court ruling that allows long-haul service

from Love. If the Supreme Court takes the case and rules in Fort Worth’s favor,

it means that American would have to ‘‘undo all that we’ve done—all the planes

we’ve reconfigured and so forth,’’ Carty said.

But, even so, ‘‘For a whole variety of reasons, we continue to believe that from

American’s perspective, that’s better for us, even though it would cost us some

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4 American now codeshares with Midwest Express.

5 American has over 1,000 slots at O’Hare; therefore, it can adjust schedules at will. Since

O’Hare is a high density airport, Legend was blocked from entering that market. Now American

has 33 scheduled roundtrips from Dallas to Chicago, Therefore, American will make it difficult

for Legend to enter that market.

As to why American is increasing its O’Hare frequencies: ‘‘If a simple price match is insufficient to deprive an entrant of enough local traffic to survive, the hub carrier can shift enough

capacity to the local markets to accomplish that goal. Moreover, where service in a market is

constrained by slot availability, a hub carrier with access to a large pool of slots has even greater ability to respond to entry in this way because the entrant will be unable to add capacity

on its own. American’s president has referred to such strategic responses as predatory scheduling. The net result of predatory scheduling is to discourage a new entry in the first place,

or render it unprofitable where it occurs. [Department of Justice Comments on Joint Application

of American Airlines and British Airways’ Application for Antitrust Immunity and Alliance

Agreement (OST–97–2058), May 21, 1998.]

money,’’ Carty told reporters after a speech yesterday at the SMU Management

Briefing Series at the Fairmount Hotel.

Carty said earlier that it would be better for the region if the Supreme Court

were to overturn the 5th U.S. Circuit Court of Appeals’ Feb. 1 ruling. (Forth

Worth Star Telegram, April 20, 2000.)

American has never utilized aircraft with one level of service and never shifted

operations to Love Field to combat Southwest. Nor has American added flights to

Cleveland to challenge the operations of Continental Express out of Love Field.

Moreover, when Midwest Express (another carrier with an upscale interior and special flight amenities) entered the DFW market American did not reconfigure aircraft

to match Midwest Express’ cabin configuration.4

The markets selected by American for its Love Field service further demonstrate

that it is focusing on Legend. Although American serves the DFW–LAX market with

18 roundtrips per day, after hearing that Legend would operate to LAX, American

immediately announced LAX as the first market it would serve from Love Field, offering four roundtrips. As a result of American’s DFW–LAX schedules, American

has a total of 20 flights in the same time period. For example, Legend has a 5:10

p.m. departure at Love Field which is surrounded by American flights at 3:50, 4:00,

4:30 (Love Field), 5:15, and 6:00. This is a prime example of an already dominant

carrier adding to its market presence to leave little room for a new entrant. To dissuade Legend from entering the Chicago market after Legend announced its intent

to serve Chicago, American will increase its roundtrips to 33.5 In addition, American

is matching fares, offering discounts and turning the heat up on travel agencies and

corporations.

While Legend’s officers and stockholder fully understand the competitiveness of

the air carrier industry and the enormous advantages that American already holds

in the Dallas-Fort Worth marketplace, American’s overall actions amount to much

more than competition. If this is not a classic case of predation, then it is hard to

imagine what would cross the line. As the Department of Justice in United States

of America v. AMR Corporation, Civil Action N. 99–1180–JTM, May 13, 1999 accurately surmised:

American is under investigation for a series of actions taken against new entrants. American dominates DFW and charges monopoly fares on many DFR

routes. When small airlines try to compete against American on these routes,

American typically responds by increasing its capacity and reducing its fares

well beyond what makes business sense, except as a means of driving the new

entrant out of the market. Once the new entrant is forced out, American

promptly raises its fares and usually reduces its service. Through its predatory

and monopolistic conduct, American deprives consumers of the benefits of competition in violation of the antitrust laws.

As American, its affiliates and alliance partners control 75 percent of the Dallas/

Fort Worth market, it makes it very difficult for a new entrant to compete. In addition to its other advantages, if a carrier with that much control over the marketplace can add any number of flights in a new entrant’s market and add a type of

service it has never before operated, then new entrants may be a thing of the past.

For these reasons, it is essential the DOT and DOJ actively pursue carriers who

engage in anticompetitive behavior and threaten to destroy the benefits of deregulation. I urge this Committee to remind both DOT and DOJ that it must move aggressively to ensure that deregulation is not just a distant memory.

Æ