United States General Accounting Office

GAO Testimony

Before the Subcommittee on Antitrust, Business Rights,

and Competition, Committee on the Judiciary, U.S. Senate

For Release

on Delivery

Expected at

2 p.m. EST

Thursday

March 19, 1998

AVIATION COMPETITION

International Aviation

Alliances and the Influence

of Airline Marketing

Practices

Statement by John H. Anderson, Jr.

Director, Transportation Issues,

Resources, Community, and Economic

Development Division

GAO/T-RCED-98-131

Mr. Chairman and Members of the Subcommittee:

We appreciate the opportunity to testify on the United States’ aviation

relations with the United Kingdom (U.K.), our largest aviation trading

partner overseas. Access to London’s Heathrow Airport is important to

any airline that desires to be a major participant in the transatlantic

market. However, our current bilateral aviation agreement with the United

Kingdom restricts the number of U.S. airlines that can serve Heathrow to

two carriers—currently American Airlines (AA) and United Airlines. In

June 1996, AA and the United Kingdom’s largest airline, British Airways

(BA), announced that they intended to form an alliance that would allow

both carriers to market each other’s flights as their own (referred to as

“code-sharing”) and that they would seek immunity for the alliance from

U.S. antitrust laws. Such alliances must be approved by the Department of

Transportation (DOT), and as a matter of U.S. policy, DOT only grants

antitrust immunity to such alliances if there is an “open skies” agreement

between the United States and the foreign airline’s country.1 DOT’s

negotiations with the British government were suspended in

February 1997, and DOT is waiting to learn when the British would like to

reopen negotiations.

Over the past several years, we have issued a number of products on

international aviation issues, including our April 1995 report on the

competitive impacts of code-sharing alliances and our June 1997 testimony

on competition issues in the U.S.-U.K. markets.2

 As requested, for this

testimony we drew on that body of work and interviewed U.S. and foreign

government officials responsible for reviewing and/or approving the

alliance, officials from airlines affected by the alliance, consumer groups,

and other aviation experts to identify the major issues that they believe

need to be considered in deciding whether to approve the alliance. My

testimony today will address three questions: (1) What is the status of the

various reviews of the proposed AA/BA alliance being undertaken by the

European regulatory agencies and the U.S. Departments of Transportation

and Justice? (2) What would be the competitive impact of the proposed

alliance? and (3) To what extent should the sales and marketing practices

1

Generally, an open skies agreement removes all restrictions on air travel between two countries and

allows airlines to fly between the countries when and where they want and to set fares in response to

market forces.

2

International Aviation: Airline Alliances Produce Benefits, but Effect on Competition Is Uncertain

(GAO/RCED-95-99, Apr. 6, 1995) and International Aviation: Competition Issues in the U.S.-U.K. Market

(GAO/T-RCED-97-103, June 4, 1997). Other related GAO products are listed at the end of this

statement.

Page 1 GAO/T-RCED-98-131
of American Airlines and British Airways be considered in reviewing the

alliance?

In summary:

• European regulatory agencies have nearly completed their reviews of the

proposed American Airlines/British Airways alliance. They are considering

a range of issues that would have to be addressed as a condition of

approving the alliance, including the number of slots and gates that other

airlines would need at London’s Heathrow Airport to compete, as well as

American Airlines’ and British Airways’ sales and marketing practices. The

European Commission3

 anticipates its report proposing draft remedies for

the American Airlines/British Airways alliance will be issued within the

coming weeks. The United Kingdom, which is also reviewing the proposed

American Airlines/British Airways alliance, is waiting for the European

Commission to announce its draft remedies. In contrast, the U.S.

Department of Transportation has not yet begun its formal review of the

proposed alliance. Because neither American Airlines nor British Airways

has filed all the documentation requested, the Department does not yet

consider the application complete. As a result, Justice has not submitted

formal comments on the alliance. Once American Airlines and British

Airways file all of the requested documents, the Department of

Transportation initially proposed holding an “oral hearing” to help

complete its analysis of the issues in dispute. However, after receiving

comments from the airlines, it is now reconsidering the type of hearing it

may hold. In addition, the Department has reiterated that it will not

approve the proposed American Airlines/British Airways alliance until the

United States successfully negotiates an open skies agreement with the

United Kingdom.

• The proposed alliance of American Airlines and British Airways—the two

largest carriers in the U.S.-U.K. markets—raises significant competition

issues. Currently, the two airlines account for nearly 58 percent of the

available seats on scheduled U.S. and British airlines between the United

States and London. In addition, they provide over 70 percent—and in some

cases all—of the available seats on scheduled U.S. and British airlines

between Heathrow and several key U.S. airports, including Chicago,

Boston, and Miami. As a result of this level of market concentration, the

3

The European Commission plays a central role in carrying out the activities of the European Union, a

supranational organization that, as of March 1998, is composed of 15 European countries known as

“member states.” The European Commission—the European Union’s executive institution—initiates

proposals for legislation, ensures that provisions of the treaties that govern the European Union are

properly implemented, and represents the European Union in international trade negotiations. The

Commission’s Directorate General for Competition is responsible for investigating airline alliances.

Page 2 GAO/T-RCED-98-131
U.S. Department of Transportation’s approval of the alliance would further

reduce competition unless, as a condition of the approval, other U.S.

airlines were able to obtain adequate access to Heathrow. Each major U.S.

carrier we spoke with, as well as the other large British carrier that

operates transatlantic service to the United States—Virgin

Atlantic—emphasized that gaining a sufficient number of takeoff and

landing slots, gates, and facilities at Heathrow was critically important to

be able to compete effectively against the alliance, and several expressed

doubt that the proposed alliance could be sufficiently restructured to

prevent it from being inherently anticompetitive.

• Although slots, gates, and facilities are most important, most experts and

some airline officials with whom we spoke also recognize that American

Airlines’ and British Airways’ sales and marketing practices may make

competitive entry more difficult for other airlines. Practices such as

frequent flier programs4

 and travel agent commission overrides5 encourage

travelers to choose one airline over another on the basis of factors other

than obtaining the best fare. Such practices may be most important if an

airline is already dominant in a given market or markets. Ultimately, this

may lead to higher fares than would exist in the absence of these

marketing practices. Even so, the experts agreed that measuring the effect

of these marketing practices is nearly impossible. In addition, mitigating

their effect without banning them is difficult, and banning them involves a

trade-off between their anticompetitive effect and the consumer benefits

that some of them bring.

Background In the international sector, the routes that airlines can fly, the frequency of

their flights, and the fares they can charge are governed by 72 bilateral

agreements between the United States and other countries. Many of these

agreements, including the accord with the United Kingdom, are very

restrictive. Since the late 1970s, U.S. policy has been to negotiate

agreements that substantially reduce or eliminate bilateral restrictions.

DOT’s Office of the Assistant Secretary for Aviation and International

Affairs, with assistance from the State Department, is responsible for

negotiating these agreements and awarding U.S. airlines the right to offer

the services provided for in those agreements.

4

Under frequent flier programs, passengers qualify for awards by flying a certain number of miles with

the sponsoring airline.

5

A travel agent commission override is a special bonus commission paid by airlines to travel agents or

agencies as a reward for booking a targeted proportion of passengers on their airline.

Page 3 GAO/T-RCED-98-131
In January 1993, DOT granted antitrust immunity to the Northwest/KLM

alliance in conjunction with the U.S.-Netherlands open skies accord. In

April 1995, DOT issued the U.S. International Aviation Policy Statement in

which it reiterated its desire for open skies agreements and endorsed the

growing trend toward alliances between U.S. and foreign airlines. Since

issuing that statement, DOT has negotiated a number of more liberal

agreements, including open skies accords with Germany and numerous

smaller European countries. In 1996, the agency granted antitrust

immunity to the alliances between United and Lufthansa, which is

Germany’s largest airline, and between Delta and several smaller

European carriers. In announcing their proposed alliance, American

Airlines and British Airways emphasized that they are at a competitive

disadvantage with these alliances because the airlines in those alliances

can, among other things, better coordinate service and jointly set fares.

Despite success in negotiating open skies agreements throughout much of

Europe, DOT has had very little success with the United Kingdom, our

largest aviation trading partner overseas. The current U.S.-U.K. accord,

commonly known as “Bermuda II,” was signed in 1977 after the British

renounced the prior agreement. Bermuda II restricts the number of U.S.

airlines that can serve Heathrow to two carriers—currently American

Airlines and United Airlines. DOT has expressed increasing dissatisfaction

with Bermuda II and attempted to negotiate increased access for U.S.

airlines to Heathrow. Negotiations with the British take on particular

importance because of the size of the U.S.-U.K. markets. In 1996, 12 million

passengers traveled on scheduled service between the United States and

the United Kingdom, which is more than twice that for the U.S.-Germany

markets and three times that for the U.S.-France markets.

Competition is restricted in the U.S.-U.K. markets because Bermuda II,

among other things, sets limits on the amount of service airlines can

provide and prevents all U.S. airlines, except American and United, from

flying to and from Heathrow. These restrictions on competition result in

fewer service options for U.S. and British consumers. In addition, they also

likely result in higher airfares. However, the extent to which airfares are

higher is uncertain. DOT does not have data on the fares paid by passengers

flown by BA or Virgin Atlantic if those passengers’ itineraries did not

involve a connection with a U.S. carrier, because it has generally not

required foreign airlines to report data from a sample of their tickets, as it

requires U.S. airlines to do.

Page 4 GAO/T-RCED-98-131
Bermuda II’s limits on competition also disproportionately affect U.S.

airlines. In contrast to the continuing restrictions placed on U.S. airlines,

the United Kingdom was successful in negotiating increased access for

British carriers to the U.S. markets in the early 1990s. Partly as a result,

between 1992 and 1996, the British carriers’ share of the U.S.-U.K. markets

rose from 49 percent to 59 percent. As figure 1 shows, this gain by British

Airways and Virgin Atlantic has come primarily at the expense of the U.S.

airlines that are not allowed to serve Heathrow.

Figure 1: Share of Scheduled

Passenger Traffic Between the United

States and the United Kingdom by

Airline, 1992, 1995, and 1996

Market share percentage

0

5

10

15

20

25

30

35

40

45

50

British Airways Virgin Atlantic American

Airlines

United Airlines Other 5 U.S.

Airlines

Year

1992

1995

1996

Source: GAO’s analysis of DOT’s international traffic data.

Page 5 GAO/T-RCED-98-131
European Reviews

Considering a Range

of Competitive Issues;

U.S. Reviews Pending

The proposed AA/BA alliance is subject to review by the European

Commission, several agencies within the U.K. government, and DOT. The

European Commission, the U.K. Department of Trade and Industry, and

DOT have decision-making authority over the proposed alliance. The U.K.

Office of Fair Trading and the U.S. Department of Justice’s Antitrust

Division (Justice) have advisory roles and provide analysis and comments

to their respective decisionmakers. According to officials, the process for

reviewing the AA/BA alliance is complicated by the fact that it is new and

untested and some European laws have not previously been applied to

airline alliances. The European regulatory agencies have nearly completed

their reviews, and the formal U.S. review has yet to get under way.

Both the European and the U.S. reviewers have access to extensive

information—including confidential proprietary data—to evaluate the

competition issues arising from the AA/BA and other alliances. This

information includes data on airline capacity, market shares on specific

routes, and passenger travel statistics.

European Commission’s

Review Forthcoming

In July 1996, because of concerns about the anticompetitive effects of the

alliances, the European Commission’s Directorate General for

Competition initiated a review of the proposed AA/BA alliance and three

other ongoing alliances: United/Lufthansa/SAS;

Delta/Swissair/Sabena/Austrian Airlines; and Northwest/KLM. This review

is examining a broad range of competition issues on AA/BA, including

access to slots and facilities at Heathrow Airport; the frequency of service

offered by AA and BA, which would dominate the market at Heathrow; and

AA/BA’s sales and marketing practices, such as frequent flier programs,

travel agent commission overrides, corporate incentive agreements,6

 and

computer reservation system practices.

The European Commission’s Directorate General for Competition expects

to issue its draft remedies for addressing the anticompetitive effects of

AA/BA within the coming weeks. Officials added that their reports on other

alliances should be done soon afterwards.7

 Various parties then have the

6

These agreements represent offers by airlines to corporate clients for fares that are discounted from

the prices that are otherwise applicable. They may be stated as percentage discounts from specified

published fares.

7

European Commission officials told us that, although they initiated their reviews of all four alliances

at the same time, they do not expect to have their proposed draft remedies for each completed at the

same time, since the competitive problems are different in each case. European Commission officials

expect to announce their draft remedies on the United/Lufthansa/SAS alliance,

Delta/SwissAir/Sabena/Austrian alliance, and Northwest/KLM alliance soon after the report on AA/BA.

Page 6 GAO/T-RCED-98-131
opportunity to provide comments and possibly participate in oral hearings

on the draft remedies. After it obtains comments from the interested

parties, the Directorate General for Competition prepares a document

outlining its recommendations on whether to approve the alliance with

conditions or to withhold approval, and submits the document to the

European Commission’s Member States Advisory Committee8

 for review.

After the Advisory Committee’s review, the Directorate General for

Competition incorporates appropriate comments and prepares its draft

final ruling, which either lays out the conditions that must be met in order

for the alliance to be approved or disapproves the alliance. It becomes the

ruling of the Commission when it is adopted by the European

Commission’s College of Commissioners.9

 Thus, the European

Commission’s final decisions are not expected for several more months.

United Kingdom Awaiting

European Commission’s

Draft Remedies

The U.K. Department of Trade and Industry is conducting its own review

of the proposed AA/BA alliance.10 It has asked the U.K. Office of Fair

Trading to investigate and provide advice on the proposed alliance. The

Office of Fair Trading investigation, which began in June 1996, examined a

broad range of issues raised by the proposed alliance, including

competitive impacts of the alliance on routes, hubs, and networks within

the U.S.-European markets; the frequency of service in the U.S.-U.K.

markets; the pooling of frequent flier programs; and access to slots at

Heathrow. The Office of Fair Trading issued a draft report in

December 1996 that called for AA/BA to, among other things, make

available to other airlines up to 168 slots per week at Heathrow for use

only on U.S.-U.K. transatlantic services and allow third-party access to

their joint frequent flier program in those cases in which that party does

not have access to an equivalent program. The report took into account

the views of third parties on conditions that should be placed on the

alliance to remedy competition concerns. Before they provide their final

advice on the proposed AA/BA alliance, the U.K. Office of Fair Trading is

awaiting the European Commission’s publication of its draft remedies. The

Secretary of State for Trade and Industry will decide on the case after

receiving final advice from the Office of Fair Trading.

The U.K. agencies reviewing the proposed AA/BA alliance are in contact

with the European Commission and have a duty to cooperate with it. If the

8

This committee is composed of competition and transport officials from each of the member states.

9

As of March 1998, the College of Commissioners was composed of 20 members proposed by the

member states.

10The Monopolies and Mergers Commission has an advisory role for mergers but has had no detailed

involvement to date concerning the alliance.

Page 7 GAO/T-RCED-98-131
United Kingdom’s decision on the proposed AA/BA alliance differs from the

European Commission’s, the differences will have to be reconciled.

According to European Commission officials, this could require a

judgement by the European Court of Justice in Luxembourg, which

ultimately judges the sound application of the European Union’s treaties

by the institutions of the Union or the member states.11

U.S. Reviews Not

Proceeding Until AA and

BA Complete the

Application Process

In the United States, DOT has the authority not only for approving airline

alliances, but also for granting those alliances immunity from the antitrust

laws. In determining whether to grant approval and antitrust immunity for

an airline alliance, DOT must find that the alliance is not adverse to the

public interest. DOT cannot approve an agreement that substantially

reduces or eliminates competition unless the agreement is necessary to

meet a serious transportation need or to achieve important public benefits

that cannot be met or that cannot be achieved by reasonably available

alternatives that are materially less anticompetitive. Public benefits

include considerations of foreign policy concerns. In general, DOT has

found code-sharing arrangements to be procompetitive and therefore

consistent with the public interest because they create new services,

improve existing services, lower costs, and increase efficiency for the

benefit of the traveling and shipping public. As with the other international

code-sharing alliances that the United States has approved, DOT officials

explained that they will not approve AA’s and BA’s proposed code-sharing

alliance with antitrust immunity unless the United States has reached an

open skies agreement with the United Kingdom.

According to U.S. law, DOT is to give the Attorney General and Secretary of

State “an opportunity to submit written comments about” the application.

In practice, DOT and Justice officials told us that they stay in contact

throughout the application process regarding their respective analyses of

airline alliances.

Justice’s role is advisory and is performed pursuant to the Sherman

Antitrust Act and the Clayton Act, which set forth antitrust prohibitions

against restraints of trade. To determine if a proposed alliance is likely to

create or enhance market power and allow firms to maintain prices above

competitive levels for a significant period of time, Justice applies its

Horizontal Merger Guidelines, which describe the analytic framework and

the specific standards to be used in analyzing mergers and alliances. A key

11Although the European Union has responsibility for applying its aviation laws, enforcement of those

laws is left to the member states.

Page 8 GAO/T-RCED-98-131
concern is whether entry into the market would deter or counteract a

proposed merger’s potential for harm.

DOT officials told us that in reviewing other code-sharing alliances, the

Department did not apply any written set of guidelines in its analysis.

Rather, DOT has discretion in deciding the factors it will analyze and in past

applications for international code-sharing alliances has considered issues

raised in petitions by interested parties. Those issues generally involved

market power between particular hub airports, except in one instance. In

response to United’s application for antitrust immunity in its code sharing

with Lufthansa, TWA contended that Lufthansa’s control over travel

agents, both through dominance of the computer reservation system and

through commissions and override payments, was a serious impediment to

new airlines’ entry into the U.S.-Germany marketplace. In making its final

decision, DOT addressed the concern about the computer reservation

system, but wrote that other forums were more appropriate for addressing

the other concerns.

DOT has considered, but not always completely agreed with, Justice’s

comments on the extent to which particular code-sharing alliances pose

threats to competition in individual markets. In the case of

United/Lufthansa, for example, Justice was concerned that competition

could be reduced in two nonstop markets—Chicago-Frankfurt and

Washington D.C. (Dulles)-Frankfurt. DOT agreed, and “carved out” (i.e.,

withheld antitrust immunity from) specific airline operations in those two

markets. In considering Delta’s proposed alliance, Justice identified seven

nonstop markets that raised concerns of reduced competition. DOT agreed

with Justice on three markets (Atlanta-Brussels, Atlanta-Zurich, and

Cincinnati-Zurich) and withheld antitrust immunity for specific operations

there; DOT generally disagreed with Justice and imposed different

conditions on the other four city-pairs, each of which involved travel from

New York.

In the case of the proposed AA/BA alliance, U.S. reviews are essentially on

hold. DOT cannot move forward with its review of the alliance until AA and

BA file the necessary documents to make their application complete. DOT

officials do not believe that AA and BA will complete their application until

after the European Commission issues its draft remedies on the alliance,

and BA officials confirmed that to us. Once DOT determines that the

application is complete, interested parties—including Justice—will have

30 business days to comment on the alliance. Interested parties and AA/BA

will then have another opportunity for rebuttal comments.

Page 9 GAO/T-RCED-98-131
According to its regulations, DOT may order a full evidentiary hearing at the

end of the comment period. Requests for DOT to hold an oral evidentiary

hearing must specify the material issues of fact that cannot be resolved

without such a hearing.12 However, DOT has the discretion by statute

whether to hold a hearing, even if requested to do so by the Attorney

General or Secretary of State.

Although the AA/BA application is not complete, DOT has already proposed

holding an oral hearing before a departmental “decisionmaker” so that

interested parties can express in person their particular opinions and

views on the issues concerning the AA/BA alliance. AA and BA have

characterized any type of hearing as merely a delaying tactic. Six airlines

opposing the proposed AA/BA alliance, on the other hand, have argued that

the kind of hearing DOT has proposed is not sufficient; they contend that

questions of fact could only be adequately explored and resolved with an

oral evidentiary hearing before an administrative law judge. For example,

AA and BA have contended that slots are easily obtainable at Heathrow and

that Gatwick is an available and competitive alternative. Other airlines

have testified that it is impossible to obtain slots at Heathrow that are

timely and competitive, that Gatwick is full, and, in any event, that

Gatwick is not a reasonable alternative to Heathrow, especially for

business travelers. DOT has told us that it may reconsider its proposed

schedule for reviewing the AA/BA alliance, along with the type of hearing it

would hold.

We are not in a position to assess whether material issues of fact remain to

be resolved in the proposed AA/BA alliance, but we believe it is critical that

DOT avail itself of all empirical data in making its determination. Although

DOT considers code-sharing agreements to be procompetitive, it has not

collected sufficient data to fully analyze the long-term effects of such

alliances. In our 1995 report on alliances, we found that DOT’s ability to

monitor the impact of alliances was limited because foreign airlines are

not required to report data from a sample of their tickets involving travel

to or from the United States.13 In addition, U.S. carriers were not required

to report traffic flying on a code-share flight. Since that report, DOT has

required foreign airlines in alliances that have been granted antitrust

immunity to report data on traffic to and from the United States. Even so,

12In the application of Delta and its European alliance partners for antitrust immunity, TWA argued

that DOT should hold an oral evidentiary hearing. DOT rejected the request, responding that it was

“unnecessary to resolve the relevant issues of fact.”

13International Aviation: Airline Alliances Produce Benefits, but Effect on Competition Is Uncertain

(GAO/RCED-95-99, Apr. 6, 1995).

Page 10 GAO/T-RCED-98-131
alliances have not been sufficiently studied to determine their long-term

consequences or to allay fears that such alliances may hinder competition

in the long term.

AA/BA Alliance Would

Dominate, and

Competition Would

Decline Unless

Substantial New Entry

Occurred

The proposed AA/BA alliance has network benefits and could increase

competition in markets between the United States and the European

continent, the Middle East, and Africa because the number of alliances

competing in these markets would increase from three to four. However, it

raises serious competition issues in U.S.-U.K. markets. Competition issues

arise because, under the alliance, rather than competing with each other,

the two largest airlines in U.S.-U.K. markets would in essence be operating

as if they were one airline. For the month of March 1998, an analysis of

Official Airline Guide data indicates that AA and BA account for nearly

58 percent of the seats available on scheduled passenger flights between

the United States and London. Moreover, as of March 1998, the two

airlines account for 37 of the 55 total daily roundtrips (67 percent)

between the United States and Heathrow offered by scheduled U.S. and

British airlines.14

AA and BA currently compete with one another from six U.S. airports to

Heathrow15 and from Dallas to London’s Gatwick airport. New York’s

importance—Kennedy and Newark—is underscored by the fact that the

market between these airports and Heathrow accounts for nearly one-fifth

of all U.S.-London service and is more than three times the size of the Los

Angeles-Heathrow market. At five of the seven airports where AA and BA

compete—Kennedy, Chicago, Boston, Miami, and Dallas—these two

airlines account for over 70 percent of the service, and at Los Angeles,

they account for almost 50 percent. In addition, in Boston, AA and BA

currently are the only carriers that serve Heathrow, and in the Dallas

market, they are the only nonstop competitors. Figure 2 shows the

location of seven cities where AA and BA currently compete with each

other.

14In several markets, other foreign carriers provide service between U.S. cities and London. For

example, Air New Zealand provides service through Los Angeles to Heathrow.

15These airports are Boston, Chicago O’Hare, Los Angeles, Miami, New York Kennedy, and Newark.

Page 11 GAO/T-RCED-98-131
Figure 2: Seven Cities Where AA and BA Directly Compete With Nonstop Service to London

Dallas (G)

Miami (H)

Chicago (H)

Boston (H)

New York (H)

and Newark (H)

London

Los Angeles (H)

Note: “H” denotes service to Heathrow; “G” denotes Gatwick.

Our review of current competitive conditions in the New York-Heathrow

(Kennedy and Newark) market indicates that substantial new entry would

need to occur to provide competition because of the (1) size of the market,

(2) large share of that market currently held by AA and BA, (3) frequency of

service in that market—15 flights a day—provided by the two airlines

(compared with 3 daily flights by United and 3 daily flights by Virgin

Atlantic), and (4) substantial portion of the market accounted for by

time-sensitive business travelers. New entry could come from Delta and

TWA, which have hubs at Kennedy, and from Continental from its hub at

nearby Newark. In the Boston and Chicago markets, new nonstop service

Page 12 GAO/T-RCED-98-131
may offset the effect on competition caused by joining the two largest

competitors in those markets.

In the event of the alliance, time-sensitive business travelers in the

Dallas-London and Miami-London markets will have fewer nonstop

options and thus will likely pay higher fares for nonstop service. In the

Dallas-London market, AA and BA are currently the only competitors

providing nonstop service. In the Miami-London market, the number of

nonstop competitors would fall from three to two. Several carriers told us

that it is unlikely that a new U.S. competitor would attempt nonstop

London service from either Miami or Dallas, since no carrier besides

American maintains a large enough network from either of those airports

to provide critical “feed” traffic. As a result, DOT will need to carefully

examine the unique circumstances associated with these markets.

At another eight U.S. cities, either BA or AA has a monopoly on nonstop

service to either Heathrow (two cities) or Gatwick (six cities). In our

October 1996 report on domestic competition, we found that competition

was most limited and airfares highest in markets dominated by one

airline.16 Figure 3 shows the location of eight cities where either AA or BA

has a monopoly.

16Airline Deregulation: Barriers to Entry Continue to Limit Competition in Several Key Domestic

Markets (GAO/RCED-97-4, Oct. 18, 1996).

Page 13 GAO/T-RCED-98-131
Figure 3: Eight Cities in Which AA or BA Is the Only Carrier Providing Nonstop Service to London

Seattle (H)

Phoenix (G)

Tampa (G)

Charlotte (G)

Raleigh (G)

Baltimore (G)

Pittsburgh (G) 

London

Philadelphia (H)

Notes: “H” denotes service to Heathrow; “G” denotes Gatwick. According to AA and BA

representatives, with an open skies policy, the alliance would likely switch much of the current

Gatwick service to Heathrow.

US Airways plans to begin Philadelphia to Gatwick service in April and hopes to begin Charlotte

to Gatwick service in May.

Page 14 GAO/T-RCED-98-131
If slots at Heathrow were made available, several U.S. carriers might serve

London from their primary or secondary hubs.17 These slots would provide

new competition to AA and BA on several routes that they currently

monopolize. In particular, U.S. carriers could provide new nonstop service

in the Philadelphia, Charlotte, and Pittsburgh markets. They could also

provide new nonstop service from cities that are currently unserved with

nonstop flights, such as Cleveland.

In addition to increased nonstop competition, carriers could provide

consumers with new one-stop options to compete with the alliance’s

nonstop services in markets that include their primary or secondary hubs.

For example, if Northwest Airlines, which is one of the largest carriers in

Seattle, could serve Heathrow from its hub in Minneapolis, consumers in

Seattle would have more and better connecting opportunities to

Heathrow, and hence competition would be greater than it is today with

BA’s being the only nonstop carrier. However, for time-sensitive travelers,

these one-stop options may not be very competitive. Consumers in cities

such as Des Moines or Fargo with no nonstop service to London, would

experience an increase in the number of one-stop options offered by

competing airlines to Heathrow.

Air Carriers Vary on the

Effort Needed to

Overcome Combined AA/BA

Strength

When we testified last June on the proposed alliance, representatives from

six major U.S. airlines told us that they would need a total of 38 daily

roundtrip slots (or 532 weekly slots) at Heathrow, along with gates and

facilities, to compete with the AA/BA alliance. For this testimony, we

discussed the issue of access to Heathrow with officials from each major

U.S. carrier, as well as with Virgin Atlantic. This time, some were not as

clear on the number of slots they would need to be competitive. The

officials emphasized that gaining a sufficient number of commercially

viable slots, gates, and facilities at Heathrow was critically important for

them to be able to compete effectively against the alliance, and several

expressed doubt that the proposed alliance could be sufficiently

restructured to prevent it from being inherently anticompetitive.

17The other six major U.S. airlines’ primary hubs for transatlantic service are Chicago (United), Detroit

(Northwest), Newark (Continental), New York (Delta and TWA), and Philadelphia (US Airways). In

general, these airlines’ secondary transatlantic hubs are Atlanta (Delta), Houston (Continental),

Minneapolis (Northwest), Charlotte (US Airways), St. Louis (TWA), and Washington Dulles (United).

However, carriers may also choose other locations as key cities in their networks for international

service. For example, Delta currently serves Gatwick from both Atlanta and its other international hub,

Cincinnati. Also, until February, Continental was authorized to serve London Gatwick from its

Cleveland hub.

Page 15 GAO/T-RCED-98-131
The carriers’ representatives expressed a range of views on the actions

needed to compete effectively against the proposed alliance. For example,

officials from Continental discussed the importance of flight frequency,

which they argued is vital for business travelers, who represent the most

valued passenger because of the revenue generated by business travel. For

Continental to be able to compete in the New York-London market, where,

they said, AA/BA would operate what amounts to a virtual shuttle, they

argued that an additional three flights between Newark and London on top

of their current schedule would not be sufficient. They believed they

would need an additional six flights per day.

Officials from United Airlines, which already participates in a global

alliance, suggested that their alliance would compete effectively with AA/BA

for many points beyond Heathrow. However, because of the importance of

Heathrow, they would like to create a greater presence for their entire

alliance. Thus, United officials did not indicate a desired number of slots

and gates needed at Heathrow but spoke about the importance of having

its STAR alliance partners (Air Canada, Thai, Varig, SAS, and Lufthansa)

operate out of a single terminal at Heathrow.

On the other hand, officials from Delta, which also participates in a global

alliance, found the proposed AA/BA alliance to be highly anticompetitive

and argued that the best way to protect the traveling and shipping public

would be to disapprove the proposed alliance. Failing that, Delta officials

have testified that the respective governments should guarantee that

competing carriers will have unrestrained opportunities to provide service

between the United States and London and receive a significant number of

commercially viable slots and airport infrastructure to support those

services. They suggested a minimum of 800 weekly peak-period slots

would be required to provide sufficient competition at Heathrow.

Virgin Atlantic officials concluded that determining the number of slots

needed for a carrier to compete successfully in the U.S.-U.K. markets is

difficult, but that BA would need to divest itself of a “very large” number of

slots to make successful competition by another airline (besides

American) a realistic possibility. 

As we testified last year, as a practical matter, because of a limited number

of slots available at Heathrow, AA and BA would likely need to have slots

transferred from them and made available to competing airlines. If the

proposed alliance is approved and the regulatory agencies decide how

many slots and gates should be made available, it is uncertain how long it

Page 16 GAO/T-RCED-98-131
would take the British Airports Authority, which owns and operates seven

U.K. airports, including London’s Heathrow and Gatwick airports, to

actually make them available to new airlines. For example, according to

the British Airports Authority, it probably will not have the facilities to

allow the STAR alliance to locate all of its members within the same

terminal until Heathrow opens the new Terminal 5, which is not scheduled

to open before the fall of 2004.

If approved, the AA/BA alliance would bring a history of competitive service

to London. Many other airlines that do not have a history of service to

London, on the other hand, would have no such advantage. DOT will have

to address this issue because it will be critical for new carriers to obtain

access to commercially viable slots, as well as needed gates and facilities,

at the same time as the proposed alliance begins joint operations. Some

have suggested that AA and BA “phase in” their alliance over time, in part to

give other carriers the time needed to establish themselves. If this

happened, new airlines’ operations should be phased in to coincide with

the alliance.

Airline Sales and

Marketing Practices

May Further Enhance

Market Dominance

Over Smaller,

Nonaligned, and New

Entrant Carriers

According to airline officials, aviation experts, and consumer groups we

interviewed, restrictions on access to slots and gates at Heathrow Airport

are the most significant barriers to competition in U.S.-U.K. markets, but

sales and marketing practices—which include frequent flier programs,

travel agent commission overrides, multiple listings on computer

reservation systems, and corporate incentive programs—may also reduce

competition. They do so by reinforcing market dominance at hubs and

impeding successful entry by new carriers and existing carriers into new

markets, which can lead to higher fares. However, measuring the impact of

these practices on fares is difficult, and limiting them would involve a

trade-off between their anticompetitive effect and the consumer benefits

that some of them bring.

In October 1996,18 we reported that sales and marketing strategies, when

used by incumbent airlines in U.S. domestic markets, make it difficult for

nonincumbents to enter markets dominated by an established airline. The

strength of these programs depends largely on an airline’s route networks,

alliance memberships, and hubs. If an airline is already dominant in a

given airport, these programs will serve to reinforce this dominance. In

particular:

18Airline Deregulation: Barriers to Entry Continue to Limit Competition in Several Key Domestic

Markets (GAO/RCED-97-4, Oct. 18, 1996).

Page 17 GAO/T-RCED-98-131
• Travel agent commission overrides encourage travel agencies to book

travelers on one airline over another on the basis of factors other than

price.

• Frequent flier programs encourage travelers to chose one airline over

another on the basis of factors other than price.

• Corporate fare agreements make it more difficult for point-to-point

carriers to compete for corporate business.

• Bias in the computer reservation systems, in which multiple listings of a

single flight offered by an alliance partner crowd the first few screens in

U.S. systems, makes the booking of an alliance flight more likely.

In our October report, we noted that travel agent commission overrides

and frequent flier programs are targeted at business fliers and encourage

them to use the dominant carrier in each market. Because business

travelers represent the most profitable segment of the industry, airlines in

many cases have chosen not to enter, or quickly exit, domestic markets

where they did not believe they could overcome the combined effect of

these strategies and attract a sufficient amount of business traffic.

AA, which is credited with having first created frequent flier programs in

1981, is reputed to have the largest frequent flier program in the world,

with more than 30 million members. Continental has more than 15 million

members. European airlines, on the other hand, tend to have much smaller

frequent flier memberships. BA’s program, for example, has approximately

1 million members. The difference in memberships compared with U.S.

carriers is due to their relative newness among European carriers and U.S.

programs’ tending to allow members to accumulate miles for activities

other than flying (e.g., through car rentals or stays at hotels), while

European carriers’ programs are more restrictive in scope.

Some airline officials we interviewed expressed concern that the scope of

AA’s and BA’s combined route network and flight frequency, in combination

with sales and marketing practices, would effectively preclude

competition by other carriers in the U.S.-U.K. markets, especially at

BA-dominated Heathrow. These carriers argued that the alliance would be

able to exercise such market power, especially in relation to travel agents

and corporate fare products, that other carriers would not be able to

attract key business traffic. Officials from Continental Airlines told us that

the problem with the sales and marketing practices of the combined AA/BA

alliance would be their effect on enhancing AA/BA’s dominance of market

share. They said that rather than restrict AA/BA in combining their frequent

flier programs, travel agent commission overrides, corporate incentive

Page 18 GAO/T-RCED-98-131
agreements, and computer reservation system practices, DOT should not

grant antitrust immunity to AA/BA. TWA officials also said that these sales

and marketing practices are anticompetitive and their use by the proposed

alliance should be restricted. Officials from Virgin Atlantic, noting the

strength and market dominance of AA and BA, questioned whether any

mitigating conditions would be sufficient to limit the competitive

advantage the two airlines would have if joined in a code-sharing

partnership.

However, United, Delta, and Northwest—each of which participates in its

own global code-sharing alliance—generally disagreed that any of these

sales and marketing practices represented significant barriers to their

ability to compete. United told us that its alliance would compete with any

other both in terms of their networks and their various sales and

marketing practices. US Airways also indicated that it was not concerned

with sales and marketing practices, as long as it had access to sufficient

Heathrow slots and gates.

Outside experts on airline competition had varying opinions on the degree

to which sales and marketing practices stifle competition. While none had

done research specifically on how these practices affect international air

transport markets, some said frequent flier programs do not raise entry

barriers for large worldwide carriers because they all have relatively

strong frequent flier programs and extensive route networks. However,

point-to-point carriers may be at an additional disadvantage when

competing against carriers with both large route networks and strong

frequent flier programs. For example, while AA and BA are perceived to

have considerable advantages in their frequent flier programs compared

with other nonallied or point-to-point airlines, the differences are

relatively minor when compared with other U.S.-European alliances. Even

so, these experts said it is almost impossible to measure the degree to

which sales and marketing practices impede competition.

We were unable to obtain any data on these sales and marketing practices.

The airlines are not required by law to report this information to DOT, and

GAO has no right of access to commercially owned data. However, we

know of at least two lawsuits alleging that BA has engaged in certain sales

and marketing practices that are anticompetitive in nature. However,

because these actions have not yet entered the trial phase, we have been

unable to obtain detailed information on the alleged economic damage

stemming from BA’s practices, or BA’s evidence to the contrary.

Page 19 GAO/T-RCED-98-131
In past alliances, DOT has not restricted partner airlines in their use of

frequent flier programs, travel agent commission overrides, or corporate

fare packages. It has, in some of the alliances, withheld antitrust immunity

from the airlines’ coordination of the management of their financial

interests in computer reservation system companies. While restrictions on

other sales and marketing practices would be unprecedented, the

European Commission, as noted earlier, is considering whether to address

sales and marketing practices with all alliances. DOT and some U.S. carriers

are concerned that the European Commission would so broadly regulate

the industry’s practices.

The outside experts we interviewed concurred that restrictions on sales

and marketing practices in alliances should not be imposed. They believed

that any restrictions on the pooling of frequent flier programs, for

example, would reduce the benefits that accrue to travelers while doing

nothing to address the underlying issue of market dominance. Moreover,

they said it would be difficult to limit alliance members’ use of these

marketing practices without eliminating them altogether; banning them

involves a trade-off between their anticompetitive effect and the consumer

benefits that some of them bring.

In summary, Mr. Chairman, as a result of the challenges in addressing the

barriers to entry at Heathrow, significant intergovernmental agreement

will be needed well beyond the scope of prior open skies agreements. If

the U.S. government is successful in obtaining an open skies agreement

with the United Kingdom, and that agreement provides for sufficient

access to Heathrow, significant new entry in the U.S.-U.K. markets would

likely provide substantial benefits for consumers in both countries in

terms of lower fares and better service. However, because these markets

have been heavily regulated for 2 decades, the incumbent airlines enjoy a

competitive advantage over new carriers in the U.S.-London markets.

Because of AA’s and BA’s dominance at certain airports and extensive

networks, that advantage may be further strengthened by sales and

marketing practices. Thus, it will be important that new competitors are

able to initiate their service no later than the time at which the AA/BA

alliance becomes operational.

How much access would be needed for other airlines to effectively

compete, and what other conditions should be imposed on the alliance can

only be determined after careful analysis of the facts to ensure that over

the long run, consumers benefit. While we recognize that ultimately,

Page 20 GAO/T-RCED-98-131
decisions on all conditions must inevitably reflect numerous policy

judgments, public policy should be based on significant quantitative

analysis of the factors at issue, rather than anecdotal evidence. At least

four governmental bodies—DOT, Justice, the European Commission, and

the U.K. Department of Trade and Industry—have the ability to get the

data needed for such analyses. Only then can the public be assured that

such important international policy is grounded on a sound basis and that

consumers benefit, both in the short and long term.

Mr. Chairman, this concludes my prepared statement. Our work was

conducted in accordance with generally accepted government auditing

standards. We would be pleased to respond to any questions that you or

any Member of the Subcommittee may have.

Page 21 GAO/T-RCED-98-131
Page 22 GAO/T-RCED-98-131
Page 23 GAO/T-RCED-98-131
Related GAO Products

International Aviation: Competition Issues in the U.S.-U.K. Market

(GAO/T-RCED-97-103, June 4, 1997).

International Aviation: DOT’s Efforts to Promote U.S. Air Cargo Interests

(GAO/RCED-97-13, Oct. 18, 1996).

Airline Deregulation: Barriers to Entry Continue to Limit Competition in

Several Key Domestic Markets (GAO/RCED-97-4, Oct. 18, 1996).

International Aviation: DOT’s Efforts to Increase U.S. Airlines’ Access to

International Markets (GAO/T-RCED-96-32, Mar. 14, 1996).

International Aviation: Better Data on Code-Sharing Needed by DOT for

Monitoring and Decisionmaking (GAO/T-RCED-95-170, May 24, 1995).

International Aviation: Airline Alliances Produce Benefits, but Effect on

Competition Is Uncertain (GAO/RCED-95-99, Apr. 6, 1995).

International Aviation: DOT Needs More Information to Address U.S.

Airlines’ Problems in Doing Business Abroad (GAO/RCED-95-24, Nov. 29,

1994).

International Aviation: New Competitive Conditions Require Changes in

DOT Strategy (GAO/T-RCED-94-194, May 5, 1994).

International Aviation: Measures by European Community Could Limit

U.S. Airlines’ Ability to Compete Abroad (GAO/RCED-93-64, Apr. 26, 1993).

Airline Competition: Impact of Changing Foreign Investment and Control

Limits on U.S. Airlines (GAO/RCED-93-7, Dec. 9, 1992).

Airline Competition: Effects of Airline Market Concentration and Barriers

to Entry on Airfares (GAO/RCED-91-101, Apr. 26, 1991).

(348053) Page 24 GAO/T-RCED-98-131
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