Domestic Aviation: Service Problems and Limited Competition Continue in Some Markets
Released: 1998-04-23T00:00:00

Letter

Benefits of Deregulation Have Been Uneven

Our April 1996 report found that since deregulation, as expected, fares had fallen and service had improved for most large-community airports. However, without the cross-subsidy that was present when the industry was regulated, experts also expected fares to increase somewhat at airports serving small and medium-sized communities and expected service to decline. We found, in fact, that since deregulation, substantial regional differences had existed in fare and service trends, particularly among small- and medium-sized-community airports. A primary reason for these differences has been the greater degree of economic growth that has occurred over the past two decades in the West and Southwest and in larger communities nationwide. In particular, we noted that most low-fare airlines that began interstate air service after deregulation, such as Southwest Airlines and Reno Air, had decided to enter airports serving communities of all sizes in the West and Southwest because of these communities’ robust economic growth. By contrast, low-fare airlines had generally avoided serving small- and medium-sized-community airports in the East and upper Midwest, in part because of the slower growth, harsher weather, and greater airport congestion in these regions.

Our review of the trends in fares between 1979 and 1994 for a sample of 112 small-, medium-sized-, and large-community airports identified 15 airports where fares, adjusted for inflation, had declined by over 20 percent and 8 airports where fares had increased by over 20 percent.Each of the 15 airports where fares had declined was located in the West or Southwest, and low-fare airlines accounted for at least 10 percent of the passenger boardings at all but one of those airports in 1994. On the other hand, each of the eight airports where fares had increased by over 20 percent since deregulation was located in the Southeast and the Appalachian region.

Our April 1996 report also discussed similar trends in the quantity and quality of air service since deregulation. Large communities, in general, and communities of all sizes in the West and Southwest had experienced a substantial increase in the number of departures and available seats as well as improvements in such service quality indicators as the number of available nonstop destinations and the amount of jet service. Over time, however, small- and medium-sized communities in the East and upper Midwest had generally experienced a decline in the quantity and quality of air service. In particular, these communities had experienced a sharp decrease in the number of available nonstop destinations and in the amount of jet service relative to turboprop service. This decrease occurred largely because established airlines had reduced jet service from these airports and deployed turboprops to link the communities to these airlines’ major hubs.

Airline Barriers to Entry Continue to Affect Competition

We reported in October 1996 that operating barriers at key hub airports in the upper Midwest and the East, combined with certain marketing strategies of the established carriers, had two effects on competition. The operating barriers and marketing strategies deterred new entrant airlines and fortified established carriers’ dominance of those hub airports and routes linking those hubs with nearby small- and medium-sized-community airports. In the upper Midwest, there is limited competition in part because two airlines control over 80 percent of the takeoff and landing slots at O’Hare, and one airline controls the vast majority of gates at the airports in Minneapolis and Detroit under long-term, exclusive-use leases. Similarly, in the East, single airlines control the vast majority of gates under exclusive-use leases at Cincinnati, Charlotte, and Pittsburgh, and a few established airlines control most slots at National, LaGuardia, and Kennedy. Perimeter rules at LaGuardia and National further limit the ability of airlines based in the West to compete in those markets.

Particularly for these key markets in the upper Midwest and East, the relative significance of these barriers in limiting competition and contributing to higher airfares has grown over time. As a result, our October 1996 report recommended that DOT take action to lower the operating barriers and highlighted areas for potential congressional action. Our 1996 report also discussed the effects that some marketing strategies by incumbent airlines have on competition.

Slots

To reduce congestion, the Federal Aviation Administration (FAA) has limited since 1969 the number of takeoffs and landings that can occur at O’Hare, National, LaGuardia, and Kennedy. By allowing new airlines to form and established airlines to enter new markets, deregulation increased the demand for access to these airports. Such increased demand complicated FAA’s efforts to allocate takeoff and landing slots equitably among the airlines. To minimize the government’s role in the allocation of slots, in 1985 DOT began to allow airlines to buy and sell them to one another. Under this “Buy/Sell Rule,” DOT “grandfathered” slots to the holders of record as of December 16, 1985. Emphasizing that it still owned the slots, however, DOT reserved the right to withdraw slots from the incumbents at any time. In addition, to mitigate the anticompetitive effects of grandfathering, DOT retained about 5 percent of the slots at O’Hare, National, and LaGuardia and in 1986 distributed them in a random lottery to airlines having few or no slots at those airports.

Even with the lottery, we found that the level of control over slots by a few established airlines had increased over time. By contrast, the share held by the airlines that started after deregulation had remained low. (See app. I.) To address this problem, in October 1996, we recommended that DOT redistribute some of the grandfathered slots to increase competition, taking into account the investments made by those airlines at each of the airports with slot controls. We were envisioning that a small percentage of slots would be redistributed. In response to our report, DOT has begun to use the authority that the Congress gave it in 1994 to allow additional slots for entry at O’Hare, LaGuardia, and Kennedy. In October 1997, DOT awarded Reno Air and Trans States Airlines exemptions from slot limitations at O’Hare, while Frontier Airlines, ValuJet Airlines, and AirTran Airways were granted exemptions at LaGuardia. Earlier this week, DOT granted additional slot exemptions at O’Hare and LaGuardia. These exemptions can help to enhance service in the East and upper Midwest. For example, Trans States Airlines received 16 exemptions to provide service between O’Hare and Chattanooga, Tennessee; Roanoke, Virginia; and Tri-Cities, Tennessee/Virginia.

Long-Term, Exclusive-Use Gate Leases

Our reports have also identified restrictive gate leases as a barrier to establishing new or expanded service at some airports. These leases permit an airline to hold exclusive rights to use most of an airport’s gates over a long period of time, commonly 20 years. Such leases prevent nonincumbents from securing necessary airport facilities on equal terms with incumbent airlines.

While some airports, such as Los Angeles International, have attempted to regain more control of their facilities by signing less restrictive, shorter-term leases once the exclusive-use leases expired, our October 1996 report identified several airports where entry was still limited because of long-term, exclusive-use gate leases with one airline. The vast majority of gates at six airports—Charlotte; Cincinnati; Detroit; Minneapolis; Newark, New Jersey; and Pittsburgh—are exclusively leased, usually to one established airline. (See app. II.) In particular, the airports in Detroit, Minneapolis, and Newark were most frequently cited by the airlines that started after deregulation as having competition limited by gate constraints. When nonincumbents have gained access to airports by subleasing gates, the access has generally come at less preferable times or at a high cost. For example, representatives from some airlines that started after deregulation told us that they strongly prefer not to sublease gates because the established airlines typically insist that the sublessee use the established airlines’ ground personnel, which artificially raises costs and may reduce efficiency. However, Delta Airlines told us that it currently has seven gates that are unused and available for subleasing at Cincinnati. In addition, no new entrant airlines have requested to sublease US Airways’ gates at the Charlotte airport since 1991, according to the airline.

Although the development, maintenance, and expansion of airport facilities is essentially a local responsibility, most airports are operated under federal restrictions that are tied to the receipt of federal grant money from FAA. To address the problems with gate leases, we recommended that when disbursing airport improvement grant moneys, FAA give priority to those airports that do not lease the vast majority of their gates to one airline under long-term, exclusive-use arrangements. DOT did not concur with this recommendation. According to DOT, because the number of airports that we identified as presenting problems with access to gates is sufficiently small, the agency would prefer to address those problems on a case-by-case basis. DOT emphasized that in cases in which incumbent airlines are alleged to have used their contractual arrangements with local airport authorities to block new entry, the Department will investigate to determine whether the behavior constitutes an unfair or deceptive practice or an unfair method of competition and take action as appropriate. In March 1998, DOT noted that it had received some complaints regarding access to gates and it was considering whether it needed to do more in this area.

Perimeter Rules

At LaGuardia and National airports, perimeter rules prohibit incoming and outgoing flights that exceed 1,500 and 1,250 miles, respectively. The perimeter rules were designed to promote Kennedy and Dulles airports as the long-haul airports for the New York and Washington metropolitan areas. However, the rules limit the ability of airlines based in the West to compete because those airlines are not allowed to serve LaGuardia and National airports from the markets where they are strongest. By contrast, because of their proximity to LaGuardia and National, each of the seven largest established carriers is able to serve those airports from its principal hub.

While the limit at LaGuardia was established by the Port Authority of New York & New Jersey, National’s perimeter rule is federal law. Thus, in our October 1996 report, we suggested that the Congress consider granting DOT the authority to allow exemptions to the perimeter rule at National when the proposed service will substantially increase competition. We did not recommend that the rule be abolished because removing it could have unintended negative consequences, such as reducing the amount of service to smaller communities in the Northeast and Southeast, which could happen if major slot holders at National were to shift their service from smaller communities to take advantage of more profitable longer-haul routes. As a result, we concluded that a more prudent course to increasing competition at National would be to examine proposed new services on a case-by-case basis.

Marketing Strategies

Our October 1996 report also emphasized that certain marketing strategies of incumbent airlines, taken together, had created strong loyalty among passengers and travel agents, making it difficult for nonincumbents to enter markets dominated by an established airline. Two strategies in particular—booking incentives to travel agents and frequent flier plans—have encouraged business flyers, who represent the most profitable segment of the industry, to use the dominant carrier in each market. Because about 90 percent of business travel is booked through travel agencies, airlines strive to influence the agencies’ booking patterns by offering special bonus commissions as a reward for booking a targeted proportion of passengers on the airlines. Similarly, frequent flier programs have become an increasingly effective tool to encourage customers’ loyalty to a particular airline. As such, entry by new and established airlines alike into a market dominated by one carrier is very difficult. This is particularly true given that to attract new customers a potential entrant must announce its schedule and fares well in advance of beginning service, thus giving the incumbent an opportunity to adjust its marketing strategies. In many cases, we found that airlines chose not to enter or chose to quickly exit markets where they did not believe they could overcome the combined effect of these marketing strategies.

In October 1996, we reported that the effect of these marketing strategies tends to be the greatest—and fares the highest—in markets where the dominant carrier’s position is protected by operating barriers. However, we also noted that the marketing strategies produced benefits for consumers, such as free frequent flier trips, and concluded that short of an outright ban, few policy options existed that would mitigate the marketing strategies’ negative impact on new entry.

Marketing Alliances Among Major Carriers

Our work has also shown that alliances between major U.S. and foreign airlines that allow airlines to market each other’s flights as their own (called “code-sharing”) have in several cases generated large gains for partners in terms of passengers and revenues. Although consumers benefit from the conveniences that alliances provide—such as decreased layover times—we have found that insufficient data exist to determine what effect alliances have had on fares in the short term and whether alliances will reduce or increase competition in the long term and thereby lead to higher or lower fares.

We recently reported that the proposed alliance between American Airlines (AA) and British Airways (BA) raises serious competition issues in U.S.-United Kingdom markets. Competition issues arise because, under the alliance, rather than competing with each other, the two largest airlines in U.S.-United Kingdom markets would in essence be operating as if they were one airline. AA and BA compete with one another from six U.S. airports to Heathrow and from Dallas to London’s Gatwick airport. At five of the seven airports where the two airlines compete—Kennedy, Chicago, Boston, Miami, and Dallas—these two airlines account for over 70 percent of the service. Although access to slots, gates, and facilities at Heathrow present the most important issues, experts and some airline officials told us that AA’s and BA’s sales and marketing practices may make competitive entry more difficult for other airlines. As a result, we expressed concern that approval of this alliance could further reduce competition unless, as a condition of the approval, other U.S. airlines were able to obtain adequate access to Heathrow airport. Recently, several domestic airlines have been discussing forming code-sharing marketing alliances with each other that would allow them to act in some ways as a single carrier. Such alliances may raise similar competition issues if they result in fewer airlines providing service on routes.

Range of Initiatives Will Likely Be Needed to Address Air Service Problems

Because a variety of factors has contributed to the higher fares and poorer service that some small and medium-sized communities in the East and upper Midwest have experienced since deregulation, a coordinated effort involving federal, regional, local, and private-sector initiatives may be needed. Recent efforts by DOT and proposed legislation are aimed at enhancing competition. Additional public and private activities are currently under way to address regional and local air service problems. If successful, these initiatives would complement, and potentially encourage, the increasing use of small jets by the commuter affiliates of established airlines—a trend that has the potential for increasing competition and improving the quality of service for some communities.

DOT Has Begun Efforts to Increase Competition

In response to our October 1996 report, DOT stated in January 1997 that it shared our concerns that barriers to entry limit competition in the airline industry. As we mentioned earlier in this testimony, in October 1997, DOT granted slots to two new entrants at O’Hare and three new entrants at LaGuardia. At the same time, DOT set forth its new policy on slot exemptions, which has been expanded to take into account the need for increased competition at the airports with slot controls. Earlier this week, DOT announced other slot exemptions but acknowledged that there are only a limited number of opportunities for them. Because some in government and academia believe that slots at some airports may be underutilized, DOT is also evaluating how effectively slots are being used at these airports.

In addition, DOT has expressed concern about potentially overaggressive attempts by some established carriers to thwart new entry. According to DOT, over the past 2 years, there has been an increasing number of alleged anticompetitive practices—such as predatory conduct—aimed at new competition, particularly at major hubs. On April 6, 1998, DOT issued draft guidelines that define anticompetitive behavior by major airlines in response to new entry and could lead to an investigation and possible fines by DOT.

Regional, State, and Local Initiatives Undertaken to Improve Service

Recognizing that federal actions alone would not remedy their regions’ air service problems, several airport directors and community chamber of commerce officials in the Southeast and Appalachian regions have begun a coordinated effort to improve air service in their regions. As a result of this effort, several Members of Congress from these regions in turn organized a bipartisan caucus named “Special Places of Kindred Economic Situation” (SPOKES). Among other things, SPOKES is designed to ensure sustained consumer education and coordinate federal, state, local, and private efforts to address the air service problems of communities adversely affected since deregulation. Two SPOKES-led initiatives include establishing a Website on the Internet and convening periodic “national air service roundtables” to bring together federal, state, and local officials and airline, airport, and business representatives to explore potential solutions to air service problems.

The first roundtable, held in Chattanooga in February 1997, concluded that greater regional, state, and local efforts were needed to promote economic growth and attract both established and new airlines to serve small and medium-sized markets in the East and upper Midwest. Suggested initiatives included (1) creating regional trade associations composed of state and local officials, airport directors, and business executives; (2) offering local financial incentives to nonincumbent airlines, such as guaranteeing a specified amount of revenue or providing promotional support; and (3) targeting marketing efforts by communities toward airlines to spur economic growth. A second roundtable was held in Jackson, Mississippi, in January 1998.

A regional conference, held in West Virginia in December 1997, brought together federal and state officials, airport representatives, and local businesses to discuss ways to restore quality air service to small communities in the state. In West Virginia, Wheeling, Elkins, and Martinsburg, for example, have lost all scheduled air service since deregulation. Throughout the state, communities have experienced declines in the number of nonstop flights, the number of seats available, and the number of jet flights. Regional concerns about air service have extended to other states, and conferences were recently held in Iowa, Arizona, Massachusetts, Nevada, New York, Montana, and North Dakota.

In addition, businesses located in the affected communities have increasingly attempted to address their communities’ air service problems. Perhaps the most visible of these efforts was the formation of the Business Travel Contractors Corporation (BTCC) by 45 corporations, including Chrysler Motors, Procter & Gamble, and Black & Decker. These corporations formed BTCC because they were concerned about the high fares they were paying in markets dominated by one established airline. BTCC held national conferences in Washington, D.C., in April and October 1997 to examine this problem and explore potential market-based initiatives. Attendees at the October conference endorsed concepts that included (1) holding periodic slot lotteries to provide new entrant airlines with access to airports with slot controls and (2) allowing new entrants and other small airlines to serve points beyond the distance established by National’s perimeter rule. While BTCC suspended operations in January 1998, its lobbying arm—the Business Travel Coalition—plans to continue efforts to increase competition.

Airlines’ Use of Regional Jets Is Improving Service

The increasing use of 50- to 70-seat regional jets is improving the quality of air service for a growing number of communities. Responding to consumers’ preference to fly jets rather than turboprops for greater comfort, convenience, and a perceived higher level of safety, commuter affiliates of established airlines are increasingly using regional jets to initiate nonstop service on routes that are either uneconomical or too great a distance to serve with slower, higher-cost, and shorter-range turboprops. For example, Comair—a commuter affiliate of Delta—initiated regional jet service between Cincinnati and Des Moines, Iowa; Tulsa, Oklahoma; White Plains, New York; and Manchester, New Hampshire. In addition, commuter carriers are using regional jets to replace turboprops on existing routes serving small and medium-sized communities. For example, Atlantic Coast Airlines—a commuter affiliate of United—has replaced turboprops with regional jets in markets serving Raleigh-Durham and Charleston, South Carolina, and Portland, Maine.

Although U.S. regional carriers operated only 154 regional jets as of March 1998, they had ordered more than 250 additional regional jets and had options to order about 435 more. Because regional jets can generally fly several hundred miles farther than turboprops, commuter carriers will be able to link more cities to established airlines’ hubs. To the extent that this occurs, it could increase competition in many small and medium-sized communities by providing consumers with more service options.

Proposed Legislation Would Address Competition Issues

Over the past several months, a number of bills have been proposed to promote aviation competition and address some of the problems we and others have identified at small and medium-sized communities. The proposals include making additional slots available at National, O’Hare, Kennedy, and LaGuardia airports to provide service to underserved communities. Because of concerns that additional slots could negatively affect the noise, congestion, and safety at these airports, the proposals specify that only stage 3 aircraft (aircraft that meet FAA’s most stringent noise standards) can be used, that no more than six additional slots per day may be granted at National, and that no more than two slots can be granted per hour at the other airports. Other proposals call for increasing access to the airports with slot controls by periodically withdrawing a small portion of the slots held by dominant airlines and redistributing them among new entrant and limited incumbent airlines. Although the proposals do not specify how DOT should implement this process, we believe that such reallocations should take into account the investments made by the established airlines that would lose some slots and carefully balance the goals of increasing competition with fair treatment of the affected parties.

The proposals also include enhancing air service to underserved areas by providing up to $10 million each year in grants under certain circumstances to assist airlines in providing new service to small underserved airports or setting up a federal loan guarantee for carriers to purchase regional jet aircraft if they agree to provide service to underserved communities for at least 2 years. Some proposals would require DOT to grant exemptions to the perimeter rule at National under certain circumstances, limit the time that DOT has to respond to complaints of predatory behavior, and ensure that all airport facilities are available to new entrants at fees that are comparable to the fees paid by incumbent airlines.

In summary, a number of factors, including operating barriers and marketing practices have limited competition at some airports and adversely affected fares and service. There are no simple solutions to these problems. However, the recent initiatives by DOT, legislative proposals to remove some operating barriers and enhance competition in underserved markets, as well as local efforts to improve service provide steps toward increasing competition and improving air service for some communities.

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

Percentage of Domestic Air Carrier Slots Held by Selected Groups

Shawmut Bank/First Security Bank, American, and DeltaAmerican, Delta, and US Airways American, Delta, and US Airways Some airlines that held slots have gone bankrupt, and as a result, financial institutions have acquired slots.

Airports Where Post Deregulation Airlines Reported Difficulty Gaining Competitive Access to Gates, and the Leasing Arrangements at Those Airports, 1998

Major leaseholders and dates of lease expiration 45 37 (82%)

37 gates leased to US Airways until 2007 67 67 (100%)

50 gates leased to Delta with 9 leases expiring in 2015 and 41 expiring in 202386 70 (81%)

59 gates leased to Northwest until 2001 70 70 (100%)

22 gates leased to Northwest until 2015, 31 gates leased to Northwest on a month-to-month basis, and the remaining 17 gates leased to other carriers on a month-to-month basis 94 79 (84%)

43 gates leased to Continental until 2013, 36 gates leased to the other established airlines until 2018, and 15 gates reserved primarily for international use 75 66 (88%)

Related GAO Products

Aviation Competition: International Aviation Alliances and the Influence of Airline Marketing Practices (GAO/T-RCED-98-131, Mar. 19, 1998).

Airline Competition: Barriers to Entry Continue in Some Domestic Markets (GAO/T-RCED-98-112, Mar. 5, 1998).

Domestic Aviation: Barriers Continue to Limit Competition (GAO/T-RCED-98-32, Oct. 28, 1997).

Airline Deregulation: Addressing the Air Service Problems of Some Communities (GAO/T-RCED-97-187, June 25, 1997).

International Aviation: Competition Issues in the U.S.-U.K. Market (GAO/T-RCED-97-103, June 4, 1997).

Domestic Aviation: Barriers to Entry Continue to Limit Benefits of Airline Deregulation (GAO/T-RCED-97-120, May 13, 1997).

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

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

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

International Aviation: Airline Alliances Produce Benefits, but Effect on Competition Is Uncertain (GAO/RCED-95-99, Apr. 6, 1995).

Airline Competition: Essential Air Service Slots at O’Hare International Airport (GAO/RCED-94-118FS, Mar. 4, 1994).

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Airline Competition: Impact of Computerized Reservation Systems (GAO/RCED-86-74, May 9, 1986).

Airline Takeoff and Landing Slots: Department of Transportation’s Slot Allocation Rule (GAO/RCED-86-92, Jan. 31, 1986).

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

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