entry and competition in US
...h percentile); but in 1998, they paid nearly three times the median. Some of this increase in fare dispersion might be attributable to cyclical effects, possibly due to disproportionately expanded demand by business travelers and to higher use of aircraft and seating capacity. Under these conditions, airlines take risks in not selling some seats in anticipation of late-booking travelers or last-minute itinerary changes, since these seats--which might otherwise have sold at lower fares earlier--might fly unsold. The highest fares, which are increasing the spread, might reflect these costs. New, low-fare carriers, which have reduced fares in many markets, likely have contributed to an overall increase in the spread between the lowest and highest airline fares. To some observers, however, the widening spread in fares reflects the increasing ability of airlines to segment price-inelastic travelers, and to charge them exceptionally high fares in markets where pricing is not adequately disciplined by competition. Emergence of Airline Alliances and Other Partnerships Several major U.S. carriers recently have formed partnerships. Most of these involve sharing frequent-flier programs, although some also coordinate flights in connecting markets through codesharing. While only one domestic alliance so far has involved financial integration, it is reasonable to worry that domestic airlines in looser marketing relationships will be less inclined to compete vigorously with one another. The possibility that these relationships will strengthen and migrate toward mergers—de facto, if not de jure—also raises concern. Even more alarming to some is the proliferation of alliances between U.S. and international carriers, often facilitated by grants of antitrust immunity to coordinate fares, seating capacity, schedules, and marketing. Although some travelers in connecting markets might benefit from these alliances, the potential gains to travelers in mainline markets—gateway-to-gateway routes where allied airlines were once main competitors—are not evident, and it is possible these travelers are losing out. Moreover, the longer-term effects of these alliances may be exclusionary, ultimately forcing some unaffiliated U.S. airlines out of international markets by diverting their feed traffic and weakening their overall route structure to the detriment of domestic competition. An issue that deserves explicit attention is whether these expanding alliances are compatible with longer-range international aviation goals, such as unrestricted entry and competition by the most efficient carriers on a multilateral or global basis. Resurgence in Low-Fare Entry and Concerns About Unfair Competition About one in five passenger trips today is on an airline that can be characterized as primarily a "low fare" operator. Southwest Airlines alone accounts for about two-thirds of these travelers, and has played an important role in the industrywide decline in average fares since deregulation, not only because of its own low prices but because it has spurred lower prices by other airlines, even compelling some to create special low-fare divisions. Other low-fare startup airlines have had mixed success. Undercapitalization, poor choices of markets, inexperienced management, and unexpectedly vigorous competitive responses have contributed to some failures. Increased market demand during the decade has raised the cost of aircraft and labor, possibly inhibiting entry and expansion by new airlines that want to pursue a low-cost, low-fare strategy. Concerns about the safety of startup airlines—particularly after the 1996 crash of a ValuJet flight—also might have slowed expansion during the latter half of the 1990s. Nevertheless, nonincumbent airlines, led by Southwest, have entered nearly 2,000 markets (nonstop segments) during the past six years, and net market entries—that is, entries minus exits—have been positive on balance, exceeding 500. Market exits and failures among new airlines are not necessarily a cause for alarm, since a high rate of failure by new businesses characterizes many—if not most—industries. But in addition to facing the normal difficulties of running a new business, as well as the longstanding impediments to entry described earlier, new airlines also have encountered aggressive responses by incumbents. DOT has expressed concern that these responses sometimes have strayed beyond the bounds of fair competition, aiming instead at improperly excluding competitors. It therefore has proposed a method for detecting and for enforcing prohibitions against unfair, exclusionary conduct in the industry (Appendix A). UNFAIR COMPETITION AND DOT’s ENFORCEMENT PROPOSAL DOT forwarded to the study committee 32 complaints of unfair competitive conduct, filed by new entrants between 1993 and 1999. The committee did not review each in detail; however, it is apparent that some of the actions described are difficult to reconcile with fair and efficient competition. About one-third reported chronic difficulties obtaining gates and other facilities at airports dominated by incumbents. About half involved sharp price cutting and increases in capacity by incumbents in response to entry. Some complained of incumbents offering higher travel agent commissions and bonus frequent-flier miles in contested markets, allegedly to divert enough potential customers to make the new service unprofitable. Among the most troubling, in the committee’s opinion, were four reports of incumbents not only sharply lowering fares but also temporarily scheduling many more flights, some in city-pair markets in which they previously had not offered nonstop service or jet flights. Sharp reductions in price and increases in capacity are "predatory" if designed to drive out or suppress competition to gain higher future prices and profits through increased market power. Some economists have postulated that firms employ predatory tactics not only to strengthen or preserve their monopoly position in the markets in which they cut prices, but also to deter competitive entry in their other markets. Therefore, a valid concern is that airlines might engage in predation, even on a limited basis, with the broader aim of dissuading entry and increasing market power throughout their networks. Distinguishing predatory behavior from the kind of competition that benefits consumers and proving the distinction empirically, however, are difficult, particularly in the airline industry with its frequent fare wars and constant shifts in city-pair service. A common test presumes that predation occurs when a firm charges prices that are below marginal costs, so that incremental revenues generated from the sale of one more unit are less than the incremental costs incurred making the sale. Determining the applicable marginal cost of providing an airline passenger trip, however, is not easy. Airlines can enter and exit markets without incurring large, unrecoverable costs, because their assets are mobile, and they can lease aircraft, airport gates, and terminal space, as well as contract for ground services. Under these circumstances, even short-run average variable costs—an accounting measure often used as a practical substitute for marginal cost—can be difficult to quantify retrospectively and at the applicable unit level. The distinctive characteristics and practices of the industry also have effects on the likelihood of successful predation and therefore on the probability of airlines employing predatory tactics. On the one hand, the relative ease of competitive entry or reentry can limit the ability of a predator to hold onto the monopoly position and recover the losses incurred from predation. On the other hand, the fluidity of airline assets and the consequent ability of incumbent carriers, when challenged by price-cutting rivals, to add and withdraw capacity quickly, can facilitate predation when there are significant barriers to competitive entry. In proposing an enforcement plan, DOT warned that it would investigate instances in which an incumbent airline, challenged by a new entrant, had responded by lowering fares and increasing seating capacity so that total revenue generated in the market is lower than would have been likely with a more "reasonable alternative response." According to DOT, a reasonable response would be for the incumbent to match the low-fare offerings of the new competitor on a restricted basis, without sharply increasing seating capacity. Apparently, DOT regards the revenue that the incumbent sacrifices by shifting capacity as an opportunity cost of predation. Opportunity cost—that is, the value of the best alternative response that is forgone—is relevant for assessing the costs of suspected predatory activity. However, DOT’s proposal for detecting predatory behavior raises valid concerns about administrative feasibility and about the potential for undesirable consequences. Defining and specifying a class of new entrants for protection risks arbitrary enforcement, possibly favoring inefficient carriers. DOT’s proposed criteria for detecting possible predation, which would require a comparison of revenues actually earned by the incumbent with hypothetical revenues from other possible responses, are inherently speculative and therefore likely to be difficult to administer. In general, industry-specific administrative agencies are prone to rely on prescriptive regulation rather than on market forces to achieve their goals; in particular, they sometimes seek to protect their constituencies from competition perceived as destructive or predatory. There is a risk, therefore, that DOT’s efforts will become increasingly regulatory and tend to inhibit, or even prohibit, some legitimate competitive responses. Moreover, policy and program objectives can change over time. Twenty years after economic deregulation, political influences on the provision and regulation of air transportation remain strong. Other experiences recounted in this report—the 30-year history of federal limits on access to some key airports or the recent antitrust immunity extended to international airline alliances—suggest that the potential for unintended policy outcomes should not be underestimated. Because of these risks, a case can be made that federal assessments of anticompetitive conduct should be entrusted primarily with the Department of Justice (DOJ), which has a clear mandate—as well as the resources and expertise—to enforce the nation's antitrust laws. DOJ also can levy significant penalties through the criminal and civil courts. The committee recognizes that DOJ has been actively exploring how antitrust laws apply to predation in the airline industry and has been developing approaches that take into account the industry’s characteristics. In the committee’s opinion, DOJ’s involvement in this area is a healthy development. The committee also believes, however, that DOT has an important role in preserving and enhancing opportunities for competitive entry in the airline industry. This must entail concerted action—as recommended in this and other reports—to remove the persisting impediments to entry that are under DOT’s authority. In addition, DOT should ensure that airlines are not exploiting their advantageous relationships with airports, air traffic control access, CRSs, and travel agents to hinder competition and to limit entry opportunities. The committee harbors reservations, however, about DOT’s proposal for identifying and forbidding predation in the airline industry. Many members are concerned that DOT’s proposal could become increasingly regulatory, thus inhibiting genuine competition, and they worry that it designates certain classes of carriers for special consideration. All committee members believe more work is necessary to develop meaningful tests for detecting and proving predation—tests that facilitate enforcement and compliance but that also protect the competitive process rather than specific competitors. For these reasons, some members of the study committee would prefer that DOJ—which is unencumbered by industry regulatory responsibility and has greater antitrust expertise—take the lead in enforcement, as it did in a recent action against a major carrier. However, other members—while sharing the committee’s general concerns about regulatory risks—judge the problem serious enough to warrant the more active involvement of DOT, exercising its own independent enforcement authority to prevent unfair methods of competition. While these committee members are uncertain about the administrative feasibility of DOT’s proposed guidelines, they believe DOT should be given the opportunity to develop and apply objective tests for predation, ensuring that markups on unrestricted fares are subject to a competitive discipline devoid of exclusionary practices. They are optimistic that DOT can do this without becoming overly regulatory and without inhibiting the kind of competitive price cutting that provides lasting fare reductions. In short, the committee believes DOT’s proposal as currently formulated has flaws. Committee members differ, however, on the seriousness of the flaws and whether the flaws can be resolved by DOT. Despite differences on these issues, committee members are unanimous in believing that DOT’s main focus should be on expanding opportunities for more entry and competition. Freedom of entry, including freedom from the threat of anticompetitive behavior, is made possible in large part by the removal of barriers to competitive entry and reentry; this is the best antidote to excessive fares stemming from too much market power. Expanding capacity and ensuring efficient use of the nation’s airports and airways is critical for this. Ensuring that structural developments within the industry, both domestically and internationally, are favorable to more competition is also important. The following recommendations emphasize these goals. RECOMMENDATIONS The purpose of this study was to examine the state of airline competition and to offer recommendations for furthering and safeguarding it. The main reason for caring about the competitive process is that vigorous rivalry promises consumers more product and service choices at lower prices and with better quality. However, in addition to consumer interests, public policy must take into account many other considerations that could not be examined in this study. The committee’s recommendations therefore must be understood as limited to the goal of preserving and fostering competition in the airline industry. To the extent that these recommendations raise additional considerations, integrating and reconciling them with the goals of competition must be left to others. System Capacity and Opportunities for Competition Congestion and delays caused by the inefficient provision of airway and airport capacity affect not only the on-time performance of airlines, but also the routes airlines choose to fly, how they schedule and design their networks, and the types of equipment they use. Capacity shortages that persist, unresponsive to increasing demand, can limit new competition, particularly entry and expansion by low-cost carriers. To compensate for shortcomings in the way airport and airway capacity are provided—and in the absence of proper pricing—many administrative limits have been imposed. These include regulatory controls on airline use of some of the nation’s most important airports; air traffic control procedures that require queuing for access to navigable airways and airports; and federal restrictions on the ability of airports to raise and invest funds for expansion. Not only have these inefficient allocation mechanisms adversely affected competition, but they have permitted the deferral or neglect of more efficient and direct means of supplying needed infrastructure. These regulatory controls a...