Plane Deal

Small airlines--and a few politicians--try to again put Washington behind the ticket counter.


If you had booked a last-minute flight from Los Angeles to Denver on United Airlines last February, it would have cost you $622. But on the same day, you could have booked the same flight on Frontier Airlines, which was trying to lure passengers away from United, and spent only $189, saving yourself 70 percent.

It's been 20 years since Jimmy Carter deregulated the airline industry, and by any measure the experiment has been a huge success. Since 1978, fares have dropped by 40 percent in real terms, while the number of flights has increased by 50 percent. Passenger boardings have soared, from 275 million to 581 million. Jet travel, once limited to those with expense accounts or a lot of money, has become accessible to ordinary people. Consumers have saved billions of dollars.

Naturally, the federal government is preparing to intervene. Small airlines like Frontier, which fear that the large carriers are using unfair practices to crush them, and business travelers, who pay high fares when they book flights at the last minute, want to put Washington back behind the ticket counter. The Justice Department, the Transportation Department, and the chairman of the Senate Commerce Committee all appear to agree that a renewed federal presence is warranted there.

With the recently announced proposals by six of the nation's biggest airlines to consolidate their marketing operations, a regulatory crackdown on airlines–building in Washington for months–is now a certainty. The only remaining question about reregulation is what form it will take–and whether federal intervention will help or make matters worse.

The proposed marketing consolidations announced in April between Delta and United (the nation's biggest carrier), and between American and USAirways, stop short of outright mergers. But like the similar proposed agreement announced last January between Northwest and Continental, these marketing partnerships would involve sharing passengers and frequent flier programs, and achieve much the same results that mergers would.

What's the problem? Government officials contend that the big carriers have entrenched themselves at "fortress hubs"–United in Denver, Northwest in Detroit and Minneapolis, and Delta in Atlanta–where they dominate 80 percent or more of all flights. From these hubs, critics say, the big airlines can attack anyone who dares enter "their" airports to compete. The big airlines can flood the routes of upstart rivals with rock-bottom fares–but just long enough to kill the intruder. After that, the big airlines can jack up their prices again.

Such "predatory pricing," officials say, has caused business fares (typically booked at the last minute) to soar, low-cost airlines to disappear, and small cities, especially in the Southeast, to lose service. Critics, including government officials, representatives of smaller airlines, and some economists, claim that unless the new ticketing and marketing arrangements are stopped by federal intervention, the major airlines and their hubs will become ever more forbidding to competition.

Even the architect of deregulation, economist Alfred Kahn, believes that airline monopolies now are driving out competitors with unfair practices. After a big carrier destroys a competitor, Kahn says, "it puts up a no trespassing sign" that scares off any potential new ones. The number of new carriers has dropped sharply since peaking in the mid-1980s, he notes. Kahn and many other airline deregulators assumed in 1978 that the government would prevent direct competitors such as Republic and Northwest, and TWA and Ozark, from merging. But it didn't.

Critics of the airlines point to other competitive problems. One is that hub dominance is reinforced by such marketing strategies as frequent flier programs and special commissions to travel agents. Another involves the bottlenecks at airports left over from the pre-1978 regulatory regime: At many airports, airlines hold exclusive-use gate leases for as long as 20 years, effectively locking out competitors.

A further complicating factor is that the federal government restricts entry to four highly congested airports–Chicago's O'Hare, Washington National, and New York's LaGuardia and Kennedy. The number of landings and takeoffs, known as "slots," was fixed in 1969 and awarded to a handful of major carriers. Despite two modest expansions of these slots since then, it has remained nearly impossible for competing airlines to fly into those four airports.

There is a trade-off in the hub-based flight system. While it fosters airline dominance at certain airports, it has proven extremely efficient. By routing passengers through a connecting hub, airlines have been able to slash costs and vastly increase the number of flights available to travelers, especially in smaller cities. The challenge facing would-be reregulators is how to aid small airlines without hurting passengers.

The government may end up undoing the benefits of deregulation, prompted by small airlines screaming foul. Frontier Vice Chairman Paul Dempsey told Congress in March that United is on a "homicidal mission" to eliminate his airline. This sort of rhetoric has caught the attention of politicians, and federal action is possible on several fronts:

• The Justice Department this spring opened an antitrust investigation of possible "predatory pricing" by big airlines. The department will also be investigating the Delta-United and American-USAirways alliances.

• The Transportation Department has issued proposed rules calling for steep fines against any airline engaging in predatory pricing, although for legal reasons it does not use that term.

• The DOT also granted slot exemptions at Chicago's O'Hare airport and New York's LaGuardia to six small carriers.

• Arizona Republican John McCain, chairman of the Senate Commerce Committee, introduced a bill to sell off landing slots at the four federally restricted airports. These slots would be available only to start-up or low-fare airlines, and only if they use the slots for flights to "underserved" destinations. McCain would also require the Transportation Department to act on predatory pricing complaints within 60 days. A similar bill has been introduced by House Democrats.

• Two Tennessee Republicans, Rep. John Duncan, chairman of the House Aviation Subcommittee, and Sen. Bill Frist, have introduced a similar bill that would guarantee aircraft loans to airlines serving "underserved" airports. It would also give $10 million a year to help small airports market themselves.

The Transportation Department's proposals identify several actions that would trigger government intervention: if a carrier offered "very low fares" that return less revenue to the airline than "a reasonable alternative response," for example. The department's rules would also prohibit an established carrier from selling more seats at low fares than a competing carrier offers. But the department does not attempt to define such key terms as "very low fares" or "reasonable alternative response." Many analysts believe the rules are so vague as to be unenforceable.

Does the airline industry need such federal fixes? Some economists think so. Irwin Steltzer, head of regulatory policy for the American Enterprise Institute, says, "[T]here is something called predation out there, no matter what the Chicago economists tell you. The major airlines are capable of it, and [the Transportation Department proposals], while not easy to apply, certainly make sense."

Others are not so sure. Michael Boyd, a Denver aviation consultant, agrees that the big airlines engage in predatory pricing (and even uses that term), but warns that the proposed remedies, "aside from making….Transportation look foolish, will do very little." In fact, he says, most of the proposals will end up raising fares and reducing flight availability.

The major airlines vow a fight. "All of these in some form or another are attempts at reregulating the pricing structure of the industry," says David Fuscus, spokesman for the Air Transport Association, an industry trade group.

Transportation Secretary Rodney Slater denies that. "This is not an effort to reregulate commercial aviation" he says, but rather an effort to preserve competition.

Whether the Transportation Department's proposed rules "preserve competition" or are "attempts at reregulating" may turn on the issue of fare competition. Industry experts say that the rules could actually prohibit fare wars. If an established airline meets a competitor's fares on too many seats, the airline would be fined by the government. "The way those rules are written," says consultant Boyd, "immediately Northwest is guilty of predatory actions because it has more seats than the smaller carrier does at low fares. That's anti-consumer."

Jim Burnley, a former secretary of transportation whose law firm represents American Airlines, adds, "The most amazing thing of all is they're going to use administrative law judges to investigate airlines for setting low fares. There is something very wrong with that scenario."

By design the rules would shield new airlines from competition, critics say, probably leading to higher, not lower, fares. "This is a fare-floor proposal," says Northeastern University economist Stephen Morrison. "The problem is, can you fix what looks to be broken without breaking what is not broken?"

The Supreme Court thinks not. "The mechanism by which a firm engages in predatory pricing–lowering prices–is the same mechanism by which a firm stimulates competition," the Court wrote in 1986. Unsuccessful predatory pricing–fare wars that do not drive out competitors–are "a boon to consumers," the Court said, and the government must be very careful not to "chill the very conduct the antitrust laws are designed to protect."

McCain's bill is subject to similar charges of reregulation. The Arizona senator says he is "amused" by charges that his bill would reregulate the airlines. "The whole purpose of our bill is to increase competition," he says.

But critics say his legislation could also backfire. "Senator McCain might want to learn about the airline business before he starts to try to fix it," Boyd says.

The problem with the McCain legislation is that selling slots will mean taking them away from existing routes that are popular and profitable–say, from Syracuse to New York City–and awarding them instead to less popular routes–say, from Knoxville to New York–that most likely cannot generate the revenue that the low-cost airlines will need to stay in business. One result could be reduced access to four of the most popular airports in the country. Moreover, the new flights from supposedly "underserved" cities will not connect to anywhere else.

"For all those folks in Dickinson, North Dakota, who have a hankering to visit Queens, this bill is a godsend," Boyd told Congress. Boyd also predicts that defining "underserved" will create "a field day for paid consultants and politicians at cities that can barely support a 7-Eleven, let alone jet service."

Giving away extra slots, as the Transportation Department is doing with its slot exemption program at the busy airports, is not necessarily a viable alternative. Members of Congress are already complaining about the potential for more noise and pollution at these airports.

As far as underserved airports go, even the Transportation Department concedes that they are underserved primarily because there is not enough traffic to justify jet service. Moreover, the market is already responding, without government subsidies, by producing small regional jets that are economical to fly on low-traffic routes.

The federal government doesn't seem to be able to make up its mind about airlines. The new initiatives are "symptomatic of the [failure] of policy makers to take a long-run view of this industry," says Clifford Winston, a Brookings Institution economist. Fewer than five years ago, Winston notes, the Clinton administration worried that the big airlines were going broke and appointed a commission to figure out how to help them. The commission recommended, Winston said, "a financial advisory board to advise the carriers about how to run their business."

The government is probably experiencing a mood swing now because the booming economy has increased demand for air travel. Learning from their near-death experience in the 1980s, the major carriers have let fares rise rather than add capacity.

In 1996, after the ValuJet crash, the government was less concerned about the survival of small airlines than it was about the survival of their passengers. Now the Transportation Department frets openly and often about how the crash of ValuJet–which in fact had a poor safety record–scared passengers away from low-cost airlines, hastening their general demise.

But Boyd says the failure rate of start-up airlines may have little to do with large carrier monopolies. Of the 30 new airlines launched prior to 1993, all but five failed, "taking enormous amounts of investors' and consumers' money with them." In nearly every instance, he contends, those failures were due to bad management and shoddy service.

There are several steps that industry analysts agree could improve competition. Some, such as freeing up gates, are already being taken by the airports. At San Francisco International, for example, long-term leases have been replaced by 30-day permits that give the airport the flexibility to shift gates and add new carriers.

"There is no one that is sitting out on the ramp with their engines running and 400 people on board waiting to get into a gate because all of them are tied up with airlines that have long-term exclusive leases," says San Francisco airport spokesman Ron Wilson. "A new airline entering the market in San Francisco has the freedom to come in and apply, and we will give them entry."

United has 40 percent of the operations at San Francisco, but it cannot exclude other carriers by tying up gates. Los Angeles has similar gate flexibility.

Another possibility is getting rid of slot controls altogether, and letting airlines bid against each other for space at the four congested airports. Competitors could enter freely, and landing rights would go to the flights that passengers, rather than Tennessee politicians, demand.

Analysts also commend McCain's move to eliminate the "perimeter rule," which diverts long-distance flights from Washington National to Dulles, and from Love Field to Dallas/Fort Worth. The rule has resulted in reduced competition.

But one of the surest and quickest ways to increase competition is not even being considered: lifting the ban on foreign carriers serving the domestic market and allowing them to carry passengers not just to but between U.S. cities. "It would be a source of instant competition by very powerful entrants," says AEI's Steltzer. Kahn calls it "our main hope" for greater competition.

It is unlikely that a tiny startup like Detroit-based Spirit Airlines will ever pose a serious threat to a big carrier like Northwest. It would be a very different story if a competitive challenge were offered by, say, Lufthansa, Air France, or British Air.

Maintaining the ban appears to reinforce the monopoly power that the government is otherwise trying to dilute. Rather than competing with U.S. carriers, foreign airlines have begun forging marketing alliances with them, sharing seats, routes, and frequent-flier programs.

McCain says he would love to end the U.S. ban on foreign carriers, but only if foreign countries reciprocate. That may never happen. "Powerful political forces prevent it," AEI's Steltzer says. "British Air doesn't have any U.S. senators."

Contributing Editor Carolyn Lochhead (lochheadc@nationalpress.com) is Washington correspondent for the San Francisco Chronicle.