oversight

Aviation Competition: Effects on Consumers from Domestic Airline Alliances Vary

Published by the Government Accountability Office on 1999-01-15.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to Congressional Requesters




January 1999
                 AVIATION
                 COMPETITION
                 Effects on Consumers
                 From Domestic Airline
                 Alliances Vary




GAO/RCED-99-37
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Resources, Community, and
      Economic Development Division

      B-280704

      January 15, 1999

      The Honorable John McCain
      Chairman, Committee on Commerce,
        Science, and Transportation
      United States Senate

      The Honorable Slade Gorton
      Chairman, Subcommittee on Aviation
      Committee on Commerce, Science,
        and Transportation
      United States Senate

      Early in 1998, the six largest U.S. airlines, which account for nearly
      70 percent of domestic airline traffic, announced their intentions to form
      three alliances, in which the partners—Northwest and Continental, Delta
      and United, and American and US Airways—would cooperate on some
      aspects of their business (see app. I for information on the airlines’ market
      shares). These alliances vary from a limited marketing arrangement, such
      as reciprocal frequent flyer programs, to more complex agreements, such
      as those involving “code-sharing”1 or one partner’s ownership of an equity
      share in the other partner’s business. The airlines say that these alliances
      will benefit consumers through expanded route networks and combined
      frequent flyer programs. Others, however, say that the alliances will
      decrease competition, ultimately reducing passengers’ choices and
      increasing fares. Concerned over the potential anticompetitive effects of
      the alliances, the Department of Transportation is reviewing them, and the
      Department of Justice filed suit in October 1998 to prevent Northwest
      from acquiring voting control of Continental. Justice did not, however,
      request a temporary injunction precluding the transfer of voting control.

      At your request, we have been examining the implications of these
      alliances. On June 4, 1998, we offered the preliminary results of our
      analysis in testimony before the Subcommittee on Aviation, Senate



      1
       Code-sharing allows an airline to sell seats on its partner’s plane as if they were its own, enabling the
      airline to expand its route network without adding any planes. For example, if Northwest and
      Continental have a code-sharing agreement and Northwest flies from Minneapolis to Duluth (and
      Continental does not), and Continental flies from Amarillo through Houston to Minneapolis (and
      Northwest does not), then both airlines could sell tickets from Amarillo to Duluth as their own flights,
      and each computer reservation system would indicate that both airlines provide seamless (“on-line”)
      service to these cities. Thus, both Continental and Northwest would increase their route networks
      without adding any new flights. The computer reservation system could also show this flight a third
      time as a connecting flight with segments served by both airlines.



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                   Committee on Commerce, Science, and Transportation.2 This report
                   expands on that testimony and offers more information about the
                   implications of the alliances. As agreed with your offices, the report
                   (1) describes the status of each of the alliances, (2) examines, for each
                   alliance, the potential beneficial and harmful effects on consumers, and
                   (3) examines the authority of the departments of Justice and
                   Transportation to review these alliances and the status of their reviews.


                   All six airlines have begun implementing various aspects of their
Results in Brief   agreements. Northwest completed its acquisition of equity in Continental,
                   and the two airlines began implementing their reciprocal frequent flyer
                   programs. Since we testified in June 1998, however, Northwest and
                   Continental have revised their agreement. Under the terms of the revised
                   agreement, Northwest altered its equity investment in Continental, agreed
                   to forgo its right to place someone on Continental’s Board of Directors,
                   and agreed to forgo code-sharing with Continental in certain domestic
                   markets. Even though Northwest and Continental have implemented their
                   agreement, it remains under review at both Justice and Transportation.
                   The alliance between United Airlines and Delta Air Lines was originally to
                   include code-sharing, but it has been scaled back to an arrangement
                   involving reciprocal frequent flyer programs and access to airport lounges.
                   This arrangement, which the airlines began implementing in September
                   1998, is much the same as the one American Airlines and US Airways
                   proposed and began implementing in August 1998.

                   The alliances may have both beneficial and harmful effects on consumers.
                   And because they differ in scope, their possible effects vary. Officials from
                   Northwest and Continental said that their alliance will benefit consumers
                   through expanded route networks, more frequency options (that is, more
                   flights on the same routes), improved connections, and enhanced frequent
                   flyer programs. Our analysis showed that the alliance could result in new,
                   possibly improved, route options, and the alliance’s extended frequent
                   flyer program may benefit members of each airline’s program. We also
                   found that this alliance will create some “new” markets that are not
                   already served by other airlines. However, our analysis indicated fewer
                   new markets than the alliance partners estimated, and it showed that these
                   new markets will serve relatively few passengers. On the other hand,
                   consumers would be harmed if competition is reduced. But it is difficult to
                   determine whether the partners in the alliance will continue to compete or


                   2
                    Aviation Competition: Proposed Domestic Alliances Raise Serious Issues (GAO/T-RCED-98-215,
                   June 4, 1998).



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whether the alliance will encourage them to act in a manner that may
reduce competition. Airline officials have said that the partners will
continue to compete. However, industry experts have raised concerns that
competition will likely decline over time as firms recognize their
interdependence and maintain prices above the competitive level. Our
analysis indicates that if Northwest and Continental do not act
independently, competition could decline in 63 markets that served
2 million passengers in 1997, and the two airlines could also increase by
5 percent the number of markets that they dominate. According to
industry experts, airlines that achieve dominant market positions can
drive out competitors with smaller shares and eventually raise fares. In
addition, we recently reported that certain airline marketing practices,
such as frequent flyer programs—a feature common to all of the
alliances—can make competitive entry more difficult for other airlines,
especially in markets where one airline has a substantial share of the
market, thus possibly limiting the benefits of deregulation in the airline
industry. However, we have not been able to quantify the effects on
competition that such practices would exert.

The departments of Justice and Transportation are separately reviewing
the three alliances under different statutory authorities and have different
remedies available to them. On October 23, 1998, Justice filed a civil
antitrust action to prevent Northwest from acquiring or holding a majority
of Continental’s voting stock. Justice said in its complaint that Northwest’s
gaining control would lessen competition in interstate trade and
commerce and unreasonably restrain trade. Justice believed that the
alliance would substantially diminish both airlines’ incentives to compete
against each other and would cause consumers to pay higher prices and
receive lower-quality service in some markets. Justice will review other
aspects of the Northwest-Continental alliance, as well as the other two
alliances, using guidelines that are applied to traditional mergers, but it is
under no timetable for these reviews. The Congress recently authorized
Transportation to impose waiting periods before certain joint venture
arrangements involving major airlines, such as frequent flyer programs,
can be effective. Transportation imposed a waiting period on the frequent
flyer and code-sharing aspects of the Northwest-Continental alliance
under this new authority but eventually agreed that the airlines could
proceed with their frequent flyer program. Transportation officials say that
they have received information about the United-Delta and American-US
Airways alliances’ frequent flyer agreements, which are already in effect.
Transportation will request additional information if it decides the
information received is not sufficient and if the airlines propose to extend



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             their alliances to include code-sharing. Transportation also has the
             authority to prohibit unfair methods of competition in the airline industry,
             which it can use in reviewing alliances after they have been implemented.


             Two or more airlines may enter into an alliance to increase their revenues
Background   and the number of passengers they carry. Code-sharing is one type of
             alliance. It can be an important marketing tool for airlines because it
             allows the code-sharing partners to replicate the “seamless travel” that can
             be provided by a single airline, known as “on-line” service. Airline
             passengers prefer this type of service because it allows the convenience of
             single ticketing and check-in, among other things.3 For a code-sharing
             flight, each partner sets its own fare for the entire trip, covering both the
             segment it flies and the one its partner flies.

             In recent years, alliances among airlines have become very common in
             international aviation because they allow airlines to enter markets that
             would be (1) too expensive to serve with their own aircraft or
             (2) restricted under a bilateral aviation agreement with another nation.4
             The Department of Transportation (DOT) reported that there were 74 active
             alliances between U.S. and foreign carriers as of June 1998. In the simplest
             case, an international code-sharing alliance links the route network of one
             airline with the route network of another, forming an end-to-end alliance
             with little overlap. Figure 1 shows how such an alliance links two airlines,
             one with an extensive route network in the United States and the other
             with an extensive route network in Europe and Africa.




             3
              Similar conveniences can be obtained between two airlines that have certain agreements, commonly
             referred to as “interline agreements.” Interline agreements provide for the mutual acceptance by the
             participating airlines of passenger tickets, baggage checks, and cargo waybills, as well as establish
             uniform procedures in these areas. These agreements are common, but not universal, among the major
             U.S. airlines. All major U.S. airlines except for Southwest have interline agreements. According to the
             Department of Transportation, there are important differences between code-sharing and interline
             agreements. For example, interline agreements typically do not include reciprocal frequent flyer and
             airport lounge rights, and airlines will generally not hold outgoing connecting flights to wait for
             delayed incoming flights. Most importantly, however, fares for code-sharing flights are generally much
             cheaper than for interline flights. See pp. 19-20 for additional information on the relative prices of
             interline and code-sharing flights.
             4
              According to United, its decision to enter a particular international market tends to be revenue-based
             and considers such factors as the airline’s overall network size and presence at that city. Certain
             markets may simply be too small to support head-to-head alliance competition.



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Figure 1: Illustration of a Hypothetical End-To-End International Alliance




                                                                Individual airline networks
                                                                Overlapping route




                                            In our previous work, we found that alliances between U.S. and foreign
                                            airlines that involved code-sharing in a large number of markets did
                                            benefit the alliance partners. The alliance generated large gains for the
                                            partners in terms of passengers and revenues, mainly at the expense of
                                            other airlines.5 We also found that although consumers benefited from
                                            conveniences such as shorter layovers, the data were insufficient to
                                            determine the effects of the alliances on fares in the short term and on
                                            competition and fares in the long term.

                                            Domestically, code-sharing alliances have generally occurred between
                                            major U.S. airlines and regional commuter airlines that transport
                                            passengers, usually from smaller communities to the cities served by the
                                            major carriers. Similar to international alliances, these alliances generally
                                            link end-to-end networks without creating a significant overlap in service.
                                            For example, United Airlines has a code-sharing agreement with Atlantic
                                            Coast Airlines to bring passengers into its hub at Washington Dulles

                                            5
                                             International Aviation: Airline Alliances Produce Benefits, but Effect on Competition Is Uncertain
                                            (GAO/RCED-95-99, Apr. 6, 1995).



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                       Airport. Additionally, several major U.S. airlines have used code-sharing in
                       a limited number of markets. For example, in 1994, Continental and
                       America West airlines entered into a limited code-sharing agreement, and
                       in 1996, Northwest and Alaska Airlines also entered into a limited
                       code-sharing agreement.

                       The federal government has limited authority over proposed airline
                       alliances. 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 are very restrictive. Since the late 1970s, U.S. policy
                       has been to negotiate agreements that substantially reduce or eliminate
                       bilateral restrictions (“open skies” agreements). In the domestic sector,
                       however, the Airline Deregulation Act of 1978 generally eliminated the
                       government’s authority over airline routes, frequencies, and pricing. Under
                       new legislation passed in October 1998, DOT has the authority to impose an
                       initial 30-day waiting period, which it may extend another 150 days for
                       joint ventures involving code-sharing between major airlines.6 This
                       authority does not limit the Department of Justice’s (DOJ) authority to
                       enforce the antitrust laws. DOT may also investigate whether an alliance is
                       an unfair method of competition.


                       Since we testified in June 1998, each of the three domestic alliances has
Status of the          begun to implement at least part of its agreement. On November 20, 1998,
Alliances: All Three   Northwest and Continental announced that Northwest had completed its
Alliances Have Been    acquisition of the equity position in Continental. The two airlines also
                       announced that they had revised their agreement and would implement
Initiated              the marketing aspects of their alliance in December 1998. United and Delta
                       and American and US Airways have begun to implement their alliances,
                       although the United-Delta proposal no longer includes code-sharing. Like
                       the American-US Airways proposal, it is now limited to offering consumers
                       reciprocal frequent flyer and airport lounge benefits. The alliance between
                       Northwest and Continental airlines remains under review at both DOJ and
                       DOT, which has requested additional information from each of the six
                       airlines on the frequent flyer arrangements with its respective alliance
                       partner.



                       6
                        P. L. 105-277, sec. 110(f). Generally, the joint venture agreements subject to this waiting period
                       include only those that were entered into by a major airline after Jan. 1, 1998, and involve
                       code-sharing, certain leasing arrangements, frequent flyer programs, and other cooperative working
                       arrangements designated by DOT.



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Northwest and Continental   On November 20, 1998, Northwest and Continental announced that
Have Begun to Implement     Northwest had completed the acquisition of 8.7 million shares of
Their Alliance Agreement    Continental’s stock, which it then deposited in a voting trust.7 The
                            agreement announced on that date is somewhat different from that
                            originally announced by the airlines in January 1998. According to the
                            airlines, under the new terms of the agreement between them, Northwest
                            will acquire less than a majority of the voting control of Continental,8 forgo
                            its right to place someone on Continental’s board of directors, and forgo
                            code-sharing with Continental in certain hub-to-hub domestic markets.
                            Continental said that to protect its stockholders, its board has adopted a
                            shareholder rights plan that will become effective if 15 percent or more of
                            its voting stock is acquired by a single investor.

                            Nevertheless, the closing of the stock acquisition represented a major step
                            toward implementing the “strategic global alliance” that the airlines
                            announced in January 1998 to connect their route systems. The two
                            airlines announced that they would accept code-sharing bookings starting
                            December 12, 1998, with code-sharing flights to Japan beginning
                            December 29, 1998, and to other destinations beginning January 7, 1999.
                            The code-sharing plan ultimately will include the airlines’ international
                            code-sharing partners, such as Air China9 and KLM Royal Dutch Airlines.10


                            7
                             According to Northwest and Continental officials, the voting trust means that Northwest’s shares will
                            generally be voted in proportion to the votes of the non-Northwest shareholders. According to airline
                            officials, except in exceptional circumstances, the outcome of a vote will not be affected. The voting
                            trust ends after 6 years, and Northwest has agreed on significant voting restrictions for 4 years
                            thereafter. Northwest has also agreed to vote for a majority of independent directors on Continental’s
                            board. After 10 years, Northwest can exercise the full power of its ownership.
                            8
                             Northwest’s equity purchase equates to approximately 46 percent of the fully diluted voting rights
                            rather than 51 percent as originally proposed. (Fully diluted voting rights are those adjusted for the
                            conversion into common stock of all convertible securities.) Under the terms of the November
                            agreement, certain partners of the original holders of that stock retained approximately 5 percent of
                            the total stock but granted Northwest a “limited proxy” to vote these shares. According to a
                            Continental official, this means that these shares may be voted generally in accordance with
                            Northwest’s wishes only in extraordinary circumstances (e.g., matters that would materially affect
                            Northwest’s ownership position, such as potential mergers, recapitalizations, or liquidations) or in
                            circumstances where Northwest votes for directors in accordance with the recommendation of
                            Continental’s board, in which limited cases they would be voted as directed by Northwest. DOJ filed
                            an amended complaint on Dec. 18, 1998, to reflect Northwest’s consummation of its stock purchase
                            agreement and changes made to various agreements by the parties involved in the transaction. The
                            amended complaint alleges that Northwest would still own more than 50 percent of the fully diluted
                            voting power over Continental.
                            9
                             Northwest and Air China, the largest airline in China, announced their code-sharing arrangement in
                            May 1998, including Alaska Airlines, Continental, and America West. The arrangement gives Alaska
                            and America West their first Asian code-sharing partner, Continental its first access to mainland China,
                            and Northwest improved access to China.
                            10
                             In Jan. 1993, DOT granted antitrust immunity to the Northwest-KLM alliance in conjunction with the
                            U.S.-Netherlands open skies accord.



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Each airline has a separate code-sharing agreement with America West11
and may independently pursue other domestic alliances.12 The alliance will
also include the airlines’ regional partners, Northwest Airlink,13 in which
Northwest holds some equity, and Continental Express, which is wholly
owned by Continental. As part of the agreement, the airlines will also
undertake other cooperative activities, including marketing and
coordinating their flight schedules to improve connection times. Airline
executives stated that they will not coordinate pricing or capacity, and
they submitted their alliance proposal to DOJ under the Hart-Scott-Rodino
Antitrust Improvements Act of 197614 (Hart-Scott-Rodino Act) as if it were
a full merger. Northwest and Continental invited DOJ to review the
transaction under its stringent merger guidelines.

In addition, the airlines established reciprocal frequent flyer programs,
allowing members to earn and redeem their miles on either carrier.
Beginning December 6, 1998, members of each airline’s frequent flyer
programs can earn miles for travel on the other airline’s flights and can
begin redeeming miles on February 1, 1999, for travel beginning on
March 1, 1999. Both airlines announced several changes to their frequent
flyer programs, as well. For example, members will be able to redeem
mileage at reduced levels and travel during off-peak times. At other award
levels, the airlines will have fewer blackout dates (when frequent flyer
awards may not be used). On November 21, 1998, each airline opened its
club facilities to members of the other airline’s clubs, thereby expanding
the number of airports where members can use clubs.

Northwest’s principal service areas are the Midwest and Midsouth, while
Continental’s are the Northeast and Southwest. Figure 2 shows the
percentage share of departing passengers that the Northwest-Continental
alliance, had it been in effect in 1997, would have carried. It indicates that
the Northwest-Continental alliance would carry large percentages of
passengers (i.e., would have relatively large market strength) in the upper
Midwest, South, and Northeast. According to the airlines, these were

11
 America West and Continental have had a relatively limited code-sharing agreement since 1994. The
agreement has grown from 45 to 72 route segments, allowing Continental to place its code on America
West’s flights west of Phoenix and Las Vegas and allowing America West to place its codes on
Continental’s flights east of Houston, Cleveland, and Newark.
12
  Alaska Air Group, Inc., owners of Alaska Airlines and Horizon Airlines, has a code-sharing agreement
with Northwest and recently agreed to one with KLM. The Alaska—Northwest code-sharing agreement
covers all of Northwest’s markets and Alaska’s feeder markets (routes into Seattle and Los Angeles
through Horizon Airlines, a wholly owned subsidiary of Alaska Air Group, Inc., which also owns
Alaska Airlines). These routes serve to funnel Alaska’s passenger traffic on to Northwest’s
trans-Pacific, transcontinental, and Midwest flights.
13
  The Northwest Airlink carriers are Mesaba Airlines and Express Airlines I. Code-sharing with other
regional partners will have to be negotiated separately.
14
 15 U.S.C. § 18a.
Page 8                                               GAO/RCED-99-37 Domestic Airline Alliances
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essentially preexisting market shares of Northwest and Continental,
respectively, and the market shares in these regions did not increase
materially as a result of the alliance.




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Figure 2: Percentage of Each State’s Departing Passengers That the Northwest-Continental Alliance Would Have Carried




                                                          Less than 10%
                                                          10% - 25%
                                                          26% - 49%
                                                          Over 50%



                                         Note: This figure is based on the alliance’s share of the number of departing passengers carried
                                         by all major airlines, by state, during 1997. In 1997, the major airlines carried 85.8 percent of all
                                         passengers enplaned in the United States.

                                         For the purposes of this and subsequent figures, we classified passengers originating from the
                                         Greater Cincinnati International Airport as originating from Ohio, rather than Kentucky (where the
                                         airport is located), and those originating from Washington Reagan National Airport as originating
                                         from Virginia, rather than the District of Columbia or Maryland. We did so because information
                                         from the airports indicated that more of their passengers came from these states than from the
                                         other jurisdictions.

                                         Source: GAO’s analysis of information provided by Data Base Products, Inc.




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                           Under the alliance, the two airlines combined carry approximately
                           15 percent of the total domestic passenger market. Such a combination
                           effectively creates the second largest domestic market share (in terms of
                           the number of passengers carried), behind Delta’s 18 percent and ahead of
                           United’s 13 percent. (See app. I for more detailed information on the
                           domestic market shares of U.S. airlines.)


United and Delta Have      In April 1998, 3 months after Northwest and Continental proposed their
Begun Implementing a       alliance and investment agreements, United and Delta announced their
More Limited Alliance      plan to form a global alliance. This alliance would have linked the two
                           largest domestic airlines through code-sharing and reciprocal frequent
Than Originally Proposed   flyer programs. Moreover, as envisioned, it would have produced a larger
                           combined market share than either of the other alliances—almost
                           31 percent of domestic passengers. It would have joined United’s
                           extensive route networks in the West and Midwest with Delta’s similarly
                           extensive networks in the East, Southeast, and Southwest. Figure 3 shows
                           the percentage share of departing passengers that the United-Delta
                           alliance, had it been in effect in 1997, would have carried. It indicates that
                           the alliance, as originally proposed, would have had market strength
                           virtually nationwide.




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Figure 3: Percentage of Each State’s Departing Passengers That the Originally Proposed United-Delta Alliance Would Have
Carried




                                                         Less than 10%
                                                         10% - 25%
                                                         26% - 49%
                                                         Over 50%



                                          Note: Figure 3 is based on the alliance’s share of the number of departing passengers carried by
                                          all major airlines, by state, during 1997. In 1997, the major airlines carried 85.8 percent of all
                                          passengers enplaned in the United States.

                                          Source: GAO’s analysis of information provided by Data Base Products, Inc.




                                          On September 1, 1998, however, Delta and United announced that they
                                          had discontinued discussions concerning code-sharing arrangements.15


                                          15
                                           On Aug. 17, 1998, Delta’s board said that it would not grant an Air Line Pilots Association proposal to
                                          convert its existing nonvoting seat on the board to full voting status.



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                           The two airlines implemented their reciprocal frequent flyer programs on
                           September 1, 1998, allowing passengers who fly on either airline to choose
                           the program where they accrue and redeem their miles.


American-US Airways        Also in April 1998, 3 months after Northwest and Continental announced
Began Implementing Their   their alliance, American Airlines and US Airways announced that they had
Alliance in August         agreed on a limited marketing relationship involving their frequent flyer
                           programs and club facilities. The airlines began implementing the frequent
                           flyer agreement in August 1998. The airlines further announced a special
                           methodology for allocating costs between the two airlines on interline
                           flights. According to US Airways, the methodology allows each airline to
                           recover its costs for the segment it flies and to divide revenues in the same
                           proportion. Airline officials have said that they may consider some very
                           limited code-sharing with their regional partners, American Eagle and US
                           Airways Express.16

                           American and US Airways offer greater market presence in different parts
                           of the country. US Airways has a strong presence in the Northeast,
                           Mid-Atlantic, and Southeast, while American’s network extends across
                           much of the rest of the United States.17 Should this arrangement move
                           beyond reciprocal frequent flyer programs to code-sharing, the alliance’s
                           market share would be about 22 percent of total domestic passengers.
                           Figure 4 shows the percentage share of departing passengers that the
                           American-US Airways alliance, had it been in effect in 1997 and extended
                           to include code-sharing, would have carried. It indicates that such an
                           alliance would have had market strength mostly on the East Coast.




                           16
                             According to the airlines, there has been some discussion of such code-sharing, but certain labor and
                           commercial issues remain to be resolved. Senior management of US Airways has stated that it does not
                           favor domestic code-sharing between the mainline divisions of US Airways and American but would
                           consider such code-sharing as a competitive response to actions of other airlines and alliances. As of
                           the end of Dec. 1998, the two airlines had not discussed mainline code-sharing.
                           17
                             On Nov. 19, 1998, American Airlines announced that it had agreed to acquire Reno Air for
                           $124 million. Reno’s 16-city route system extends from Oklahoma City to Anchorage and includes
                           service to Tucson, San Diego, Los Angeles, San Francisco, Portland, and Seattle. It also serves San
                           Jose, subleasing the gates formerly operated by American. This purchase will strengthen American’s
                           north-south route system on the West Coast. On Dec. 9, 1998, Alaska Air Group, Inc., announced that it
                           had signed a letter of intent for the creation of a marketing partnership between its subsidiaries,
                           Alaska Airlines and Horizon Air, and American Airlines—American Eagle. Alaska and Horizon intend
                           to implement fully reciprocal frequent flyer relationships with American and American Eagle, allowing
                           customers to earn and use mileage awards across each other’s networks. Code-sharing by the airlines
                           has also been discussed but is subject to labor contract provisions.



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Figure 4: Percentage of Each State’s Departing Passengers That a Code-Sharing Alliance Between American and US
Airways Would Have Carried




                                                          Less than 10%
                                                          10% - 25%
                                                          26% - 49%
                                                          Over 50%




                                         Note: Figure 4 is based on the alliance’s share of the number of departing passengers carried by
                                         all major airlines, by state, during 1997. In 1997, the major airlines carried 85.8 percent of all
                                         passengers enplaned in the United States. This figure also includes Reno Air’s share of
                                         departures in the markets served by Reno in 1997.

                                         Source: GAO’s analysis of information provided by Data Base Products, Inc.




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                           The alliances may have beneficial and harmful effects on consumers.
Alliances Could Have       Because the alliances currently differ in scope, their potential benefits
Beneficial and             range from increased on-line service and more efficient routings to
Harmful Effects on         enhanced frequent flyer programs and access to more club facilities.
                           Harmful effects will occur if competition is reduced. Alliance airline
Consumers                  officials have stated that they will act independently. On the other hand,
                           industry experts have said that they think competition between alliance
                           partners will decline over time. It is difficult to determine what will
                           happen in the future, but some experts’ concerns are consistent with
                           widely held economic principles and past experience in the airline
                           industry. With code-sharing, the opportunity for harm increases with the
                           number of overlapping markets and the number of passengers flying in
                           these markets. Thus, an end-to-end alliance with few overlapping routes
                           that serves fairly small markets is less likely to threaten competition than
                           an alliance between partners that share a number of heavily traveled
                           markets. In addition, under enhanced frequent flyer programs, it may be
                           more difficult for would-be competitors to enter markets where the
                           alliance partners already have a substantial market share, thus further
                           limiting competition and the potential benefits of deregulation in the
                           airline industry.

                           This section examines the potential beneficial and harmful effects on
                           consumers of the arrangement between Northwest and Continental—the
                           only one with plans for equity acquisition and code-sharing as of
                           December 1998 (see app. II for a detailed description of our scope and
                           methodology). However, the other alliances may introduce code-sharing if
                           the Northwest-Continental proposal is implemented. Consequently, we
                           analyzed the potential effects of the United-Delta alliance (see app. III) and
                           of the American-US Airways alliance (see app. IV) using the same
                           approach and framework that we applied to the Northwest-Continental
                           alliance. We also analyzed the potential effects, on consumers and the
                           industry as a whole, of all three alliances’ implementing code-sharing (see
                           app. V).


Northwest-Continental      Because the Northwest-Continental alliance involves code-sharing, it
Alliance Could Have Both   could benefit consumers in several ways. First, it will create new on-line
Beneficial and Harmful     destinations, even though no aircraft or flights are added. In addition, it
                           will increase the number of flights in a market attributable to a single
Effects on Consumers       airline (flight frequencies) and provide better connections so that
                           consumers can reach their destinations sooner. Finally, the alliance will
                           give consumers more frequent flyer award destinations and access to more



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                              club facilities. At the same time, however, the alliance creates the
                              possibility of harm for air travelers, especially over the longer term. If
                              competition is reduced, consumers would be harmed. Specifically, should
                              the airlines compete less vigorously or act as one entity if Northwest
                              acquires a majority interest in Continental, then consumers could be
                              harmed through the decrease in competition, especially on routes where
                              both airlines previously competed. Our analysis of the potential beneficial
                              and harmful effects of the alliance between Northwest and Continental
                              follows.

Alliance Could Benefit        According to Northwest and Continental officials, their alliance will create
Consumers by Providing More   new on-line service to 2,007 new domestic and international city pairs,
On-Line Destinations          thereby benefiting the approximately 3.4 million passengers who flew on
                              these routes in 1997.18 One airline official believes that the new on-line
                              service will divert passengers from other airlines that provide poorer
                              connections and will stimulate new flying by passengers who previously
                              chose not to fly. Because the alliance will convert passenger routings from
                              interline connections to on-line connections, the official also expects the
                              alliance partners to offer lower fares in some markets that previously
                              could be served only on an interline basis.19In turn, such lower fares will
                              also stimulate travel on these routes.

                              Because this study is limited to domestic airline alliances, we did not
                              analyze the impact of the alliance on Northwest’s and Continental’s
                              international markets. We did, however, analyze its impact on both
                              airlines’ domestic markets and included in our review new markets that
                              would be created through routes with one or two connections. Although
                              the airlines also included new city pairs that would be created through
                              routings that require three connections, we did not include these markets
                              because we believe that the number of passengers who would book flights
                              with so many connections is relatively small.20

                              18
                                According to an economic consultant for Northwest, these cities are mainly, but not exclusively,
                              located in the United States. Included are cities served by Northwest and Continental in North and
                              Central America, but not those in Europe, Asia, or South America.
                              19
                                According to airline officials, interline fares are most frequently the sum of the fares for each airline’s
                              segment of the itinerary. Even when tickets are purchased well in advance to take advantage of
                              possible airline discounting, such fares tend to be considerably higher than on-line fares from the same
                              origin to the same destination. Newly created on-line fares should be less expensive than these
                              interline fares because each airline in an alliance now has an incentive to compete on fares to attract
                              passengers to its own airline.
                              20
                                We also limited our analysis of this and the other alliances in other ways. For example, using the
                              airlines’ published schedule for May 1998, we required arriving and departing flights to be scheduled
                              within 30 and 150 minutes to qualify as potentially valid connections. For double connections, we
                              limited our analysis to flights that connected through the partners’ hubs. For additional information on
                              our methodology, see app. II.



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Our analysis showed that a code-sharing alliance between Northwest and
Continental would serve considerably fewer new airport pairs than the
airlines estimated. We found, first, that such an alliance could create
on-line single-connection service in 74 markets that served about 400,000
passengers in 1997 (or about 15 per day per route). In 22 of these markets,
the Northwest-Continental alliance would produce superior service to that
already offered by a competitor. In the other 52 markets, competing
airlines’ existing service would be superior or at least equal to that
anticipated under the alliance. At the same time, however, we found that
the alliance would create no new service in any of these single-connection
markets because all 74 were already served either by one of the alliance
partners or by a competitor. We also found that a Northwest-Continental
alliance could create 71 new double-connection markets. The
Northwest-Continental alliance would provide superior service to that
offered by competitors in two markets, but other competing airlines
already provided superior or equal service in the other 69 markets. Table 1
provides our detailed analysis of the new on-line benefits that consumers
could expect from this alliance.




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Table 1: GAO’s Analysis of Airport Pairs That Would Receive New On-Line Service Through Single or Double Connections
Under a Northwest-Continental Alliance
                              Total markets and average number of
                                 passengers per day who would
                               receive new Northwest-Continental
                                              service                      Number of         Number of         Number of
                                               Average number            markets in which        markets in which        markets in which
                                              of passengers per                 competing               competing               competing
                                    Number of day per market in           airlines provide        airlines provide        airlines provide
Type of new on-line service           markets             1997           superior servicea         equal serviceb         inferior servicec
Single-connection                           74                     15                      10                      42                         22
Double-connection                           71                       6                     54                      15                          2
                                        a
                                         Superior service includes current direct and nonstop service by competitors between airports
                                        that Northwest-Continental could serve at best with single-connection service; and direct,
                                        nonstop, or single-connection service by competitors between airports that Northwest-Continental
                                        could serve at best with double-connection service. Direct service differs from nonstop service in
                                        that a “direct” flight makes a scheduled stop between an origin and a destination, but passengers
                                        flying between the origin and destination are not required to change planes, while a nonstop flight
                                        between an origin and a destination makes no scheduled stops en route.
                                        b
                                         Equal service means that competing airlines currently offer service that matches the
                                        Northwest-Continental alliance’s potential single- or double-connection service.
                                        c
                                         Inferior service means that competing airlines currently offer (1) no service or double-connection
                                        service between airports where the Northwest-Continental alliance could offer single-connection
                                        service or (2) no service between airports where the alliance could provide double-connection
                                        service.

                                        Source: GAO’s analysis of information provided by BACK Associates and Data Base Products,
                                        Inc.



Alliance Could Benefit                  According to Northwest and Continental officials, the alliance will provide
Consumers by Providing More             17,446 new on-line flight opportunities in 10,459 markets that, they say,
Frequencies and Improved                will create additional routings in existing markets, increasing convenience
Routings                                and choice for their passengers and reducing travel times for an estimated
                                        250,000 passengers. For example, Northwest and Continental say that by
                                        routing passengers from Milwaukee to Honolulu through San Francisco
                                        instead of Seattle, the alliance will shorten these passengers’ connection
                                        times by about 1.5 hours.

                                        Our limited analysis of flight frequencies suggests that the alliance could
                                        result in new, possibly improved, route options. For various technical
                                        reasons, we were unable to duplicate the model that Northwest and
                                        Continental used to calculate the number of new routing possibilities. We
                                        note, however, that their earlier modeling of benefits included destinations
                                        other than those in the United States, causing them to overestimate the
                                        new domestic routing possibilities.



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Alliance Could Benefit         Although there is some uncertainty about the extent of the service and
Members of the Airlines’       routing benefits under the Northwest-Continental alliance, the agreement
Frequent Flyer Programs and    to offer reciprocal access to the airlines’ frequent flyer programs and club
Clubs                          facilities could provide direct benefits to customers of both airlines.
                               Passengers may choose to participate in one or both of the frequent flyer
                               programs (either Northwest’s “WorldPerks” program or Continental’s
                               “OnePass” program), but miles earned on any given alliance flight can be
                               awarded to only one program. Travelers will not be able to combine miles
                               from both programs to achieve an award. This reciprocal relationship
                               should increase the value of these programs to frequent flyers because
                               more destinations and frequencies will be available. Northwest and
                               Continental do not expect to significantly change how they distribute
                               frequent flyer seats, which may be different on each flight because of
                               various market forces. According to the airlines, club members will have
                               access to facilities at all the airports where the alliance partners have club
                               facilities starting November 21, 1998.

                               Members of each airline’s frequent flyer program could benefit from the
                               alliance’s ability to offer new destinations. When announcing the
                               consummation of their alliance, both airlines announced enhancements to
                               their programs. Northwest noted that its WorldPerks members will still be
                               able to redeem free travel awards for as few as 20,000 miles within North
                               America and that these awards will be available for travel during 9 months
                               of the year instead of just 10 weeks. Northwest also announced a number
                               of changes to its frequent flyer program, including fewer blackout dates
                               (when frequent flyer awards cannot be used) for WorldPerks travel within
                               North America. Continental announced that travel during off-peak times
                               will be available at reduced mileage levels starting March 1, 1999.

Potential Harmful Effects of   According to Northwest and Continental, their alliance is unlikely to harm
Alliance Depend on Whether     consumers because it is an end-to-end alliance with relatively few
Partners Compete Less          overlapping markets. Nevertheless, the alliance could harm consumers if it
Vigorously                     decreases competition in markets that are already served by both
                               partners,21 especially in those where the alliance gives the partners a
                               “dominant” market position (i.e., control of more than 50 percent of the
                               market). Such an increase in market dominance is significant, according to
                               industry analysts, who predicted that the partners might not be able to
                               gain much market share overall but might be able to increase
                               revenues—presumably by raising fares—in individual markets where they


                               21
                                DOJ’s lawsuit against the investment agreement between Northwest and Continental states that the
                               acquisition would substantially diminish the incentives for the two airlines to compete against each
                               other.



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                               held a dominant position.22 The Northwest-Continental alliance could also
                               increase barriers for other airlines that might want to enter particular
                               markets. To examine the potential harm from the alliance, we determined
                               the extent to which each airline’s routes overlapped with those of its
                               alliance partner by analyzing 1997 data on the 5,000 busiest domestic
                               airport-pair origin and destination markets or markets for air travel
                               between two airports. These 5,000 markets accounted for over 90 percent
                               of the total U.S. domestic air traffic in 1997.23

Experts Suggest Partners May   The potential for the Northwest-Continental alliance to harm consumers
Not Compete Vigorously, but    depends on the features of the agreement and on whether it creates an
Airlines Say They Will         environment that discourages competition between the two partners.
                               Several factors could influence whether the partners cooperate rather than
                               compete as independent entities. These factors include how much
                               ownership one partner has in the other, how revenue from jointly operated
                               flights is shared, whether the airlines’ pricing practices change, and
                               whether the airlines coordinate their schedules, especially if such
                               coordination reduces the total number of flights or available seats in a
                               market. Some of this information is contained in proprietary documents
                               provided by Northwest and Continental to DOJ and DOT. Northwest and
                               Continental declined to let us review these confidential documents, but we
                               discussed various elements of the agreement with airline officials and
                               industry experts.24

                               All but one of the industry experts whom we interviewed agreed that an
                               investment such as Northwest’s in Continental would be likely to affect
                               the behavior of the airlines over time, encouraging them to cooperate in
                               order to maximize the value of the investment to their stockholders. Some
                               of these industry experts believed that the alliance partners would not
                               vigorously compete with each other, particularly over the long term. If
                               they are correct, then the alliance could have harmful effects on
                               consumers. In contrast, officials from Northwest and Continental insist
                               that while their alliance arrangement is in many ways like a merger, the
                               airlines will continue to operate independently. They said that although

                               22
                                We have also reported in the past that airfares in dominated markets tend to be higher than in other
                               markets. See, for example, Airline Competition: Effects of Airline Concentration and Barriers to Entry
                               on Airfares (GAO/RCED-91-101, Apr. 26, 1991).
                               23
                                 The following example indicates how large these markets are: The smallest of the top 5,000 were
                               between Jacksonville, Florida, and Newport News/Williamsburg, Virginia, and between Burlington,
                               Vermont, and Cleveland, Ohio. In each of these markets, 7,964 passengers (an average of 22 each day)
                               flew in 1997.
                               24
                                These industry experts included several financial analysts in New York investment firms and
                               brokerage services, nationally recognized academicians, and other individuals with expertise in
                               specific aspects of the industry, such as computer reservation systems.


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Northwest will own the largest percentage of the voting stock in
Continental, it will not own a majority of the voting stock and its voting
trust agreement with Continental is such that it effectively has no ability to
affect or influence the control or management of Continental for the next
10 years.25

Industry experts expressed concern that this alliance could create an
environment in which the airlines would compete less vigorously even if
there were no change in equity between the alliance partners. One
industry expert we spoke with said that in the airline industry, where there
are only a few firms and where rivals’ fare and schedule information is
widely available, tacit coordination is relatively easy. Some industry
experts pointed out, for example, that the two airlines could cooperate on
some aspects of their business. As a result, according to this expert,
Northwest and Continental might not compete aggressively on fares or
schedules, fares could rise, and service levels could eventually decline. In
contrast, Continental and Northwest officials said that they will continue
to set fares and schedules independently and that competition will not
decline because of the alliance. For example, on nonstop routes that both
airlines serve, Continental will receive a booking fee that is similar to a
travel agent’s fee (an amount equal to Continental’s costs) for ticketing a
passenger on a Northwest flight, but none of the revenue, and vice versa.
As a result, airline officials say, each airline will have an incentive to book
passengers on its own airplanes. When a passenger’s travel involves
segments served by both airlines, revenues will be split between the two
airlines on the basis of a prorated schedule that is standard in the industry.
When announcing the stock acquisition, Northwest and Continental also
said that they would not implement code-sharing on the seven hub-to-hub


25
  According to Continental officials, the governance agreement between the two airlines deprives
Northwest of substantially all voting power over the Continental securities it acquired, severely limits
Northwest’s ability to acquire additional voting securities, and prohibits Northwest from seeking to
affect or influence Continental’s business. As a result, they say, Northwest effectively has no ability to
affect or influence the control or management of Continental. In its antitrust complaint against
Northwest and Continental, DOJ disagreed with this conclusion. DOJ said that “. . . the governance
agreement does not prevent the harm likely to result from Northwest’s acquisition of voting control of
Continental. No private agreement can alter the fact that Northwest still owns Continental, and
Continental will not compete vigorously with its owner during the term of the governance agreement.”
After DOJ filed its complaint, Northwest and Continental announced a revision to the acquisition
agreement that provides Northwest with less than half—46 percent—of the voting control of
Continental. Certain partners of the original seller of the majority control of Continental, Air Partners,
L. P., retained ownership of 853,644 shares of Continental’s stock, or about 5 percent, and granted
Northwest a limited proxy for the voting of these shares, thereby limiting the ability of Northwest to
exercise strict voting control over Continental. On Dec. 18, 1998, DOJ filed an amended complaint
reflecting the consummation of Northwest’s stock purchase agreement and changes made to various
agreements by the parties involved in the transaction. The amended complaint alleges that Northwest
would still own more than 50 percent of the fully diluted voting power over Continental. See pp. 37 to
39 for additional information.



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                                 routes that they both serve. For example, for flights from New York City to
                                 Detroit, the two would continue to compete directly.

                                 It is difficult to determine precisely how the alliance will affect
                                 competition, but the industry experts’ concerns and the airlines’ past
                                 records establish cause for concern. As discussed, there is widespread
                                 agreement among these experts that competition will likely decline over
                                 time as firms recognize their interdependence and maintain prices above
                                 the competitive level. This understanding is consistent with widely held
                                 economic principles showing that competition lessens when there are
                                 fewer competitors. It is also consistent with a recent DOT paper containing
                                 evidence that, when given the chance, airlines do not compete vigorously.26
                                  According to DOT, prices on routes of less than 750 miles were generally
                                 not competitive unless a low-fare carrier, such as Southwest, served the
                                 route and kept prices closer to a competitive level. On routes not served
                                 by a low-cost carrier, major airlines have recognized their
                                 interdependence and kept prices above the competitive level. If the ties
                                 between major airlines are strengthened, the airlines will have even more
                                 opportunities to recognize their interdependence. If this occurs,
                                 competition may suffer and prices may rise.

Northwest-Continental Alliance   If the partners in the Northwest-Continental alliance do not vigorously
May Decrease Competition in      compete over time, the harm to consumers will depend on the number of
Certain Markets and Could        markets where the partners provide overlapping service (including the
Potentially Harm Consumers       number of passengers served), the alliance’s share27 of these markets, and
                                 the effects of the alliance on barriers to entry.

                                 The Alliance Could Reduce Competition in Shared Markets. We found that
                                 a Northwest-Continental alliance could reduce or eliminate competition in
                                 63 of the top 5,000 markets. Nearly 2 million passengers traveled in these
                                 markets in 1997. The alliance could effectively eliminate competition in
                                 five markets, with about 36 percent of these passengers (723,186 in 1997),
                                 by reducing the number of competing airlines from two to one. The largest
                                 of these markets is Detroit to Newark, where the alliance partners served
                                 97 percent of the market in 1997—428,574 passengers. In 24 markets, the
                                 alliance could reduce the number of competitors from three to two, and it
                                 could become the largest carrier in nearly two-thirds of these markets. The

                                 26
                                  See Competition in the U.S. Domestic Airline Industry: The Need for a Policy to Prevent Unfair
                                 Practices, DOT (July 1998).
                                 27
                                   Market share may be determined by any number of measures, such as the total number of passengers
                                 that an airline carries, the number of available seats flown by the airline, or the total number of
                                 departures in a given market. For this report, we measured market share by the number of passengers
                                 carried in a given airport-pair market.



                                 Page 22                                              GAO/RCED-99-37 Domestic Airline Alliances
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markets where the alliance could decrease the number of competitors to
three or fewer served approximately 1.6 million passengers in 1997. These
are the markets that could suffer the greatest potential harm from the
alliance.28 Figure 5 illustrates the number of markets and passengers with
the potential to be harmed under a Northwest-Continental alliance if the
partners do not price their fares independently.




28
  For all markets that experienced decreases in the number of active competitors, we calculated the
Herfindahl-Hirschmann Index (HHI), a measure of concentration used by DOJ, in which higher scores
reflect greater increases in market dominance. The HHI is calculated by summing the squares of the
individual market shares of all participants. An HHI below 1000 is considered unconcentrated,
between 1000 and 1800 moderately concentrated, and above 1800 highly concentrated. The average
change in the HHI for the Northwest-Continental alliance was 994, with a range of 219 to 4,588. This
suggests that the Northwest-Continental alliance would create much greater concentration in markets
where the alliance might reduce the number of active competitors from three to two and from two to
one than in markets where the alliance might reduce the number of active competitors from five to
four.



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Figure 5: Number of Markets and
Passengers Subject to Potentially
                                    Markets                                                                           Passengers (millions)
Decreased Competition Under the
                                    250                                                                                                  11
Northwest-Continental Alliance
                                    225                                                                                                  10

                                                                                                                                         9
                                    200

                                                                                                                                         8
                                    175
                                                                                                                                         7
                                    150
                                                                                                                                         6
                                    125
                                                                                                                                         5
                                    100
                                                                                                                                         4
                                    75
                                                                                                                                         3

                                    50
                                                                                                                                         2

                                    25                                                                                                   1

                                     0                                                                                                   0

                                               2 to 1      3 to 2           4 to 3                      5 to 4              6 to 5
                                          Potential decrease in number of competitors
                                               Number of markets
                                               1997 passengers



                                    Note: So that readers can more easily compare the number of markets and passengers
                                    potentially affected by the Northwest-Continental alliance with the number of those potentially
                                    affected by the two other alliances and by all three alliances, should they eventually move to
                                    code-sharing (see figs. III.1, IV.1, and V.1), we are using the same scales for all figures.

                                    Source: GAO’s analysis of data provided by Data Base Products, Inc., on the top 5,000 origin and
                                    destination markets in 1997.




                                    Northwest and Continental have attempted to address DOJ’s concerns
                                    about competition. According to Northwest and Continental officials, the
                                    airlines have agreed not to implement code-sharing in the local hub-to-hub
                                    markets, such as Detroit to Newark, where DOJ identified potentially




                                    Page 24                                              GAO/RCED-99-37 Domestic Airline Alliances
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anticompetitive effects.29 While refraining from code-sharing is a positive
step on the part of the airlines to address these concerns, some industry
experts with whom we spoke expressed doubt about how much it would
reduce the potential harm to consumers. They explained that because the
alliance partners would continue to exchange information on other
aspects of their operations, such as scheduling, they may not be able to act
as independent competing airlines.

To a certain extent, the harmful effects of reducing competition in some
markets, assuming the alliance partners will not compete, could be
mitigated by increasing competition in other markets. In 286 of the top
5,000 markets, each of the two carriers has a limited market share that, if
combined, would create a larger, active competitor.30 These markets
served a total of 15.1 million passengers in 1997.31 However, on average,
the effect of creating this potentially stronger competitor is relatively small
because some of these markets continue to be dominated by other
airlines.32 For example, in 36 of the 286 markets where the
Northwest-Continental alliance’s market share will equal or exceed 10
percent, another single competitor will remain dominant. These 36
markets served 1.2 million passengers in 1997. Thus, although the alliance

29
  The DOJ complaint also cited the following six city-pair market as potentially troublesome:
Detroit-Cleveland, Detroit-Houston, Cleveland-Minneapolis, Minneapolis-New York City,
Houston-Minneapolis, and Houston-Memphis. By forgoing code-sharing in these markets, the airlines
have adopted an approach similar to that often used by international airline alliances seeking antitrust
immunity. For example, in reviewing the alliance between United and Lufthansa German Airlines, DOJ
expressed concern that the two airlines could dominate particular city- or airport-pair markets. DOT
ordered that antitrust immunity would not extend to airline activities relating to pricing, inventory or
yield management coordination, or pooling of revenues, with respect to certain passengers flying
nonstop between Chicago and Frankfurt, and Washington and Frankfurt.
30
  Our prior testimony, Aviation Competition: Proposed Domestic Airline Alliances Raise Serious Issues
(GAO/T-RCED-98-215, June 4, 1998), which presented our preliminary work, used 5 percent as a
minimum market share to determine the presence of a competitor, a standard consistent with the
work of some other researchers. DOT uses 10 percent to define a competitor, and subsequent
discussions with DOT officials, some airline officials, and industry experts convinced us that 10
percent better reflected a competitor in the market. Accordingly, for the purposes of this report, we
are defining any airline or alliance as an “active competitor” if it carries 10 percent or more of any
given market. Conversely, if an airline or an alliance has less than 10 percent of any given market, we
are defining its market share as “limited.” The effect of raising the market threshold should help
eliminate some potential problems in the quality of the data reported to DOT and reduce the counts of
markets (and thus of passengers) affected positively or negatively by the formation of the alliances.
31
  Northwest-Continental officials used a higher threshold in calculating when the alliance would
increase service. They stated that by creating a market presence of at least 15 percent, their alliance
would create broader service offerings in 32 other major cities, affecting 33.4 million passengers. For
example, cities like Orlando and Indianapolis would have two significant carriers instead of one; and
Baltimore, Tampa, and Columbus would have three significant carriers instead of two. We could not
verify the number of passengers affected.
32
  The average increase in the HHI attributable to the creation of the Northwest-Continental alliance for
these 286 markets is 71, with a range of 2 to 191. This indicates that the addition of the alliance as an
active competitor would make relatively little difference in the competitive structure of these markets.



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will create a greater presence in many markets, offering more flights and
choices to travelers, the overall improvement in competition will be
limited by other dominant competitors.

The Alliance Could Create Some Additional Dominant Markets. Market
share is particularly important in determining the extent to which an
alliance may be harmful to consumers. Industry experts generally agree
that if an airline can capture significant market share, its revenue share
will increase faster than its market share; in other words, an airline can
earn a fare premium because, among other reasons, it offers the high level
of flight frequencies preferred especially by business travelers. Airlines
that achieve a dominant market position can drive out airlines with
smaller market shares by making it unprofitable for them to compete.
Additionally, a number of studies have shown that markets with fewer
competitors, especially those dominated by a single carrier, have higher
fares.33 We reported in 1993, for example, that fares at concentrated
airports were about 22 percent higher than fares at less concentrated
airports.34

Table 2 shows how many of the top 5,000 busiest airport-pair markets in
1997 were already dominated by either Northwest or Continental, as well
as how many will be dominated through the alliance’s creation. Northwest
dominated 325 markets and Continental dominated 142 markets. By
combining the partners’ market shares, the alliance will gain a majority
share in 25 additional markets (an increase of 5 percent). One market,
Atlanta-Newark, was relatively large, having served 1.2 million passengers
in 1997 (3,205 passengers per day, on average). However, none of the other
markets were relatively large; they served an average of 135 passengers
per day in 1997. Markets that will be dominated by the new alliance
include Atlanta-Newark and Cleveland-Phoenix.




33
 See, for example, Steven A. Morrison, “New Entrants, Dominated Hubs, and Predatory Behavior,”
Statement before the Subcommittee on Antitrust, Business Rights, and Competition, Committee on the
Judiciary, United States Senate (Apr. 1, 1998).
34
 Airline Competition: Higher Fares and Less Competition Continue at Concentrated Airports
(GAO/RCED-93-171, July 15, 1993).



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Table 2: Effect of the
Northwest-Continental Code-Sharing                                          Number of markets with
Alliance on Market Dominance                                                  more than 50-percent                           Number of
                                                                                      market share                     passengers, 1997
                                     Northwest                                                        325                       20,790,192
                                     Continental                                                      142                       17,548,616
                                     Alliance (new)                                                    25                        2,355,163
                                     Total                                                            492                       40,693,971
                                     Notes: Market share is defined as the percentage of domestic traffic in 1997. Dominant markets
                                     are defined as those with more than 50-percent market share.

                                     Source: GAO’s analysis of data provided by Data Base Products, Inc., on the top 5,000 origin and
                                     destination markets in 1997.



                                     The Alliance Could Increase Operating and Marketing Barriers to Entry.
                                     To the extent that an alliance creates barriers to market entry, it can limit
                                     competition. If entry is easy, a single airline cannot charge monopoly
                                     prices over the long term because other airlines will enter and provide
                                     competition. However, if entry is difficult, then the airline may offer fares
                                     above competitive levels. As we have reported in the past, operating
                                     barriers such as slot controls and gate constraints (long-term leases for
                                     one airline’s exclusive use of a large number of gates) have contributed to
                                     higher fares on routes to and from some airports.35 If the formation of an
                                     alliance further concentrated control in one entity at any of these airports,
                                     then fares might rise and the prospects of new competition at these
                                     airports might be further diminished. Similarly, marketing barriers such as
                                     frequent flyer programs and travel agent commission overrides36 can also
                                     inhibit competition, particularly in markets already dominated by a given
                                     airline.37

                                     The Northwest-Continental alliance will not appreciably change the level
                                     of concentration at slot-controlled and gate-constrained airports.
                                     Northwest’s hubs at Minneapolis and Detroit and Continental’s hub at
                                     Newark are gate-constrained airports because Northwest and Continental
                                     control all or a majority of the leases there. However, these three airports
                                     are already heavily concentrated, and the combination of these two
                                     carriers will not change that. For example, in 1997, Northwest held

                                     35
                                      See Airline Deregulation: Barriers to Entry Continue to Limit Competition in Several Key Domestic
                                     Markets (GAO/RCED-97-4, Oct. 18, 1996).
                                     36
                                      A travel agent commission override is a special bonus paid by an airline to travel agents or agencies
                                     as a reward for booking a targeted proportion of passengers on the airline.
                                     37
                                      See Aviation Competition: International Aviation Alliances and the Influence of Airline Marketing
                                     Practices (GAO/T-RCED-98-131, Mar. 19, 1998).



                                     Page 27                                               GAO/RCED-99-37 Domestic Airline Alliances
                             B-280704




                             77.8 percent of the market (defined as the total number of enplanements
                             for the year) at Detroit, and Continental held only 1.6 percent.

                             We did not evaluate the potential effect on other carriers or consumers of
                             combining the two airlines’ frequent flyer benefits. Earlier this year,
                             however, we reported on how certain marketing practices, such as
                             frequent flyer programs, can act as barriers to entry.38 The combination of
                             frequent flyer programs under an alliance could present a more formidable
                             barrier to entry for new-entrant airlines and point-to-point carriers lacking
                             extensive networks. Northwest has approximately 20 million members in
                             its WorldPerks frequent flyer program, and Continental has approximately
                             16 million in its OnePass program.

                             Consumer advocates we interviewed expressed some concern that the
                             airlines might increase their frequent flyer award requirements in the
                             future, thereby discounting the value of the frequent flyer benefits. They
                             also noted that because members of both airlines’ frequent flyer programs
                             may redeem miles on both carriers, finding available mileage awards could
                             become far more difficult.

                             In addition, a nonaligned airline, consumer groups, and an industry expert
                             stressed the adverse effect on competition that alliances like the one
                             between Northwest and Continental could have through computer
                             reservation systems. The alliance could gain a competitive advantage
                             through multiple listings of the same code-sharing flight on the reservation
                             screen, increasing the likelihood that the alliance’s flights would be the
                             first offered to the consumer.


Alliances Between            As of October 1998, the arrangements between American and US Airways
American-US Airways and      and between Delta and United were generally limited to ties between their
United-Delta May Increase    respective frequent flyer programs, including reciprocal access to airport
                             lounges. Implementation of the frequent flyer agreement between
Operating and Marketing      American and US Airways began in August 1998, and Delta and United
Entry Barriers for Certain   began participating in each other’s frequent flyer programs on
Airlines                     September 1, 1998.39 Reciprocal access to both airlines’ airport clubs will
                             follow. Both alliances will provide benefits to members of each airline’s


                             38
                               See footnote 38.
                             39
                               According to data from InsideFlyer magazine, as of Aug. 1998, American had 32.0 million members in
                             its Aadvantage program (the largest membership of any frequent flyer program in the world), US
                             Airways had 4.0 million Dividend Miles members, United had 23.0 million MileagePlus members, and
                             Delta had 17.5 million SkyMiles members.



                             Page 28                                             GAO/RCED-99-37 Domestic Airline Alliances
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frequent flyer program by offering new destinations to which members can
fly. At the same time, however, by solidifying their customer base through
such marketing efforts, the alliances may raise further barriers to entry for
new airlines in certain markets.

Passengers who belong to both American’s and US Airways’ frequent flyer
programs will be able to combine miles from both airlines to redeem an
award for travel on either airline. Because the partners offer greater
market presence in different parts of the country (as well as
complementary international destinations), according to airline officials,
American’s frequent flyers will have access to 105 new award destinations
and US Airways’ frequent flyers will be eligible for award travel to 120 new
destinations. In addition, American’s frequent flyers will be able to use
their miles from either airline to claim awards on certain US Airways
Shuttle flights between Washington, D.C.; New York; and Boston.40 The
two airlines have also agreed to allow reciprocal access to all domestic
and international club facilities. American’s club members will gain access
to US Clubs at 12 additional airports, and US Club members will gain
access to 35 American clubs. The agreement between Delta and United is
somewhat more limited. Passengers may choose to participate in one or
both frequent flyer programs, but miles earned on any given alliance flight
may be awarded to only one program. Passengers will not be able to
combine miles earned from both programs to obtain an award from one of
the alliance partners. Because of the number of locations served uniquely
by United and Delta, according to airline officials, United’s frequent flyers
will have access to 75 new domestic award destinations and Delta’s
frequent flyers will be eligible for award travel to 108 new domestic
destinations (assuming the alliances’ frequent flyer program award
destinations extend to the airlines’ commuter partners).

As noted in discussing the Northwest-Continental alliance, we did not
evaluate the effect on other carriers or consumers of combining frequent
flyer benefits through an alliance, but we have reported that the existence
of frequent flyer programs can act as a barrier to entry for new-entrant
airlines and point-to-point carriers lacking extensive networks.




40
  Effective Feb. 1, 1999, American will raise the number of miles required for first class and business
class tickets in most international markets. In addition, an upgrade from a discounted domestic ticket
to a first class ticket will require 30,000 miles instead of 20,000 miles. Coach class awards will remain
the same. American also eased some mileage requirements, such as the number of miles needed to
claim an upgrade for passengers traveling on a full-fare ticket.



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                            DOJ and DOT have both been examining the alliances. Although
Federal Reviews of          cooperating, they are conducting separate reviews because they have
Alliances Are Ongoing       different statutory authorities, responsibilities, and remedies. DOJ filed a
                            civil antitrust action in October to block the equity investment agreement
                            between Northwest and Continental and amended its complaint against
                            the revised agreement in December. DOT has the authority to prevent
                            unfair, deceptive, or anticompetitive practices, and its statute lists the
                            avoidance of unreasonable concentration in the airline industry as a public
                            interest factor to be considered in its decision-making. Under authority
                            provided by a new law, DOT has imposed waiting periods for certain
                            aspects of the Northwest-Continental alliance.41 Although it does not have
                            the authority to preapprove an alliance, DOT can seek to stop specific
                            anticompetitive practices.


DOJ Has Filed Legal         On October 23, 1998, DOJ filed a civil antitrust complaint to prevent
Action to Block Northwest   Northwest from acquiring or holding a majority of Continental’s voting
From Obtaining Voting       stock. DOJ said in its complaint that Northwest’s gaining voting control
                            would lessen competition in interstate trade and commerce and
Control Over Continental    unreasonably restrain trade and that the transaction would also likely
                            create “interlocking directors” on the boards of directors of both airlines,
                            with certain individuals sitting on both boards. DOJ believed that the
                            alliance would substantially diminish both airlines’ incentives to compete
                            against each other and would cause consumers to pay higher prices and
                            receive lower-quality service in some markets.

                            DOJ has specific authority to review mergers or stock acquisitions before
                            they take place under the Hart-Scott-Rodino Act to see whether they
                            violate antitrust laws, and it has general authority to review alliances
                            under the Sherman Antitrust Act and the Clayton Act. Under the
                            Hart-Scott-Rodino Act, an acquisition of voting securities above a set
                            monetary amount must be reported to DOJ for prior review. DOJ has the
                            authority to institute civil or criminal proceedings under the Sherman Act
                            if a merger or acquisition may restrain competition or is an attempt to
                            monopolize a particular market.42 In addition, DOJ may bring a civil action
                            under the Clayton Act if a merger or acquisition may substantially lessen
                            competition in a relevant market or tend to create a monopoly.43 If DOJ



                            41
                              P. L. 105-277, division C, title I, sec. 110(f) (1998).
                            42
                              15 U.S.C. §§ 1-7.
                            43
                              15 U.S.C. §§ 12-27.



                            Page 30                                                     GAO/RCED-99-37 Domestic Airline Alliances
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believes any agreement is anticompetitive in whole or in part, it may seek
to block the agreement in federal court.

DOJ has been reviewing the Northwest-Continental alliance since it was
first announced in January 1998, under the Hart-Scott-Rodino process.
Under the Hart-Scott-Rodino Act, an acquisition of voting securities above
a set monetary amount must be reported to DOJ44 for review prior to the
merger. On October 23, 1998, DOJ filed a civil antitrust action to prevent
Northwest from acquiring or holding a majority of the Continental’s voting
stock. DOJ alleged that the effects of the alliance might be to substantially
lessen competition in interstate trade and commerce in violation of the
Clayton Act and to unreasonably restrain trade in violation of the Sherman
Act. According to the complaint filed by DOJ, Northwest’s acquisition of an
equity stake and controlling interest in Continental would reduce
Continental’s incentive to compete aggressively against Northwest. As a
result, consumers would pay higher prices and receive lower-quality
service in markets dominated by Northwest and Continental. In addition,
according to the complaint, consumers would lose the benefits of new,
competitive entry by Continental against Northwest in the future and of
potential competition in other markets.

DOJ did not seek a restraining order to stop all aspects of the alliance from
moving forward. While it filed a complaint against the alliance’s
investment or stock acquisition agreement, it did not address the
code-sharing alliance and frequent flyer agreements. In December 1998,
Northwest and Continental proceeded with their alliance under a modified
arrangement. For example, they said that they would not introduce
code-sharing on flights between each other’s hubs, where both airlines
currently compete, and announced that Northwest would acquire less than
half of the voting control of Continental’s stock. DOJ responded to the
revised agreement between Northwest and Continental by filing an
amended complaint on December 18, 1998. DOJ alleged that despite the
amended agreement, Northwest could still own more than 50 percent of
the fully diluted voting power over Continental.45 As a result, DOJ alleged
that consumers would likely still be harmed in the markets dominated by


44
 DOJ and the Federal Trade Commission have concurrent jurisdiction over Hart-Scott-Rodino matters
and the Clayton Act. DOJ has jurisdiction over airline alliances and the airline industry in general
because of an exemption in the Federal Trade Commission Act.
45
 According to DOJ’s amended complaint, notwithstanding the Nov. amendment to the Investment
Agreement between Northwest and Air Partners, L.P., Northwest separately entered into another
agreement on Mar. 2, 1998, with Barlow Investors III, LLC, to purchase approximately 5 percent of the
voting power over Continental to ensure that Northwest would own over 50 percent of the fully diluted
voting power over Continental.



Page 31                                             GAO/RCED-99-37 Domestic Airline Alliances
B-280704




Northwest and Continental. DOJ has also indicated that it has competitive
concerns about certain specific aspects of the alliance between the airlines
and that its investigation of these aspects of the alliance continues.
According to DOJ officials, Northwest and Continental have 60 days from
the date of DOJ’s filing to respond. During that period, however, the parties
may also file legal motions on various subjects, such as the procedural
schedule.

DOJ has also indicated that it is looking at proposals for the other two
alliances, as well as the potential impact of the alliances on the entire
airline industry. Without detailing its ongoing reviews, it stated that its
analyses of the three alliances under the Sherman and Clayton acts’
authorities will follow an approach similar to that found in the Merger
Guidelines, which are applied to a traditional merger. Under these
guidelines, DOJ uses a five-part analytical process. First, DOJ defines the
markets in which the partners operate and determines whether they are
actual or potential competitors. DOJ testified before the House Committee
on the Judiciary on May 19, 1998, that the greatest threat to competition
comes when two of very few airlines that compete in a market enter into a
code-sharing agreement in that market. DOJ stated that it is concerned
about the effect on competition any time two of very few airlines in a
market act jointly. Second, DOJ examines aspects of the agreement that
may affect competition—for example, whether the partners’ capacity,
scheduling, and pricing decisions will remain independent. Third, DOJ
considers the extent to which new competitors are likely to enter the
market in response to anticompetitive behavior by the alliance partners.
Fourth, DOJ examines the operational efficiencies or other benefits that
may be generated by the agreement. Finally, DOJ considers whether one of
the partners is likely to exit a market because of financial considerations if
the alliance does not occur. After completing these parts, DOJ attempts to
balance all of the factors in deciding whether the alliance raises any
antitrust concerns. DOJ officials told us that they are under no timetable for
their antitrust review of the United-Delta and American-US Airways
alliances.

If DOJ has concerns, it usually attempts, before bringing a suit, to negotiate
a consent agreement that will restructure the transaction to remedy the
competitive harm. DOJ pointed to its recommendations to DOT for the
international code-sharing arrangements between American and British
Airways and American and the TACA group as an indication of the types of
solutions that could be used domestically. In its recommendations to DOT
on these international alliances, DOJ outlined several possible solutions,



Page 32                                 GAO/RCED-99-37 Domestic Airline Alliances
                            B-280704




                            including slot and/or market-specific divestitures to allow greater
                            opportunity for new entry and carve-outs to eliminate certain city-pairs
                            from an alliance where two airlines serve overlapping markets.


DOT Can Delay Alliances     DOT is authorized to impose waiting periods on proposed alliances
but Has No Preapproval      involving major U.S. airlines but has no authority to preapprove domestic
Authority Unless a Change   airline alliances, except to conduct a fitness review when a change in
                            ownership occurs. However, once an alliance is in place, DOT has the
in Ownership Occurs         authority to prohibit unfair methods of competition in the airline industry,
                            which it can use in reviewing the alliances.

                            DOT derives its authority to review proposed alliances from several
                            statutory sources. DOT can review a proposed alliance under its
                            certification and fitness procedures. However, once an alliance is in place,
                            DOT can challenge it under its authority to prohibit unfair methods of
                            competition and unfair and deceptive practices.46 In addition, DOT’s
                            authorizing statute specifies that DOT should consider such policy matters
                            as preventing unfair, deceptive, and predatory practices and avoiding
                            unreasonable industry concentration and excessive market domination in
                            carrying out its duties.47 Furthermore, under new legislation passed in
                            October 1998, DOT has the authority to impose an initial 30-day waiting
                            period on certain joint ventures between major air carriers, which it may
                            extend another 150 days for such joint venture agreements involving
                            code-sharing.48 This authority of DOT’s does not limit DOJ’s authority to
                            enforce the antitrust laws.

                            DOT officials said they have focused their efforts to date on the
                            Northwest-Continental alliance and on whether it meets fitness
                            requirements.49 DOT’s fitness procedures include looking at U.S. citizenship
                            requirements for the airlines involved, as well as their financial statements
                            and safety records. Only the Northwest-Continental alliance is subject to
                            these requirements because it alone is proposing a change in ownership
                            that requires that a new owner’s fitness be determined.50 As of

                            46
                              49 U.S.C. § 41712.
                            47
                              See 49 U.S.C. §§ 40101(a)(9), (10), and (12).
                            48
                              P.L. 105-277, § 110(f). The joint ventures subject to this waiting period include only those entered into
                            by a major airline after Jan. 1, 1998, that involve code-sharing, certain leasing arrangements, frequent
                            flyer programs, and certain other cooperative working arrangements.
                            49
                              49 U.S.C. § 41102.
                            50
                              14 C.F.R. § 204.5.



                            Page 33                                                GAO/RCED-99-37 Domestic Airline Alliances
                  B-280704




                  December 31, 1998, DOT’s fitness determination was ongoing. DOT also
                  imposed waiting periods on the implementation of the
                  Northwest-Continental alliance’s frequent flyer and code-sharing
                  agreements but said on December 4, 1998, that the airlines could proceed
                  with their reciprocal frequent flyer program, which had been modified
                  somewhat at DOT’s request.

                  Although DOT does not have the authority to preapprove an alliance, it
                  could institute an administrative enforcement proceeding if it determined
                  that some aspect of an alliance or the alliance itself amounted to an unfair
                  method of competition.51 DOT did not object to previous domestic
                  alliances—Continental-America West and Northwest-Alaska—because it
                  did not find them to be anticompetitive. As for its review of the
                  United-Delta and American-US Airways alliances, a DOT official said the
                  Department has received some information from the airlines on their
                  frequent flyer agreements and certain other matters. A DOT official said
                  that the Department will request additional information if it decides the
                  information received is not sufficient and if the airlines propose to extend
                  their alliances to include code-sharing. DOT will coordinate with DOJ in
                  reviewing these alliances.


                  We provided copies of a draft of this report to DOT and DOJ for their review
Agency Comments   and comment. We met with DOT officials from the Office of the Secretary,
                  including the Deputy Assistant Secretary for Aviation and International
                  Affairs and the Special Counsel. These officials indicated that the report
                  provides a useful and constructive discussion of issues presented by
                  alliances among airlines. They indicated that because DOT is reviewing
                  each of these alliances, it is not at liberty, at this time, to provide specific
                  comments on the potential effects of the alliances discussed in the draft
                  report. Nonetheless, they indicated that DOT’s authority over these three
                  alliances is not as broad as the draft report might have led some readers to
                  believe. DOT noted that it could challenge an alliance after it is in place,
                  citing the Department’s authority to prohibit unfair methods of
                  competition and unfair and deceptive practices. DOT provided a number of
                  specific and technical comments that addressed this and other issues; we
                  incorporated these comments as appropriate. We also held discussions
                  with DOJ officials, including the Chief of the Transportation, Energy, and
                  Agriculture Section, within DOJ’s Antitrust Division. In general, DOJ found
                  the report to be a useful and constructive discussion of the issues
                  presented by the airline alliances, and it provided technical corrections,

                  51
                    49 U.S.C. § 41712.



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which we incorporated into the report as appropriate. DOJ asked that we
more clearly distinguish our use of the term “alliance,” (which DOJ applies
only to code-sharing agreements, frequent flyer agreements, and similar
arrangements between separate airlines) from arrangements in which an
equity share is involved. We did so by specifically noting when the equity
investment agreement was at issue. We also provided each participating
airline with a copy of the section of the report describing its alliance
agreement or proposal. The airlines generally agreed with our
characterization of their arrangements and offered technical corrections,
which we incorporated into the report as appropriate. Some airlines
suggested other methods we might use to determine markets and market
shares. In discussing our scope and methodology (see app. II), we point
out that there may be several ways to define markets in the airline
industry, and we carefully describe what we did and why. We did not share
our analysis of the beneficial or harmful effects of the alliances with the
airlines.


As arranged with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 10 days after the
date of this letter. At that time, we will send copies to the Secretary of
Transportation; the Attorney General; the Director, Office of Management
and Budget; and other interested parties. We will send copies to others
upon request.

If you have any questions, please call me at (202) 512-2834. Major
contributors to this report are listed in appendix VI.




John H. Anderson, Jr.
Director, Transportation Issues




Page 35                                  GAO/RCED-99-37 Domestic Airline Alliances
Contents



Letter                                                                                               1


Appendix I                                                                                          40
Airlines’ Market
Shares of Domestic
Passenger
Traffic—1997
Appendix II                                                                                         41
Scope and
Methodology
Appendix III                                                                                        46
                         United-Delta Alliance With Code-Sharing Would Have New                     46
Potential Beneficial         Destinations and Frequencies
and Harmful Effects      If the Partners Did Not Compete, a United-Delta Code-Sharing               49
                             Alliance Could Harm Consumers
on Consumers of the
Alliance Initially
Proposed by United
Airlines and Delta Air
Lines
Appendix IV                                                                                         54
                         A Code-Sharing Alliance Between American and US Airways                    54
Potential Beneficial         Would Include New Destinations and Frequencies
and Harmful Effects      If the Partners Did Not Compete, an American-US Airways                    55
                             Code-Sharing Alliance Could Harm Consumers
on Consumers of a
Code-Sharing Alliance
Between American
Airlines and US
Airways




                         Page 36                              GAO/RCED-99-37 Domestic Airline Alliances
                        Contents




Appendix V                                                                                           59
                        Consumers Could Realize Some Benefits If All Three Alliances                 60
Implementation of All      Were to Proceed as Code-Sharing Agreements
Three Alliances as      If Partners Did Not Compete, Code-Sharing Alliances Could Harm               60
                           Consumers
Code-Sharing
Arrangements Could
Substantially Affect
Competition
Major Contributors to                                                                                65
This Report
Related GAO Products                                                                                 67


Tables                  Table 1: GAO’s Analysis of Airport Pairs That Would Receive                  18
                         New On-Line Service Through Single or Double Connections
                         Under a Northwest-Continental Alliance
                        Table 2: Effect of the Northwest-Continental Code-Sharing                    27
                         Alliance on Market Dominance
                        Table III.1: GAO’s Analysis of the Benefits of a United-Delta                48
                         Code-Sharing Alliance: Airport Pairs That Would Receive New
                         On-Line Service Through Single or Double Connections
                        Table III.2: Potential Effect of a United-Delta Code-Sharing                 53
                         Alliance on Market Dominance
                        Table IV.1: GAO’s Analysis of Benefits Under an American-US                  55
                         Airways Code-Sharing Alliance: Airport Pairs That Would Receive
                         New On-Line Service Through Single or Double Connections
                        Table IV.2: Potential Effect of an American-US Airways                       58
                         Code-Sharing Alliance on Market Dominance
                        Table V.1: Alliance Partners’ Combined Market Share at                       63
                         Slot-Controlled and Gate-Constrained Airports

Figures                 Figure 1: Illustration of a Hypothetical End-to-End International             5
                          Alliance
                        Figure 2: Percentage of Each State’s Departing Passengers That               10
                          the Northwest-Continental Alliance Would Have Carried




                        Page 37                                GAO/RCED-99-37 Domestic Airline Alliances
Contents




Figure 3: Percentage of Each State’s Departing Passengers That            12
  the Originally Proposed United-Delta Alliance Would Have
  Carried
Figure 4: Percentage of Each State’s Departing Passengers That a          14
  Code-Sharing Alliance Between American and US Airways Would
  Have Carried
Figure 5: Number of Markets and Passengers Subject to                     24
  Potentially Decreased Competition Under the
  Northwest-Continental Alliance
Figure III.1: Number of Markets and Passengers Subject to                 51
  Potentially Decreased Competition Under a United-Delta
  Code-Sharing Alliance
Figure IV.1: Number of Markets and Passengers Subject to                  56
  Potentially Decreased Competition Under an American-US
  Airways Code-Sharing Alliance
Figure V.1: Number of Markets and Passengers Subject to                   61
  Potentially Decreased Competition Under Three Code-Sharing
  Alliances




Abbreviations

DOJ        Department of Justice
DOT        Department of Transportation
GAO        General Accounting Office
HHI        Herfindahl-Hirschmann Index


Page 38                             GAO/RCED-99-37 Domestic Airline Alliances
Page 39   GAO/RCED-99-37 Domestic Airline Alliances
Appendix I

Airlines’ Market Shares of Domestic
Passenger Traffic—1997


                                                         1997 domestic traffic
                                                             (total number of                   1997 market share
                                                      passengers enplaned, in                  (percentage of total
               Airline or alliance                                   millions)a                      passengers)c
               Northwest                                                       47.1                                8.5
               Continental                                                     34.2                                6.2
               Northwest-Continental                                           81.3                               14.7
               Delta                                                           97.3                               17.6
               United                                                          72.9                               13.2
               Delta-United                                                   170.2                               30.8
               American                                                        66.1                               12.0
               US Airways                                                      57.4                               10.4
               American-US Airways                                            123.5                               22.3
               Alliance subtotal                                              375.0                               67.8
               America West                                                    17.9                                3.2
               Alaska                                                          11.5                                2.1
               Southwest                                                       56.1                               10.1
               Trans World                                                     22.2                                4.0
               Other major airlines
               subtotal                                                       107.7                               19.5
                                      b
               Other large airlines                                            70.2                               12.7
               Totalc                                                         552.8                             100.0
               a
                “Passenger enplanements” represent the total number of passengers boarding an aircraft. Thus,
               for example, a passenger that must make a single connection between his or her origin and
               destination counts as two enplaned passengers because he or she boarded two separate flights.
               Other measures, such as the number of domestic origin and destination passengers or revenue
               passenger miles flown during a year, are sometimes used to illustrate the relative sizes of airlines.
               We believe that using these measures would produce few differences from the results shown in
               this table.
               b
                This category includes such airlines as Reno, Midwest Express, and AirTran, along with the
               larger “regional” commuter airlines such as Atlantic Southeast, Continental Express, Horizon Air,
               Mesa, and Simmons. We are excluding other smaller commuter airlines because they tend not to
               compete for the same passengers as the larger airlines and carried only 1.5 percent of the total
               number of passengers that flew within the United States in 1997.
               c
               Percentages may not sum to subtotals because of rounding.

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




               Page 40                                               GAO/RCED-99-37 Domestic Airline Alliances
Appendix II

Scope and Methodology


              At the request of the Chairman of the Senate Committee on Commerce,
              Science, and Transportation and the Chairman of that committee’s
              Subcommittee on Aviation, we addressed three issues relating to the
              alliances among six of the largest U.S. airlines. Specifically, our objectives
              were to (1) determine the status of each of the alliances; (2) examine, for
              each alliance individually, the potential beneficial and harmful effects on
              consumers; and (3) examine the authority of the departments of Justice
              (DOJ) and Transportation (DOT) to review these alliances and the status of
              these reviews.

              To determine the status of each of the alliances, we interviewed officials
              from each of the participating airlines, along with officials from DOJ and
              DOT. Because each of the alliances changed somewhat during the
              assignment, we maintained contact with officials from the airlines
              involved. We reviewed publicly available documentation that described
              the structure of each alliance and asked each airline about the
              involvement of its regional “feeder” commuter partners, international
              code-sharing partners, and other domestic code-sharing airlines (in the
              case of Continental and Northwest).52 To ensure that we understood the
              structure of each alliance, we also sought explanations from the partners
              on how they would share revenue in a variety of situations (for example,
              when one airline would sell a ticket to a passenger for a trip that was to
              involve both the main alliance airline and one of its regional partners.)

              To determine the extent of the service benefits associated with the
              alliances, we examined the airlines’ statements on their routing and
              connection benefits. To evaluate these statements, we analyzed airline
              schedule information for May 1998. To obtain these data for this report, we
              contracted with BACK Associates, Inc., an aviation consulting firm. BACK
              Associates, Inc., used information on flight schedules submitted by all U.S.
              airlines to the Official Airline Guide Worldwide and prepared computer
              programs to produce tables to our specifications. We based these
              specifications on information submitted by the airlines on the scope of
              their alliances. We also imposed some limiting assumptions that our
              discussions with industry experts led us to believe were reasonable. We
              adopted these to prevent our consulting firm’s computer programming

              52
                Some of the alliance airlines—notably Continental and Northwest—said that they intended to extend
              code-sharing to their international partners. United and Delta officials said that if their alliance had
              proceeded, they would have liked to extend it to their international partners as well, but would wait
              for the resolution of a number of issues related to their existing alliances within Europe. (The
              European Union is reviewing all international code-sharing agreements involving European and U.S.
              airlines and proposing various changes in these business arrangements.) Because of differences in the
              extent to which the alliances have announced how their international partners would be integrated, we
              limited our analysis to the effects on U.S. domestic travel only.



              Page 41                                               GAO/RCED-99-37 Domestic Airline Alliances
Appendix II
Scope and Methodology




from identifying what would seem to be obviously unreasonable flight
patterns (e.g., flights between New York and Chicago that would connect
through Los Angeles). These included (1) requiring potential connections
between flights to fall between 30 and 150 minutes of one flight’s
scheduled arrival at the connecting airport and the next flight’s scheduled
departure53 and (2) limiting the distance that possible flight segments
might cover (“circuity”) to 125 percent of the distance between a flight’s
origin and destination, unless the flight connected through one of the
airline’s hubs, in which case we allowed up to 150 percent of the distance.
Furthermore, with possible new double-connection markets, we limited
the number of potential connection points by requiring connections to be
made through the airlines’ hubs. Because we were principally interested in
the impact of the alliances on the U.S. domestic market, we excluded
international destinations (including U.S. territories). We did not review
BACK Associates, Inc.’s programming but verified the logic of that
programming and discussed with company officials the approach that they
used. This analysis provided information on the extent to which the
alliances may produce actual new “on-line” connections or service
opportunities for passengers. Finally, we examined whether competitors
provided equivalent, superior, or inferior service to these destinations.54
To estimate the number of passengers who might benefit from the new
on-line service, we then matched the new on-line origins and destinations
against the 1997 passenger traffic in these markets. We did not
independently assess the airlines’ basis for stating that their improved
service options would generate additional traffic. We also did not attempt
to quantify the benefits of the reciprocal relationships among frequent
flyer programs and clubs that would be established under the alliances.

To examine the potential harm from the alliances, we determined the
extent to which each airline’s routes overlap with those of its alliance
partner by analyzing 1997 data on the 5,000 busiest domestic airport-pair
origin and destination markets or markets for air travel between two
airports. These 5,000 markets accounted for over 90 percent of the total
396 million U.S. domestic passengers in 1997. To obtain these data for this

53
 On the basis of information provided by the alliance airlines, we assumed that the alliance partners
would make minimal changes to their schedules. Airline officials told us that larger changes would
disrupt their entire systems.
54
  Equal service means that competing airlines currently offer service that matches the alliance’s
potential single- or double-connection service. Superior service includes current direct and nonstop
service by competitors between airports that the alliance could serve at best on a single-connection
basis; and direct, nonstop, or single-connection service by competitors between airports that the
alliance could serve at best on a double-connection basis. Inferior service means that competing
airlines currently offer no service or double-connection service between airports where the alliance
could offer single-connection service, or no service where the alliance would provide
double-connection service.


Page 42                                               GAO/RCED-99-37 Domestic Airline Alliances
Appendix II
Scope and Methodology




report, we contracted with Data Base Products, Inc., which used
information submitted by all U.S. airlines to DOT for 1997 and produced
various tables to our specifications. Data Base Products, Inc., used three
different data sources from DOT: the Origin and Destination Survey (O&D)
based on a 10-percent sample of tickets containing itinerary and pricing
information; T-100 on-flight data;55 and 298C T-1 data, which supplement
the T-100 data with data on commuter and small certified air carriers. Data
Base Products, Inc., made certain adjustments to these data, such as
correcting recognized deficiencies in the air carriers’ O&D data
submissions, which have not met DOT’s standard of 95-percent accuracy.
For example, Data Base Products, Inc., used the T-100 and the 298C T-1
data to obtain more accurate passenger counts. We did not review the
company’s programming but did discuss with company officials the
adjustments that they made.

We examined whether the formation of alliances might reduce
competition within a given airport-pair market under various assumptions
about how large a market share an alliance would need to be considered
an “active competitor.” In our testimony on June 4, 1998, which reported
our preliminary results on the effects of the proposed alliances, we
defined a competitor as one that carried at least 5 percent of the enplaned
passengers in a particular market.56 DOT uses 10 percent as a minimum
market share. Our conversations with DOT officials, some airline officials,
and industry experts convinced us that 10 percent better represented a
competitor in the market and also eliminated some potential problems in
the quality of the data that are reported to DOT. For all these reasons, we
decided to use DOT’s minimum. To provide additional insight into markets
where an alliance may exert additional or disproportionate market
influence, we then further refined our analysis to focus on those markets
where an alliance would have a dominant share—more than 50 percent.
Various studies support the finding that airlines holding dominant shares
of a market reap disproportionate amounts of the revenue available in that
market, because they are able to provide far more frequent service, which
is important for time-sensitive, high-yield business travelers. To a limited
extent, the harmful effects of having fewer competitors in some markets,

55
  14 C.F.R. 241 prescribes the collection of scheduled and nonscheduled service traffic data from the
domestic and international operations of U.S. air carriers. The schedules submitted by the air carriers
to DOT under this requirement collect nonstop segment data and on-flight market information by
equipment type and by service class. This report is known as the “T-100” report.
56
   See Aviation Competition: Proposed Domestic Airline Alliances Raise Serious Issues,
(GAO/T-RCED-98-215, June 4, 1998). Our use of 5 percent as a minimum market share to determine the
presence of a competitor is supported by some researchers, notably Belobaba and Van Acker in
“Airline Market Concentration: An Analysis of U.S. Origin—Destination Markets,” Journal of Air
Transport Management (1994).



Page 43                                               GAO/RCED-99-37 Domestic Airline Alliances
Appendix II
Scope and Methodology




assuming the alliance partners would not compete, could be mitigated by
an increase in competition in other markets.

We defined a market as one involving airport pairs, rather than city pairs,
because certain groups of passengers—particularly business
travelers—who may need to make connections to reach their final
destination do not regard various airports as substitutes. For example,
many, if not most, business travelers going to and from Chicago, would not
regard Midway Airport as an adequate substitute for O’Hare. This market
definition is in line with the analysis of international airline alliances that
appeared in DOJ’s comments on the proposed code-sharing alliance
between American Airlines and British Airways.57

In our analysis of markets that lost or gained a competitor with the
formation of an alliance, we determined the significance of this loss or
gain by looking at changes in market concentration. To do this, we used an
index used by DOJ, the Herfindahl-Hirschmann Index (HHI), in which higher
scores reflect greater increases in market dominance. The HHI is calculated
by summing the squares of the individual market shares of all participants.
We calculated changes in the HHI in the markets where a competitor was
lost and where a competitor was added, as well as the changes in the
range of HHIs for these markets. We recognize that the HHI may provide
somewhat misleading results when applied to the airline industry but
believe that it is nonetheless useful in suggesting the change in the amount
of concentration over time.

To determine the cumulative effect that all three alliances might exert on
the U.S. traveling public, we analyzed the routings and traffic
simultaneously. This analysis accounted for various offsetting effects that
the alliances might produce and explains why the total number of
passengers potentially benefiting from or harmed by the three alliances is
not simply the sum of those affected by the three individual alliances. For
example, the analysis of a single alliance might suggest that if two partners
did not continue to charge competitive prices, then a particular
airport-pair market might lose a competitor, and that loss, according to
1997 origin and destination information, would affect some number of
passengers. However, that same airport-pair market might conceivably
benefit from another alliance, whose formation would create a new active

57
 United and American disagreed with our definition of the relevant markets, arguing in favor of city
pairs. We recognize that city pairs can also be used to analyze various air markets. At the same time,
while some airports may serve as substitutes for other airports in the same community, they are often
not perfect substitutes. Only an extensive analysis of the traffic of each airline at each of these airports
would reveal the extent to which the airports could serve as substitutes.



Page 44                                                 GAO/RCED-99-37 Domestic Airline Alliances
Appendix II
Scope and Methodology




competitor. Consequently, the net effect of both alliances might be to
produce the same number of competitors in the market, and the total
number of passengers affected would be the difference between the two.
Because of technical and computing limitations, we were unable to
analyze the cumulative benefits that implementing all three alliances’
would have had on flight connections, flight frequencies, and the number
of new on-line destinations.

We interviewed officials from DOT, DOJ, consumer groups, a flight
attendants’ union, and each of the six major airlines contemplating
domestic alliances. For the remaining nonaligned major U.S. passenger
airlines, we either interviewed officials or obtained their views through
published speeches or news releases.

We also conducted interviews with recognized industry experts. These
included academic experts recognized nationally for their expertise in
airline competition work (including the effects of various cooperative
ventures, such as frequent flyer programs); individuals with expertise in
particular aspects of the industry, such as ticketing and computer
reservation system issues; and several Wall Street airline financial
analysts. We asked for their views on how the alliances might affect
domestic airline competition, participating airlines, and consumers. We
selected these individuals on the basis of their published work on the
industry.

To determine the authority of DOT and DOJ to review the domestic
alliances, we reviewed the statutory basis for each department’s work,
including DOJ’s Merger Guidelines, and we interviewed officials at both DOT
and DOJ. We also reviewed the complaint filed by DOJ against Northwest
and Continental, as well as the public responses provided by these airlines.

We conducted our work from May 1998 through December 1998 in
Washington, D.C., and Seattle, Washington, in accordance with generally
accepted government auditing standards.




Page 45                                 GAO/RCED-99-37 Domestic Airline Alliances
Appendix III

Potential Beneficial and Harmful Effects on
Consumers of the Alliance Initially Proposed
by United Airlines and Delta Air Lines
                           The current alliance between United and Delta involves reciprocity
                           between their frequent flyer programs. We analyzed the potential
                           beneficial and harmful effects of such a structure in the body of this
                           report. However, the alliance between United and Delta could incorporate
                           code-sharing in the future. As a result, in this appendix, we analyzed this
                           alliance assuming a code-sharing relationship. Our assumption is based on
                           discussions with various industry experts, who maintain that if the
                           code-sharing alliance between Northwest and Continental is implemented,
                           the other major airlines may move toward some sort of code-sharing
                           alliance as a competitive response. If the United-Delta alliance does
                           proceed with code-sharing, the potential for beneficial and harmful effects
                           on consumers could be significant.


                           When United and Delta originally proposed a code-sharing alliance, they
United-Delta Alliance      said that it responded to their customers’ wishes and would benefit
With Code-Sharing          consumers. The airlines explained that code-sharing would create new
Would Have New             on-line service, providing consumers with more flight frequencies and
                           improving connections. A comparison of the airlines’ estimates of a
Destinations and           code-sharing alliance’s benefits and our analysis of these benefits follows.
Frequencies
Originally Proposed        According to United and Delta, a code-sharing alliance such as they
United-Delta Alliance      originally proposed would create new service in many U.S. cities. The
Would Have Provided More   airlines reported that, under such an alliance, Delta would gain access to
                           19 domestic points that it does not now serve and United would gain
On-Line Destinations for   access to 37 such points. In particular, 14 small and medium-sized cities,
Travelers                  such as Bangor, Maine, and Santa Barbara, California, would gain new
                           service. In total, the airlines said, if a code-sharing alliance were extended
                           as originally planned to the airlines’ commuter partners, Delta would
                           extend its on-line network to 108 new domestic points and United to 75
                           new domestic points. Thus, multiplying the possible new destinations
                           together, the airlines said that 8,100 domestic city pairs could gain new
                           on-line service as a direct result of a code-sharing alliance. For example, a
                           passenger in Lincoln, Nebraska, could fly on-line to Sarasota, Florida, for
                           the first time on either United or Delta. The airlines said they expected
                           that on-line fares would be lower than interline fares, which are generally
                           the sum of the fares on each airline’s segments.

                           Our analysis showed that a code-sharing alliance between United and
                           Delta would serve fewer new airport pairs than the airlines estimated.58

                           58
                             See app. II for additional information on our methodology.



                           Page 46                                              GAO/RCED-99-37 Domestic Airline Alliances
Appendix III
Potential Beneficial and Harmful Effects on
Consumers of the Alliance Initially Proposed
by United Airlines and Delta Air Lines




Applying the same criteria that we used for our analysis of the
Northwest-Continental alliance, we first found that such an alliance could
create on-line single-connection service in 157 markets that served
2.6 million passengers in 1997. In 86 of these markets, a United-Delta
code-sharing alliance would produce superior service to that already
offered. (In 78 of these markets, the United-Delta service would be
improved on-line single-connection service compared with existing
double-connection service; competitors provided existing
double-connection service in the other 8 markets.) However, in 71
markets, competing airlines’ existing service would be superior or at least
equal to that which the alliance would provide. We also found that a
United-Delta code-sharing alliance could create 50 new double-connection
markets. However, either one of the alliance partners or a competitor
already provided on-line service to each of these markets. Although the
United-Delta alliance would provide superior service to that offered by
competitors in 9 markets, other competing airlines already provided
superior or equal service in 41 of these markets. Table III.1 provides our
detailed analysis of the new on-line benefits that consumers could expect
from this code-sharing alliance.




Page 47                                        GAO/RCED-99-37 Domestic Airline Alliances
                                           Appendix III
                                           Potential Beneficial and Harmful Effects on
                                           Consumers of the Alliance Initially Proposed
                                           by United Airlines and Delta Air Lines




Table III.1: GAO’s Analysis of the Benefits of a United-Delta Code-Sharing Alliance: Airport Pairs That Would Receive New
On-Line Service Through Single or Double Connections
                                Total markets and average number of
                                   passengers per day who would
                                  receive new United-Delta service
                                                      Average number               Number of               Number of                Number of
                                                        of passengers       markets in which        markets in which        markets in which
                                                               per day             competing               competing                competing
                                      Number of             per market       airlines provide        airlines provide         airlines provide
Type of new on-line service             markets                 in 1997     superior servicea         equal serviceb         inferior servicec
Single-connection                               157                   46                      20                      51                         86
Double-connection                                50                     6                     33                        8                         9
                                           a
                                            Superior service includes current direct and nonstop service by competitors between airports
                                           that a United-Delta code-sharing alliance could serve at best with single-connection service; and
                                           direct, nonstop, or single-connection service by competitors between airports that United-Delta
                                           could serve at best with double-connection service. Direct service differs from nonstop service in
                                           that a “direct” flight makes a scheduled stop between an origin and a destination, but passengers
                                           flying between the origin and destination are not required to change planes, while a nonstop flight
                                           between an origin and a destination makes no scheduled stops en route.
                                           b
                                            Equal service means that competing airlines currently offer service that matches a United-Delta
                                           code-sharing alliance’s potential single- or double-connection service.
                                           c
                                            Inferior service means that competing airlines currently offer (1) no service or double-connection
                                           service between airports where a United-Delta code-sharing alliance could offer
                                           single-connection service or (2) no service between airports where a United-Delta code-sharing
                                           alliance could provide double-connection service.

                                           Source: GAO’s analysis of information provided by BACK Associates and Data Base Products,
                                           Inc.




A United-Delta                             According to airline officials, a code-sharing alliance would provide more
Code-Sharing Alliance                      flight frequencies and better connections to 81 U.S. cities. For example,
Would Provide More                         United currently offers one daily nonstop round-trip flight between Atlanta
                                           and San Francisco, and Delta offers six flights in the same market. Under a
Frequencies and Routings                   code-sharing alliance, consumers could choose among seven daily nonstop
                                           flights as if they were all Delta or all United flights. United and Delta
                                           officials said that combining each of their nonstop flights would result in a
                                           total of 4,600 new daily flight frequencies, affording over 2.3 million
                                           passengers additional nonstop frequency options. Moreover, the airlines
                                           projected that these additional nonstop frequency options would attract
                                           new passengers to their alliance.59 Our limited analysis of flight


                                           59
                                             The alliance projected 750,000 new passengers. Experts we consulted, however, said that the model
                                           used was more appropriate for determining the direction of a change rather than the absolute amount
                                           of a change. Moreover, the model assumed that no competing airline would make a competitive
                                           response, which might decrease the projected number of passengers.



                                           Page 48                                              GAO/RCED-99-37 Domestic Airline Alliances
                        Appendix III
                        Potential Beneficial and Harmful Effects on
                        Consumers of the Alliance Initially Proposed
                        by United Airlines and Delta Air Lines




                        frequencies suggests that the alliance could result in new, possibly
                        improved, route options.


                        Because of the size of United’s and Delta’s respective route networks, a
If the Partners Did     code-sharing alliance would produce more overlapping domestic routes
Not Compete, a          than the other alliances and could harm many travelers if the airlines did
United-Delta            not compete. United and Delta officials stated that their alliance would
                        prove beneficial rather than harmful because each airline would remain
Code-Sharing Alliance   independent and would continue to compete with the other.
Could Harm
                        According to United and Delta, neither airline would coordinate with the
Consumers               other on operations, such as setting fares and schedules, managing
                        revenue, or acquiring aircraft. Without coordination in these areas, they
                        said, the potential for adversely affecting competition is greatly
                        diminished. According to both United and Delta, if they had a code-sharing
                        agreement, only the airline that would actually provide transportation to a
                        passenger on a given flight segment would receive revenue from that
                        passenger.60 Each airline would establish fares separately for the seats it
                        sells. If a passenger were to fly one segment on United and another on
                        Delta, the revenue would be prorated according to a standard agreement.
                        The airlines had also proposed that the “marketing carrier” (i.e., the airline
                        selling the ticket) would receive a cost-based distribution fee, roughly
                        equivalent to a travel agent’s fee, for tickets sold under its code. Thus,
                        company officials said, the best way for each airline to maximize its
                        revenue and profits would be to sell as many seats as possible on its own
                        aircraft.

                        We interviewed industry experts when United and Delta were still
                        planning a code-sharing alliance. These experts maintained that such an
                        alliance would likely harm consumers by reducing competition between
                        the two airlines, eventually leading to higher fares. They said that over
                        time, airlines in this type of alliance would jointly identify the markets
                        where it would make financial sense for them to reduce or eliminate
                        capacity, especially those markets where the partner airline had more
                        flights. They said that because each airline’s management would retain a
                        strong incentive to maximize revenue and profit, each would benefit by
                        reducing competition with its alliance partner. However, they added that
                        detecting the exact point at which anticompetitive behavior is occurring,
                        or could be attributed to the existence of the alliance rather than to

                        60
                          Because of the airlines’ concerns about confidentiality, we were unable to conduct an independent
                        review of the agreement.



                        Page 49                                              GAO/RCED-99-37 Domestic Airline Alliances
                        Appendix III
                        Potential Beneficial and Harmful Effects on
                        Consumers of the Alliance Initially Proposed
                        by United Airlines and Delta Air Lines




                        independent business decisions, is extremely difficult. This same
                        reasoning—that alliance partners would be unlikely to compete in markets
                        that each served—was used by United when it filed a formal statement
                        opposing American’s alliance with the TACA group.61


A United-Delta          If the airlines established a code-sharing alliance and competed less with
Code-Sharing Alliance   each other, approximately 27.8 million passengers in 550 distinct markets
Would Reduce            could be harmed through reductions in service and increases in airfares.
                        Figure III.1 shows the number of markets that could be adversely affected
Competition in Shared   by a code-sharing alliance if the two airlines did not continue to compete.
Markets                 The figure shows, among other things, that in 58 markets that served
                        4.3 million passengers in 1997, the alliance would become the only active
                        competitor with a market share of more than 10 percent.




                        61
                         Comments of United Airlines, Inc., on American Airlines, Inc., et al. and the TACA Group’s Reciprocal
                        Code-Sharing Services Proceeding, Docket OST-96-1700-72 (Sept. 11, 1997). The TACA group
                        comprises the national airlines for Guatemala, Panama, Costa Rica, Nicaragua, Honduras, and El
                        Salvador.



                        Page 50                                              GAO/RCED-99-37 Domestic Airline Alliances
                                      Appendix III
                                      Potential Beneficial and Harmful Effects on
                                      Consumers of the Alliance Initially Proposed
                                      by United Airlines and Delta Air Lines




Figure III.1: Number of Markets and
Passengers Subject to Potentially
                                       Markets                                                                       Passengers (millions)
Decreased Competition Under a
United-Delta Code-Sharing Alliance     250                                                                                               11

                                       225                                                                                               10

                                       200                                                                                               9

                                                                                                                                         8
                                       175
                                                                                                                                         7
                                       150
                                                                                                                                         6
                                       125
                                                                                                                                         5
                                       100
                                                                                                                                         4
                                           75
                                                                                                                                         3
                                           50                                                                                            2
                                           25                                                                                            1

                                           0                                                                                             0
                                                  22 to
                                                      to 1
                                                          1          33 to
                                                                        to 2
                                                                             2       44to
                                                                                        to 3
                                                                                           3           55to
                                                                                                          to 4
                                                                                                              4            66 toto5 5
                                            Potential decrease in number of competitors
                                                 Number of markets
                                                 1997 passengers




                                      Source: GAO’s analysis of data provided by Data Base Products, Inc., on the top 5,000 origin and
                                      destination markets in 1997.




                                      In many of the markets where the number of active competitors would
                                      decrease if the two airlines did not continue to compete with each other,
                                      the changes in concentration would be significant.62 For example, in the
                                      179 markets where the creation of a code-sharing alliance would decrease
                                      the number of active competitors from three to two, the alliance would
                                      become the largest carrier in 151 and the second largest carrier in the
                                      remaining 28. These 179 markets served over 10.5 million passengers in
                                      1997.


                                      62
                                        The average change in the Hirschmann-Herfindahl Index (HHI) for these 550 markets is 1,208, with a
                                      range of 235 to 4,470. This suggests that a United-Delta code-sharing alliance would substantially
                                      increase concentration in certain markets.



                                      Page 51                                             GAO/RCED-99-37 Domestic Airline Alliances
                           Appendix III
                           Potential Beneficial and Harmful Effects on
                           Consumers of the Alliance Initially Proposed
                           by United Airlines and Delta Air Lines




                           In some markets, the establishment of a code-sharing alliance between
                           United and Delta could have benefits that might, to some extent, mitigate
                           the harmful effects that the alliance might otherwise create. Specifically, at
                           airports where each airline alone has a relatively insignificant competitive
                           presence, a code-sharing alliance would create a larger, potentially
                           stronger entity, allowing it to compete more effectively against other
                           airlines. In 1997, United and Delta each had a limited share (i.e., less than
                           10 percent) in 143 of the top 5,000 markets that served 11 million
                           passengers during that year. However, under a code-sharing alliance, their
                           combined market share would exceed 10 percent, and the partnership
                           would constitute a new active competitor. Of these 143 markets, 59 are
                           currently dominated by one major airline, and a United-Delta code-sharing
                           alliance could increase competition for the 4.9 million passengers served
                           in these markets. Nevertheless, our analysis shows that the addition of the
                           alliance as an active competitor in these markets would make little overall
                           difference because the alliance would remain relatively small, especially
                           compared with other competitors.63


A United-Delta             According to industry experts, if the partners of a code-sharing alliance
Code-Sharing Alliance      held a dominant share of the passenger traffic in shared (i.e., overlapping)
Would Establish Dominant   markets, they could more easily coordinate capacity and maximize
                           revenue, potentially harming passengers. Specifically, the partners could
Shares in Over 200 New     choose to maximize revenue by raising fares in selected markets where
Markets                    they hold a dominant share—thereby harming consumers in these
                           markets—even without increasing their market share overall. Table III.2
                           shows that a United-Delta code-sharing alliance would have more than a
                           50-percent market share in 1,218 of the top 5,000 airport-pair markets.
                           These 1,218 markets served more than 84 million passengers in 1997. The
                           alliance itself would add 213 markets (11.8 million passengers) to the 1,005
                           markets already currently dominated by either United or Delta.




                           63
                             The average change in the HHI for the 143 United-Delta markets where the number of active
                           competitors would increase because of the alliance is 69, with a range of 1 to 193. This indicates that
                           the addition of the alliance as an active competitor would make relatively little overall difference in
                           these markets.



                           Page 52                                                GAO/RCED-99-37 Domestic Airline Alliances
                                        Appendix III
                                        Potential Beneficial and Harmful Effects on
                                        Consumers of the Alliance Initially Proposed
                                        by United Airlines and Delta Air Lines




Table III.2: Potential Effect of a
United-Delta Code-Sharing Alliance on                                         Number of markets with
Market Dominance                                                                more than 50-percent                         Number of
                                                                                        market share                   passengers, 1997
                                        United                                                        273                      30,227,283
                                        Delta                                                         732                      42,681,590
                                        Alliance (new)                                                213                      11,754,050
                                        Total                                                       1,218                      84,662,923
                                        Note: Market share represents the percentage of 1997 passenger traffic carried by each airline.

                                        Source: GAO’s analysis of data provided by Data Base Products, Inc., on the top 5,000 origin and
                                        destination markets in 1997.




A United-Delta                          At the nation’s slot-controlled and gate-constrained airports, a
Code-Sharing Alliance                   United-Delta code-sharing alliance would not appreciably change the level
Would Have the Potential                of concentration. Any potential harm to consumers would probably be
                                        slight. For example, United’s 48.3-percent share of traffic at Chicago’s
to Affect Operating and                 slot-controlled O’Hare Airport and Delta’s 76.8-percent share of traffic at
Marketing Barriers to                   Cincinnati’s gate-constrained airport would not be significantly affected by
Entry                                   the combination, since neither airline maintains a significant presence at
                                        the other’s hub. At O’Hare, a code-sharing alliance’s share would increase
                                        to 51.7 percent; at Cincinnati, it would increase to 77.9 percent.

                                        Nonaligned airlines, consumer groups and one industry expert stressed
                                        the adverse effect on competition that a code-sharing alliance such as that
                                        originally proposed between United and Delta could exercise through
                                        computer reservation systems. The alliance could gain a competitive
                                        advantage through multiple listings of the same code-sharing flight on the
                                        reservation screen, increasing the likelihood that the alliance’s flights
                                        would be the first offered to the consumer.




                                        Page 53                                             GAO/RCED-99-37 Domestic Airline Alliances
Appendix IV

Potential Beneficial and Harmful Effects on
Consumers of a Code-Sharing Alliance
Between American Airlines and US Airways
                            For American Airlines and US Airways, as for United and Delta, we
                            assumed that their alliance could proceed to a partnership involving
                            code-sharing. Because officials from both airlines said that they would
                            implement code-sharing if the other two alliances moved forward with
                            code-sharing arrangements, our analysis of the alliance’s potential
                            beneficial and harmful effects assumes that they would do the same. With
                            code-sharing, the alliance could have significant effects—both positive and
                            negative—on consumers throughout the United States.


                            If American Airlines and US Airways ultimately decide to implement
A Code-Sharing              code-sharing in a substantial number of markets, passengers could benefit
Alliance Between            from more on-line destinations, better routes and connections, and more
American and US             flight frequencies. But because the alliance does not currently include
                            code-sharing between main American and main US Airways, the two
Airways Would               partners have not predicted any benefits.
Include New
Destinations and
Frequencies
An American-US Airways      We found that a code-sharing alliance between American and US Airways
Code-Sharing Alliance       could create new single- and double-connection markets. Because
Would Offer Consumers       American currently serves 55 airports from its hubs that US Airways does
                            not serve and US Airways serves 76 airports from its hubs that American
More On-Line Destinations   does not serve, the alliance could, in theory, provide on-line service in
                            4,180 new markets. However, many of these markets would require more
                            than two connections. When we eliminated these impractical routes,64 we
                            found that an American-US Airways code-sharing alliance could create 483
                            new single- or double-connection markets.

                            We found that such an alliance could create on-line single-connection
                            service in 166 markets that served 2.0 million passengers in 1997.65 In 47 of
                            these markets, the alliance would produce superior service to that already
                            offered by a competitor. However, in 119 markets, competing airlines’
                            existing service would be superior or at least equal to that created by the
                            alliance. We also found that an American-US Airways code-sharing
                            alliance could create 317 new double-connection markets. However, either
                            one of the alliance partners or a competitor already provided on-line
                            service to each of these markets. Although an American-US Airways

                            64
                              See app. II for additional information on our methodology.
                            65
                              See app. II for additional information on our methodology.



                            Page 54                                              GAO/RCED-99-37 Domestic Airline Alliances
                                         Appendix IV
                                         Potential Beneficial and Harmful Effects on
                                         Consumers of a Code-Sharing Alliance
                                         Between American Airlines and US Airways




                                         code-sharing alliance would provide superior service to that offered by
                                         competitors in 3 markets, other competing airlines already provided
                                         superior or equal service to 314 markets. Table IV.1 provides our detailed
                                         analysis of the new on-line benefits that consumers could expect from this
                                         alliance.


Table IV.1: GAO’s Analysis of Benefits Under an American-US Airways Code-Sharing Alliance: Airport Pairs That Would
Receive New On-Line Service Through Single or Double Connections
                               Total markets and average number of
                                  passengers per day who would
                                receive new American-US Airways
                                              service                     Number of           Number of          Number of
                                               Average number             markets in which        markets in which        markets in which
                                              of passengers per                  competing               competing                competing
                                    Number of day per market in            airlines provide        airlines provide         airlines provide
Type of new on-line service           markets             1997            superior servicea         equal serviceb         inferior servicec
Single-connection                            166                    34                      24                      95                         47
Double-connection                            317                      7                    271                      43                          3
                                         a
                                          Superior service includes current direct and nonstop service by competitors between airports
                                         that an American-US Airways code-sharing alliance could serve at best with single-connection
                                         service; and direct, nonstop, or single-connection service by competitors between airports that an
                                         American-US Airways code-sharing alliance could serve at best with double-connection service.
                                         Direct service differs from nonstop service in that a “direct” flight makes a scheduled stop
                                         between an origin and a destination, but passengers flying between the origin and destination are
                                         not required to change planes, while a nonstop flight between an origin and a destination makes
                                         no scheduled stops en route.
                                         b
                                          Equal service means that competing airlines currently offer service that matches an
                                         American-US Airways code-sharing alliance’s potential single- or double-connection service.
                                         c
                                          Inferior service means that competing airlines currently offer (1) no service or double-connection
                                         service between airports where an American-US Airways code-sharing alliance could offer
                                         single-connection service or (2) no service between airports where an American-US Airways
                                         code-sharing alliance could provide double-connection service.

                                         Source: GAO’s analysis of information provided by BACK Associates and Data Base Products,
                                         Inc.




                                         Given the size of the partners’ respective route networks, a code-sharing
If the Partners Did                      alliance between American and US Airways would produce much overlap
Not Compete, an                          and could harm many travelers if, over time, the airlines did not continue
American-US Airways                      to compete as independent companies.
Code-Sharing Alliance
Could Harm
Consumers

                                         Page 55                                              GAO/RCED-99-37 Domestic Airline Alliances
                                     Appendix IV
                                     Potential Beneficial and Harmful Effects on
                                     Consumers of a Code-Sharing Alliance
                                     Between American Airlines and US Airways




An American-US Airways               If the current American-US Airways alliance moved to a code-sharing
Code-Sharing Alliance                arrangement, it could reduce competition in 260 of the top 5,000 markets.
Could Potentially Reduce             These 260 markets served 13.3 million passengers in 1997. Moreover, such
                                     an alliance could eliminate competition in 24 of the markets, which served
Competition in Shared                2.0 million passengers in 1997. Such an alliance could also decrease the
Markets                              number of active competitors from three to two in 90 markets. Our
                                     analysis shows that in 80 of these 90 markets, the alliance would become
                                     the largest carrier, and in the remaining 10 markets, it would become the
                                     second largest carrier (see fig. IV.1).66


Figure IV.1: Number of Markets and
Passengers Subject to Potentially         Markets                                                                   Passengers (millions)
Decreased Competition Under an
                                          250                                                                                           11
American-US Airways Code-Sharing
Alliance                                  225                                                                                           10

                                          200                                                                                           9

                                                                                                                                        8
                                          175
                                                                                                                                        7
                                          150
                                                                                                                                        6
                                          125
                                                                                                                                        5
                                          100
                                                                                                                                        4
                                           75
                                                                                                                                        3
                                           50                                                                                           2
                                           25                                                                                           1

                                            0                                                                                           0
                                                      2 to 1             3 to 2        4 to 3
                                                      2 to 1             3 to 2       4 to 3            55 to
                                                                                                           to 4
                                                                                                                4          6 to 5
                                                                                                                           6 to 5
                                                Potential decrease in number of competitors

                                                     Number of markets
                                                     1997 passengers




                                     Source: GAO’s analysis of data provided by Data Base Products, Inc., on the top 5,000 origin and
                                     destination markets in 1997.




                                     66
                                       The average change in the Hirschmann-Herfindahl Index (HHI) for these 260 markets is 1,217, with a
                                     range from 228 to 4,477. This suggests that an American-US Airways code-sharing alliance would
                                     significantly increase concentration in a number of origin and destination markets.



                                     Page 56                                              GAO/RCED-99-37 Domestic Airline Alliances
                         Appendix IV
                         Potential Beneficial and Harmful Effects on
                         Consumers of a Code-Sharing Alliance
                         Between American Airlines and US Airways




                         The harmful effects that could result from reducing the number of
                         competitors in 260 markets could be mitigated by the benefits of
                         increasing competition in some individual markets. Each of the two
                         airlines has a limited share (i.e., less than 10 percent) in 60 of the top 5,000
                         markets. These 60 markets served 5.2 million passengers in 1997. Under a
                         code-sharing alliance, the airlines’ share in these markets would exceed 10
                         percent, and the alliance would represent a new active competitor. Of
                         these 60 markets, 15 are currently dominated by a single airline. In these
                         15 markets, the alliance’s creation could enhance competition, benefiting
                         the 2.3 million passengers who were served in these markets during 1997.
                         However, on average, the addition of the alliance as an active competitor
                         would make relatively little difference in the level of concentration in
                         these markets.67


An American-US Airways   With code-sharing, an American-US Airways alliance would hold a
Code-Sharing Alliance    majority share in 977 of the top 5,000 origin and destination markets.
Would Increase           These 977 markets served 58.2 million passengers in 1997. According to
                         1997 data, American had a dominant share in 278 markets that served
Dominance in Certain     about 25.1 million passengers, and US Airways had a majority share in 596
Markets                  markets that served about 29 million passengers. Thus, a code-sharing
                         alliance would give the partners a majority share in 103 additional
                         markets. This increase in dominance is significant because it would allow
                         the partners to raise fares in selected markets—thereby potentially
                         harming consumers in these markets—without increasing their market
                         share overall. These 103 markets served nearly 4.2 million passengers in
                         1997 (see table IV.2). These markets include routes between American’s
                         hubs in Dallas or Miami and US Airways’s hubs in Philadelphia and
                         Pittsburgh where the alliance would carry more than 80 percent of the
                         passengers.




                         67
                          Under the American-US Airways alliance, the average change in the HHI for these 60 markets is 62,
                         with a range of 5 to 156. This indicates that the addition of the alliance as an active competitor would
                         make relatively little overall difference in these markets.



                         Page 57                                                GAO/RCED-99-37 Domestic Airline Alliances
                                     Appendix IV
                                     Potential Beneficial and Harmful Effects on
                                     Consumers of a Code-Sharing Alliance
                                     Between American Airlines and US Airways




Table IV.2: Potential Effect of an
American-US Airways Code-Sharing                                           Number of markets with
Alliance on Market Dominance                                                 more than 50-percent                         Number of
                                                                                     market share                   passengers, 1997
                                     American                                                       278                      25,050,145
                                     US Airways                                                     596                      28,995,941
                                     Alliance (new)                                                 103                       4,171,404
                                     Total                                                          977                      58,217,490
                                     Note:Market share represents the percentage of 1997 passenger traffic carried by each airline.

                                     Source: GAO’s analysis of data provided by Data Base Products, Inc., on the top 5,000 origin and
                                     destination markets in 1997.




An American-US Airways               Operating barriers could be an issue for this alliance if it proceeds to
Code-Sharing Alliance                code-sharing. Both airlines have significant presences at slot-controlled
Would Also Increase                  Washington Reagan National and New York LaGuardia airports. US
                                     Airways holds the largest percentage of slots at Washington Reagan
Barriers to Entry                    National (35.4 percent). Under an alliance, it would control 49.0 percent of
                                     the slots there. US Airways also holds the largest percentage of slots at
                                     New York LaGuardia (27.0 percent). Under an alliance, it would control
                                     44.5 percent of the slots there. The change in concentration that would
                                     occur under an alliance at gate-constrained airports would be less
                                     significant. US Airways already has more than 80 percent of the market (as
                                     measured by 1997 enplanements) at the Pittsburgh airport. We have
                                     previously reported fares more than 20 percent higher in constant dollars
                                     since deregulation at this airport.68 However, because American does not
                                     have a significant market share at Pittsburgh (less than 2 percent), an
                                     alliance would not significantly increase the partners’ market share.

                                     In addition, some nonaligned airlines, consumer groups, and an industry
                                     expert stressed the adverse effect on competition that a code-sharing
                                     alliance between American and US Airways could exercise through
                                     computer reservation systems. The alliance could gain a competitive
                                     advantage through multiple listings of the same code-sharing flight on the
                                     reservation screen, increasing the likelihood that the alliance’s flights
                                     would be the first offered to the consumer.




                                     68
                                      Airline Deregulation: Barriers to Entry Continue to Limit Competition in Several Key Domestic
                                     Markets (GAO/RCED-97-4, Oct. 18, 1996).



                                     Page 58                                             GAO/RCED-99-37 Domestic Airline Alliances
Appendix V

Implementation of All Three Alliances as
Code-Sharing Arrangements Could
Substantially Affect Competition
               If all three of the alliances were to move forward as code-sharing
               arrangements, many questions would arise not only about the beneficial
               and harmful effects that could be attributed directly to the individual
               alliances but also about the cumulative effect of the alliances on
               competition in the industry, particularly for new-entrant and nonaligned
               airlines.

               If all three alliances were implemented as code-sharing agreements, some
               consumers would benefit from extended route networks but other
               consumers could be harmed if competition were to decline. On the one
               hand, consumers would gain access to new airport pairs served by the
               three alliances, as well as additional flight frequencies, new routes with
               better connections, and expanded frequent flyer programs. On the other
               hand, according to the industry experts we interviewed, the alliances
               would stimulate little growth in passenger traffic and would generally shift
               passengers either among themselves or away from other nonaligned
               airlines in various markets. No airline partner currently plans to add new
               flights or airplanes in any given market.

               Moreover, if the formation of code-sharing alliances created an
               environment in which the partners competed less vigorously, the number
               of competitors could be reduced in hundreds of domestic airport-pair
               markets that were among the top 5,000 in 1997, potentially affecting tens
               of millions of passengers. In addition, the number of markets dominated
               by the alliances would increase by about 10 percent, causing over
               two-thirds of U.S. travelers to fly in markets dominated by a single airline.
               Operating barriers could increase at the slot-controlled airports in New
               York and Washington, D.C., and if more markets were dominated by the
               alliances, marketing barriers such as those represented by combined
               frequent flyer programs could make entry by new airlines more difficult.
               Finally, if all three alliances were to move forward as code-sharing
               arrangements, the computer reservation systems that travel agents use to
               book airline tickets could begin to display each alliance’s flights
               twice—once under each partner’s code. Independent or new-entrant
               airlines then might have more difficulty getting their flights listed
               prominently in travel agents’ displays.




               Page 59                                 GAO/RCED-99-37 Domestic Airline Alliances
                         Appendix V
                         Implementation of All Three Alliances as
                         Code-Sharing Arrangements Could
                         Substantially Affect Competition




                         If the three alliances were to proceed as code-sharing agreements, they
Consumers Could          would be likely to create some new on-line destinations, allow some new
Realize Some Benefits    or improved routes and connections, and expand frequent flyer and club
If All Three Alliances   benefits to members. However, because of some overlap among the
                         alliances, the total number of unique, new markets would be smaller than
Were to Proceed as       the sum of such markets for each of the three alliances, and fewer
Code-Sharing             passengers would be likely to benefit from the alliances than some of the
                         airlines have predicted because their estimates assume no competitive
Agreements               responses from other airlines. Overall, the industry experts we interviewed
                         indicated that the alliances would do little to stimulate growth in
                         passenger traffic because they would mainly shift passengers among
                         themselves, or from other airlines, in various markets.

                         Two alliances would be likely to create new frequencies and better
                         connections (assuming no schedule changes by the airlines).
                         Northwest-Continental officials and United-Delta officials did not count
                         their possible new frequencies and routings in the same manner, and
                         because American and US Airways originally proposed a much more
                         limited alliance, they did not calculate how many new frequencies and
                         routes a code-sharing alliance would make possible.

                         Many consumers may also benefit from the expanded frequent flyer
                         options available under the current alliance agreements. However, the
                         particular frequent flyer benefits will vary by alliance for consumers. In
                         addition, the ability of consumers to obtain awards may depend on the
                         availability of frequent flyer seats, the number of miles required to obtain
                         awards, and the types of restrictions (e.g., blackout dates) that the airlines
                         specify. Moreover, as noted earlier, award requirements may change over
                         time.

                         For methodological reasons, we were unable to quantify potential
                         cumulative benefits (e.g., new routes or flight frequencies) that could be
                         created by the alliances, but we believe that these benefits could be
                         substantial.


                         It is difficult to determine whether three code-sharing alliances would
If Partners Did Not      reduce competition, but industry experts’ concerns and the airlines’ past
Compete,                 records give cause for concern. There is agreement among some industry
Code-Sharing             experts that competition would be likely to decline over time as the
                         partners recognized their interdependence and began to maintain fares
Alliances Could Harm     above the competitive level. Such an outcome is consistent with widely
Consumers                held economic principles that associate less competition with fewer


                         Page 60                                    GAO/RCED-99-37 Domestic Airline Alliances
                                    Appendix V
                                    Implementation of All Three Alliances as
                                    Code-Sharing Arrangements Could
                                    Substantially Affect Competition




                                    competitors. As the ties between major airlines were strengthened, the
                                    opportunities would increase for airlines to recognize their
                                    interdependence. If this should occur, competition would suffer and fares
                                    would rise.


Competition Could Decline           If all three alliances were to proceed with code-sharing, then the number
in Shared Markets                   of competitors could decline in some domestic airport-pair markets. As
                                    figure V.1 shows, 78 of the top 5,000 markets would become single-airline
                                    markets if the alliance partners did not compete with each other. Overall,
                                    concentration would also increase.


Figure V.1: Number of Markets and
Passengers Subject to Potentially   Markets                                                                     Passengers (millions)
Decreased Competition Under Three   350                                                                                            11
Code-Sharing Alliances
                                    325                                                                                            10
                                    300
                                                                                                                                   9
                                    275
                                    250                                                                                            8
                                    225                                                                                            7
                                    200
                                                                                                                                   6
                                    175
                                                                                                                                   5
                                    150
                                    125                                                                                            4
                                    100                                                                                            3
                                        75
                                                                                                                                   2
                                        50
                                        25                                                                                         1

                                        0                                 a                                 c                      0
                                                  22toto
                                                       1   1       34to
                                                                3 or  to 22       44orto  33b
                                                                                       5 to        55  toto44
                                                                                                    or 6              66
                                                                                                                       to to
                                                                                                                          5    5
                                             Decrease in number of competitors
                                                 Number of markets
                                                 1997 passengers



                                    a
                                     Includes 17 markets where the three alliances would reduce the number of active competitors
                                    from four to two.
                                    b
                                     Includes 23 markets where the three alliances would reduce the number of active competitors
                                    from five to three.




                                    Page 61                                             GAO/RCED-99-37 Domestic Airline Alliances
                          Appendix V
                          Implementation of All Three Alliances as
                          Code-Sharing Arrangements Could
                          Substantially Affect Competition




                          c
                           Includes two markets where the three alliances would reduce the number of active competitors
                          from six to four.


                          Source: GAO’s analysis of data provided by Data Base Products, Inc., on the top 5,000 origin and
                          destination markets in 1997.


                          If the alliance partners did not compete, the harmful effects of fewer
                          competitors could, to a limited extent, be mitigated by an increase in
                          competition in some markets. In total, the three alliances could add an
                          active competitor to 328 of the top 5,000 markets. Of these 328 markets,
                          which served almost 22 million passengers in 1997, 97 are currently
                          single-competitor markets. In these markets, which served over 7.8 million
                          passengers in 1997, the alliances would add one or more active
                          competitors.


Market Dominance Would    If three code-sharing alliances were implemented, the number of
Increase                  dominated markets would increase by 341 (about 10 percent), from 3,381
                          to 3,722 airport pairs—or about 75 percent of the top 5,000 markets in
                          1997.69 Such an increase in market dominance is significant, according to
                          industry analysts, who predicted that alliance partners might not be able
                          to gain much market share overall but might be able to increase revenues
                          in individual markets where they held a dominant position. In 1997,
                          approximately 280 million passengers, or over two-thirds of those who
                          flew domestically, flew in these markets.


Barriers to Entry Could   Overall, airfares have decreased and service has improved since the airline
Increase                  industry was deregulated in 1978. Nevertheless, operating and marketing
                          barriers have presented significant barriers to competition. The existence
                          of these barriers increases the likelihood that additional concentration
                          could harm consumers by discouraging entry by other established or new
                          entrant airlines, thus allowing the alliance partners to raise their fares
                          and/or reduce their services. As we have previously pointed out, operating
                          restrictions such as slot controls and gate constraints can make it more
                          difficult for new carriers to enter a market. In all cases, the alliances could
                          add to the level of concentration at these airports, as shown in table V.1.



                          69
                           Non-alliance airlines—such as TWA, AmericaWest, and Southwest—dominated 1,035 of the top 5,000
                          routes in 1997. Over 96 million passengers flew on these routes. Thus, were the three alliances to
                          proceed to code-sharing and not act independently, they would dominate 2,687 routes, on which over
                          183 million passengers flew in 1997.



                          Page 62                                            GAO/RCED-99-37 Domestic Airline Alliances
                                          Appendix V
                                          Implementation of All Three Alliances as
                                          Code-Sharing Arrangements Could
                                          Substantially Affect Competition




Table V.1: Alliance Partners’ Combined Market Share at Slot-Controlled and Gate-Constrained Airports
                                                                                   Postalliance market sharea
                                              Prealliance market                                         American-US          Northwest-
Constraint          Airport                   sharea/dominant airline              United-Delta              Airways          Continental
Slot                Chicago O’Hare            48.3/United                                   51.7                40.1                  4.2
                    Washington Reagan         35.4/US Airways
                    National                                                                24.0                49.0                 14.4
                    New York Kennedy          30.0/American                                 28.9                30.1                  1.1b
                    New York LaGuardia        27.0/US Airways                               34.3                44.5                 10.1
Gate                Charlotte                 83.8/US Airways                                 3.3               85.3                  1.4
                    Cincinnati                76.8/Delta                                    77.9                 0.9                  1.4
                    Detroit                   77.8/ Northwest                                 4.8                4.8                 79.4
                    Minneapolis               80.5/Northwest                                  5.9                3.9                 81.5
                    Newark                    60.8/Continental                              15.0                12.1                 64.6
                    Pittsburgh                82.2/US Airways                                 3.6               83.1                  2.5
                                          a
                                          Market share is expressed as the percentage of total 1997 enplanements at each airport.
                                          b
                                              Continental did not serve New York’s Kennedy Airport in 1997.

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



                                          Although, in most cases, the percentage increase in market share would be
                                          small, in every case, the alliance partner with the lesser share might have
                                          an opportunity to improve its market position, potentially increasing the
                                          difficulty for other airlines of gaining access at these 10 important airports.
                                          In the complaint it filed against Northwest and Continental, DOJ also noted
                                          that difficulty in obtaining access to gate facilities impedes new entry. One
                                          opportunity that the lesser partner might derive from its immediate access
                                          to the dominant partner’s strength at the airport is that its flights might
                                          appear more attractive to consumers. For example, under a code-sharing
                                          alliance, Texas consumers might find Continental a more desirable airline
                                          to fly to Minneapolis, where Northwest enjoys a dominant market share.
                                          This is because Continental’s presence in the alliance would allow it to
                                          market, and to offer, an increased number of daily flights in these markets
                                          under its code on Northwest’s planes. Another opportunity for the lesser
                                          partner might be to remove aircraft from airports where its operations are
                                          unprofitable and to shift passengers to its partner’s aircraft, thereby
                                          strengthening its partner’s position at that airport. For example, if
                                          Northwest and Continental each operated flights from Minneapolis to
                                          Cleveland, but Continental served that market only with smaller commuter
                                          aircraft instead of larger jets, it might choose to put its passengers on




                                          Page 63                                               GAO/RCED-99-37 Domestic Airline Alliances
Appendix V
Implementation of All Three Alliances as
Code-Sharing Arrangements Could
Substantially Affect Competition




Northwest’s jet flights. Concentration at airports other than the 10 cited in
table V.1 could also increase, potentially preventing small and new-entrant
carriers from gaining market share at heavily concentrated airports.

We have also reported that airline sales and marketing practices may make
competitive entry more difficult for other airlines.70 However, we have not
been able to quantify the effects of these barriers on competition for any
or all of the alliances. Nevertheless, marketing practices such as frequent
flyer programs and special bonuses to travel agents for booking traffic on
an incumbent airline may encourage travelers to choose one airline over
another on the basis of factors other than the best fares. Such practices
may be most important if an airline is already dominant in a given market
or markets. Because the alliances could increase dominance by about
10 percent in the top 5,000 markets in 1997, marketing barriers in these
metropolitan areas would be likely to become more important. DOJ also
noted the effect that such practices had on impeding competition from
new entrants in the complaint it filed against Northwest and Continental.
Nonetheless, mitigating the effect of these practices without banning them
is difficult, and banning them involves a trade-off between their potential
anticompetitive effects and the consumer benefits that some of them
bring.

Some nonaligned airlines, consumer groups, and an industry expert
stressed the adverse effects on competition that code-sharing alliances
could exercise through computer reservation systems. Through
code-sharing, flights that previously appeared in these systems under one
airline’s code could now appear twice—once under the operating airline’s
code and once under the code-sharing partner’s. Connecting flights
between the partners could appear three times, once under each partner’s
code and once as a connecting flight. Thus, it is likely that the creation of a
code-sharing alliance would increase the number of flights listed for the
partners on the first reservation screen, from which travel agents often
book flights. Where three alliances provided code-sharing flights in the
same markets, six or more code-sharing flights might appear on the first
screen, crowding out opportunities for other airlines.




70
 See, for example, Aviation Competition: International Aviation Alliances and the Influence of Airline
Marketing Practices (GAO/T-RCED-98-131, Mar. 19, 1998).



Page 64                                               GAO/RCED-99-37 Domestic Airline Alliances
Major Contributors to This Report


                        Aaron Casey
Resources,              Elizabeth Eisenstadt
Community, and          Tina Kinney
Economic                Steven Martin
                        Sara Ann Moessbauer
Development             Marnie Shaul
Division, Washington,
D.C.
                        Paul Aussendorf
Seattle Regional        Stan Stenersen
Office
                        David Hooper
Office of General
Counsel
                        Joseph Kile
Office of the Chief
Economist




                        Page 65                GAO/RCED-99-37 Domestic Airline Alliances
Major Contributors to This Report




Page 66                             GAO/RCED-99-37 Domestic Airline Alliances
Related GAO Products


              Aviation Competition: Proposed Domestic Airline Alliances Raise Serious
              Issues (GAO/T-RCED-98-215, June 4, 1998).

              Domestic Aviation: Service Problems and Limited Competition Continue in
              Some Markets (GAO/T-RCED-98-176, Apr. 23, 1998).

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

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




              Page 67                                 GAO/RCED-99-37 Domestic Airline Alliances
           Related GAO Products




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

           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: 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).




(348107)   Page 68                                GAO/RCED-99-37 Domestic Airline Alliances
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