oversight

Effects of Airline Entry Barriers on Fares

Published by the Government Accountability Office on 1990-04-05.

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

                   UnitedStates   GeneralAccountingOffIce
                   Testimony



For Release         Effects of Airline    Entry   Barriers
on Del ivery        on Fares
Expected at
2:3!l o.m. EDT
Thursday                                                ..
April 5, 1990




                    Statement of
                   Kenneth M. Mead
                   Director,  Transportation Issues
                   Resources, Community, and Economic
                   Development Division

                   Before the
                   Subcommittee on Aviation
                   Committee on Connnerce, Science,
                   and Transportation
                   United States Senate




GAOfLJ?CED-90-62
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        Mr.   Chairman   and Members of the Subcomittee:

              We appreciate the opportunity   to testify   on the work we are
        doing at your request  on the effects   of airline   market
        concentration      and barriers    to entry on airline       fares.   We testified
        before this Committee last June on our analysis of the effects of
        airport    concentration    an airline     fares.l    We testified    again last
        September on the extent of barriers            to entry in the airline
        industry.2      Since that time, the Department of Transportation               has
        issued its report of the Secretary's             Task Force on Competition in
        the U.S. Domestic Airline        Industry.       Our testimony today will       (1)
        update our June 1989 analysis of airline             pricing    and compare our
        results    to those of the Secretary's         Task Force, (2) report on the
        preliminary     results of our econometric analysis of the effect of
        barriers     to entry on airline     fares, and (3) discuss the
        implications     of our findings     for policymaking.                          2

               Last June, we testified    that airline     yields,  or fares per
        passenger-mile,     at 15 concentrated airports       in 1988 were 27 percent
        higher than at 38 unconcentrated       airports.3      We have updated our
        data through the second quarter of 1989, and find that the gap
        persists.    It is now 26 percent.      The DOT report reached
        conclusions    very similar   to ours.    After adjusting    for differences
        in flight   distance between concentrated and unconcentrated
        airports,   both studies found yields at concentrated airports           around
        20 percent higher than at other airports          (DOT's estimate was 18.4
        percent; ours was 21.0 percent).        The Task Force also reviewed a
        number of the entry barriers      that we discussed in our September

        %ir Farms and Service at Con                ted Air~ortq     (GAO/T-NED-89-
        37, June 7, 1989).
        2Barr&rs                  . the w
                  to Competition In                                ry (GAO/T-RCED-899
        65, Sept. 20, 1989).
        3GA0 considered an airport        market concentrated if one
        airline handled 60 percent        of the enplanements or if two airlines
        handled 85 percent.
                                                1

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    testimony    and found,     as we had, that        several    of them have the
    potential    to significantly     limit       entry into     airline markets.

           We are currently      estimating    the relationships    between fares
    and the various operating and marketing practices              that may
    discourage entry.       Our analysis to date indicates         that many of the
    airline     operating and marketing practices          we have discussed are in
    fact related      in a statistically      significant    way to higher airline
    fares. Our results      suggest that no single fac$or is responsible           for
    higher fares at concentrated          airports,     but that it is,the
    interaction      of a number of barriers        that allows carriers   at these
    airports     to charge higher fares,

          We recognize that various solutions           have been proposed for
    dealing with the factors that limit            competition   in the airline
    industry,   including    limiting     concentrated    hub airports    and    z_
    increasing    airport   capacity.      We have reservations      about presuming
    all concentrated      hubs to be anticompetitive.          We agree that
    increasing   capacity would be helpful,          but we are concerned that
    increasing    capacity will take too long, and that increases in
    capacity alone will not solve all the problems of competitiveness
    that we have identified.          Along with initiatives      to enhance airport
    capacity,  we believe that a broad range of policy options to reduce
    the anticompetitive      effects     of various industry     operating and
    marketing practices,       such as those we have discussed in our
    previous testimony,      should be considered.




          Yield8 at the 15 concentrated   airports    rose in 1989,            from 18.5
    cents per passenger-mile    in 1988 to 21.0 cents in the first                two
    quarters of 1989. Yields at the 38 unconcentrated           airports          also
    rose, from 14.5 cents to 16.7 cents, leaving a gap between                  the
    yields at concentrated   and unconcentrated    airports     of 26.4         percent.
    The dominant airline's   yields rose particularly       rapidly    at        Detroit,
                                              2


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       Raleigh-Durham,       Greensboro,     Pittsburgh,     Syracuse,     and Denver.     When
       compared to the yields         at 22 unconcentrated        airports    where average
       trip    distance was about the same as at the concentrated                airports,
       yields     at concentrated     airports     were 20.7 percent higher        in the
       first    half of 1989.      Airline     travel    from the 15 concentrated
       airports     represents    21.8 percent of all airline           revenue passenger
       miles.      Concentrated airports         that did not meet other criteria          of
       our study    accounted    for   another   9.5 percent     of airline      traffic.4

               In February, the Secretary of Transport&ion         released the
       report of his Task Force on Competition in the U.S. Domestic
       Airline      Industry.    The report discussed changes in market
       structure,      pricing,    and barriers  to entry since the airline
       industry      was deregulated in 1978. The report concluded that air
       fares     (in constant    dollars)   have fallen  since 1979 but that,   as our
       work has shown, air fares are higher at concentrated            airports  t_han
                                                                                  2
       at unconcentrated        airports,

               Our analysis of the higher yields at concentrated airports          and
       the Task Force's analysis are similar.            The Task Force found that
       fares at the 15 concentrated airports,           after adjustment for
       variations     in flight   distance,   were 18.4 percent higher than at
       airports    generally.     We found, after also adjusting        for flight
       distance,    that yields at the concentrated airports          were 21.0
       percent higher than at unconcentrated airports.              The remaining
       difference    may be due to the fact that DOT's study examined
       passengers both originating         and terminating    their trips at the
       concentrated      airport,  while we looked only at passengers
       originating     there.

            The Task Force also came to conclusions similar   to ours
       concerning a number of the entry barriers   we have examined. The


       40ne of these airports    was outside the 48 contiguous                states:
       the others were in cities    with multiple airports.
                                                 3



-.__
 Task Force found that new entrants           are likely   to pay higher lease
 rates at airports       with exclusive-use      leases,  where the entrant   must
sublease space from incumbent carriers.               The Task Force also found
that majority-in-interest          and other clauses that limit      expansion at
airports   may discourage        new entry.5     It did not find that slots
are, by themselves,         an entry barrier.6       However, it concluded that
there is the potential         for the exercise of market power in the
market for slots,    and therefore  that the slot rule had the
potential to result in an entry barrier.       Th&Task Force concluded
that noise restrictions     are not now a major barrier     to entry, but
that they could become a barrier      if noise restrictions    proliferate,

      In reviewing   airline   marketing strategies,        the Task Force
found that frequent flyer plans may make it more difficult               for
smaller air carriers      to compete successfully      in some markets; that
computerized reservation      systems (CRSs) may transfer        $2 billionlto
$3 billion   in gross revenues to CRS vendors; that travel agent
commission overrides weaken the competitive           position   of smaller
carriers;   and that new entrants     have difficulty       competing with
code-sharing   regional airlines     on hub-to-spoke routes.'


5A majority-in-interest     clause (MI) in an airport      use
agreement gives the carriers       performing a majority   of the
operations at the airport      authority    to disapprove expansions of
the airport     that would be paid for through fees charged to those
airlines.
6The Federal Aviation Administration     restricts   landings and take-
offs at four congested airports     (Washington National,    New York
LaGuardii and Kennedy, and Chicago O'Hare).        Carriers wishing to
serve thue airports    must secure a reservation,      or Mslot,1V at the
airport  to use the airport  regularly   at a particular    hour each day,
'Code-sharing     agreements are agreements between jet airlines   and
commuter airlines      in which the commuter airline  agrees to share the
two-letter    designator code of the jet airline,    so that both
airline's   flights   are booked as if they were the same airline.     The
commuter airline     also generally paints its planes in the colors of
the jet airline     and coordinates  schedules so as to enhance the
convenience of connections.
                                       4
        ANALYSIS OF RELATIONSHIP BETWEENAIRLlNl$
        OPERATING AND MARKETING PRACTICES AND FARES

              Part   of our investigation      has been an effort  to estimate the
        relationship    between each of these airline      operating and marketing
        practices    and airline    fares, using an econometric model of airline
        industry pricing.        We would expect that factors that discourage
        entry would generally       tend to raise fares.    We wanted to find out
        which factors were related to higher fares, either directly           or
        through their effect on market share.          &I @COnOm@triC.mOd@l   US8S
        statistical    t@Chniw@S t0 analyze the relationships        between airline
        fares and a large number of other factors.          These t@ChniqU@SallOW
        us to measure the effects        on fares of changes in one Variable When
        Other variables     are held constant.

                Our model incorporates       various factors that influence       far&B,
        including     cost factors such as flight       distance and traffic      VOlIlm8;
        demand factors,        such as income levels and consumer preferences for
        different     airlines;     market structure   factors,    such as market share
        and concentration        indexes; as well as several factors representing
        airline    operating and marketing practices          that may function as
        entry barriers,         We analyzed 1988 DOT data on airline       fares,
        traffic    levels,     and enplanements for over 1600 routes.         W8 also
        gathered original        survey data on airport     gates, leasing agreements,
        noise restrictions,        and expansion plans for the 183 airports
        covered by the analysis.          Our analysis thus covers the effects of
        entry barriers       at both concentrated and unconcentrated airports.
        We analyzed the effects         of these factors on both fares and market
        Shares.

               while our findings  are preliminary    and subject to change, and
        while an econometric model cannot prove that a factor causes higher
        prices, we believe that the model allows u8 to make system-wide
        observations   of the r@latiOnShips between various airline     operating
        and marketing practices   and airline    fares and market shares.
                                               5

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           Our analysis to date indicates       that many of the airline
    operating   and marketing  practices      we have discussed are in fact
    related in a statistically     significant      way to airline fares.   In
    particular,   our results  indicate     the following:

         -- The larger the share of gates a carrier          leased at an
            airport,    especially   if those gates were on long-term
            exclusive-use     leases, the higher its.'.tares     were at that
            airport    (for example, a doubling of a carrier!s        gate share
            is associated     with an increase in fares on a route of, on
            average, 3.5 percent).

         -- Flights  at airports  where a majority-in-interest      clause
            might reduce the ability   of the airport      to expand had, on
            average, about 3 percent higher air fares.                     a
                                                                           =

         -- Flights    at airports where entry was limited  by slot
            controls    had, on average, about 7 percent higher air         fares.

         --   If the runway capacity of the airport  is congested, and
              expansion is limited  by the presence of a majority-in-
              interest clause or other problems, fares are, on average,
              about 3 percent higher.

         -- noise   restrictions      were not consistently   related   to higher
            fares   at airports      where they were in effect;

         -- tha larger an airline's    share of the computerized
            nmrvation     system market in a metropolitan   area, the
            larger its market share on routes from airports      in that
            area, though the amount of the increase varied with
            different  versions of the model;

         -- The more travel        agents to whom a carrier   paid commission
                                           6


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              overrides  in a metropolitan  area, the higher the carrier's
              fares tended to be on service    in that area, though the size
              of this effect  also varied with different    versions of the
              model.

           -- Carriers with a code-sharing agreement at one of the
              airports   on a route charged fares almost 8 percent higher
              than carriers   did on routes on which they did not have
                                                      .
              code-sharing agreements.               .-

            Though these magnitudes represent our best estimates to date,
     these results    are preliminary,    and the relative    effects    of some
     specific   industry practices     may change somewhat as our analysis is
     completed.     We were not able to develop any measure of the impact
     of frequent flyer plans on airline        fares in particular      markets
     because the data needed to measure the impact of frequent fly8F
     programs on a particular      route are proprietary.      However, we have
     recently   completed a survey of 522 travel agents and found that the
     business customers of more than 80 p8rcent of travel agents
     nationally   choose their flights      on the basis of frequent flyer
     plans at least half the time,8        Our analysis of the structure        of
     frequent flyer plans indicates       that the dominant carrier        in a
     market will have a powerful advantage in attracting           airline
     passengers to us8 its plan.




            There are several approaches to dealing with problems of
     competitSon in the airline   industry.  One approach is to focus
     directly   on the high shares of enplanements that carriers    have at
     some airporta,   which we found were associated with higher fares.
     For example, the Congress could limit   the number of airports    at


     8The 950percent confidence     interval   on this   percentage   is f:
     approximately  4 percent.
                                           7

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which enplanements   exceed a particular      level.     We have reservations
about this approach,   however.   The actual       market power that a
carrier  wields depends not just on its share of enplanements,             but
on the number of gates the carrier       controls,    the terms on which it
controls    those gates, and the extent to which expansion of the
airport   is limited    by majority-in-interest       clauses or other
factors.     We found in our airport        survey that 85 percent of all
gates at the 66 large and medium airports            are leased on an
exclusive-use    basis.    The market power of a cibminant airline       is
also affected by its use of various marketing strategies,             such as
CRSs and frequent flyer plans.           In general, we believe that it is
more effective     to address these sources of market power than to
assume that any particular       level of enplanements is
anticompetitive.

        A second approach is to expand the capacity of existing                   s
 airports     and to build new ones. We certainly             agree that, in the
 long run, expansion of capacity is the best way to ensure that
 carriers     can easily establish         service at any airport.       We included
 in our model a variable          to measure airport       congestion,   and found
that it was significantly            related to higher fares.         However, there
are two significant          problems with relying exclusively          on this
approach.       First,     our model makes clear that other factors were
significantly       related to fares as well, such as shares of gates
leased.      Second, airport        expansion takes time.        Disagreements about
where airports         should be located and how they should be financed
can be expected to continue to delay airport                 expansion.    If airport
expansion cannot be achieved in the near term, and if two or three
more carriers       go bankrupt, competition          could be reduced to the
point that it would be much more difficult                 and complex to inject
new competition         in the industry.        Already there are suggestions
that fare caps be imposed.              In our view, these proposals are
premature; it would be more consistent                with relying on market
competition      to take the comparatively           modest steps required now to
preserve competition          where it is already vigorous and reverse the
                                         8
         erosion   of competitive   markets   that    has already   occurred.

               A third   approach    would focus on adopting a wide range of
         policy options    to address airline     competition problems related to
         specific   entry  barriers.      Our econometric work suggests that a wide
         range of factors appear to interact     to produce the higher fares we
         have observed, so the policy response to market power at
         concentrated     airports should be broad-based, addressing several
         factors at once. We have suggested in our p&vious testimony a
         number of policy options for the Congress to consider.       Several of
         these options are incorporated     in S. 1741.

                For example, policies    that would make it easier for carriers
         to obtain access to gates at airports,         perhaps by requiring    the use
         of use-or-lose     clauses or preferential-use      leases, should be
         considered.     Also, some method of re-allocating        airport take-off
         and landing slots would help to open the four slot-controlled
         airports   up to more competition     from low-cost airlines.      our
         analysis   found that fares tend to be lower in markets where low-
         cost airlines    are competing,     We have also suggested various ways
         of reducing the incremental airline        revenues and excessive booking
         fees earned by CRS vendors.

               This concludes my statement.          I would be happy to answer any
         questions you may have.




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