Domestic Aviation: Barriers to Entry Continue to Limit Benefits of Airline Deregulation

Published by the Government Accountability Office on 1997-05-13.

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

                    United States General Accounting Office

GAO                 Testimony
                    Before the Subcommittee on Aviation,
                    Committee on Commerce, Science,
                    and Transportation
                    U.S. Senate

For Release
on Delivery
Expected at
                    DOMESTIC AVIATION
2:30 p.m. EDT
May 13, 1997
                    Barriers to Entry Continue
                    to Limit Benefits of Airline
                    Statement of John H. Anderson, Jr.
                    Director, Transportation Issues,
                    Resources, Community, and Economic Development

    Mr. Chairman and Members of the Subcommittee:

    We appreciate the opportunity to testify on competition in the domestic
    airline industry. In April 1996, we reported that the deregulation of the
    industry in 1978, as intended, has led to lower fares and better service for
    most air travelers.1 Deregulation’s benefits stem largely from increased
    competition spurred by the entry of new airlines into the industry and
    established airlines into new markets. Nevertheless, some airports,
    primarily in the East and upper Midwest, have not experienced such entry
    and thus have not experienced the lower fares and better service that
    deregulation has brought to other markets. In October 1996, we reported
    that certain industry practices, such as restrictive gate-leasing
    arrangements, impeded entry, particularly at a number of major airports in
    the East and upper Midwest.2 Based on our findings, we made a number of
    recommendations to the Department of Transportation (DOT) aimed at
    addressing these barriers to entry and identified potential actions the
    Congress might wish to consider.

    Our October 1996 report was the latest in a series of studies we have
    conducted over the past decade on domestic airline competition.3 As
    requested, our testimony discusses (1) our findings and recommendations
    concerning barriers to entry in the airline industry and (2) DOT’s response
    to the recommendations in our October 1996 report.

    In summary,

•   In our October 1996 report, we stated that little progress has been
    achieved in lowering the barriers to entry since we first reported on these
    barriers in 1990. As a result, the full benefits of airline deregulation have
    yet to be realized. In particular, operating limits in the form of slot
    controls,4 restrictive gate leasing arrangements, and perimeter rules5

    Airline Deregulation: Changes in Airfares, Service, and Safety at Small, Medium-sized, and Large
    Communities (GAO/RCED-96-79, Apr. 19, 1996).
    Airline Deregulation: Barriers to Entry Continue to Limit Competition in Several Key Domestic
    Markets (GAO/RCED-97-4, Oct. 18, 1996).
     These products are listed at the end of this statement.
     To minimize congestion and reduce flight delays, the Federal Aviation Administration (FAA) has since
    1969 set limits on the number of operations (takeoffs and landings) that can occur during certain
    periods of the day at four congested airports—Chicago O’Hare, Washington National, and New York
    Kennedy and LaGuardia. The authority to conduct a single operation during those periods is commonly
    referred to as a “slot.”
     Rules governing operations at New York’s LaGuardia and Washington’s National airports prohibit
    flights to and from those airports that exceed a certain distance.

    Page 1                                                                         GAO/T-RCED-97-120
    continue to block entry at key airports in the East and upper Midwest.
    Likewise, several marketing strategies, including special incentives for
    travel agents and frequent flier programs, give advantages to the
    established carriers.6 These strategies, taken together, continue to deter
    new as well as established airlines from entering those markets where an
    established airline is dominant. The effect of these strategies tends to be
    greatest—and airfares the highest—in markets where the dominant
    carrier’s position is protected by operating barriers. As a result, we
    recommended in October 1996 that DOT take actions that we had
    previously suggested in 1990 to lower the operating barriers. Moreover, we
    suggested that, absent action by DOT, the Congress may wish to consider
    revising the legislative criteria that governs DOT’s granting slots to new
    entrants. We also suggested that the Congress consider granting DOT the
    authority to allow exemptions to the perimeter rule at National Airport to
    increase competition.
•   In responding to our recent report, DOT concurred with our findings and
    expressed concern about “overly aggressive” attempts by established
    airlines to thwart new entry. To make it easier for new entrants to obtain
    slots, the agency indicated that it would revise its restrictive interpretation
    of the legislative criteria governing the granting of new slots. While this is
    a positive step, additional action will likely be needed because the number
    of new slots that DOT can grant is very limited. In our report, we also
    recommended that DOT create a pool of available slots by periodically
    withdrawing a small percentage from the major incumbents at each airport
    and distribute those slots in a fashion that increases competition. DOT
    indicated that it is still considering this action. The agency did not agree
    with our recommendation that FAA consider an airport’s efforts to make
    gates available to nonincumbents when making federal airport grant
    decisions. Instead, DOT said that it would rather address this issue on a
    case by case basis as problems are brought to its attention. In light of the
    lack of progress over the past 7 years, however, we believe that our
    recommendations, combined with our suggestions for potential
    congressional action, offer prudent steps to promote competition in
    regions that have not experienced the benefits of airline deregulation.

    Established airlines include the nation’s seven largest: American Airlines, Continental Airlines, Delta
    Air Lines, Northwest Airlines, TWA, United Airlines, and US Airways.

    Page 2                                                                           GAO/T-RCED-97-120
                       Operating barriers continue to limit competition and contribute to higher
Airline Barriers to    airfares in several key markets in the upper Midwest and East. In some
Entry Persist and      cases, these barriers have grown worse. As a result, our October 1996
Predominantly Affect   report recommended that DOT take actions that we originally suggested in
                       1990 and highlighted areas for potential congressional action. The report
Competition in the     specifically addressed the effects of slots, perimeter rules, exclusive-use
East and Upper         gate leases, and marketing strategies developed by the established airlines
                       since airline deregulation.
Slots                  To reduce congestion, FAA has since 1969 limited the number of takeoffs
                       and landings that can occur at O’Hare, National, LaGuardia, and Kennedy.
                       By allowing new airlines to form and established airlines to enter new
                       markets, deregulation increased the demand for access to these airports.
                       Such increased demand complicated FAA’s efforts to allocate takeoff and
                       landing slots equitably among the airlines. To minimize the government’s
                       role in the allocation of slots, DOT amended its rules in 1985 to allow
                       airlines to buy and sell them to one another. Under this “Buy/Sell Rule,”
                       DOT grandfathered slots to the holders of record as of December 16, 1985.
                       Emphasizing that it still owned the slots, however, DOT randomly assigned
                       each slot a priority number and reserved the right to withdraw slots from
                       the incumbents at any time.

                       In August 1990, we reported that a few established carriers had built upon
                       the favorable positions they inherited as a result of grandfathering to such
                       an extent that they could limit access to routes beginning or ending at any
                       of the slot-controlled airports.7 In October 1996, we reported that this level
                       of control over slots by a few established airlines had increased even
                       further (see app. I). As a result, little new entry has occurred at these
                       airports, which are crucial to establishing new service in the heavily
                       traveled eastern and midwestern markets.

                       Recognizing the need for new entry at the slot-controlled airports, the
                       Congress in 1994 created an exemption provision to allow for entry at
                       O’Hare, LaGuardia, and Kennedy in cases where DOT “finds it to be in the
                       public interest and the circumstances to be exceptional.”8 However, the
                       exemption authority, which in effect allows DOT to issue new slots, has
                       resulted in little new entry because DOT has interpreted the “exceptional

                        Airline Competition: Industry Operating and Marketing Practices Limit Market Entry
                       (GAO/RCED-90-147, Aug. 29, 1990).
                        FAA Authorization Act of 1994, P.L. 103-305, Section. 206. The number of flights at National Airport is
                       further limited by federal law to address local concerns about noise. As a result of these additional
                       limits, the Congress chose not to extend DOT’s exemption authority to include National.

                       Page 3                                                                           GAO/T-RCED-97-120
                  circumstances” criterion very narrowly. DOT has only approved
                  applications to provide service in markets not receiving nonstop service,
                  even if the new service would result in substantial competitive benefits.
                  We found no congressional guidance, however, to support this
                  interpretation. As a result, we suggested in our October 1996 report that
                  the Congress may wish to revise the extraordinary circumstance provision
                  so that consideration of competitive benefits is a key criterion.

                  Nevertheless, we indicated that action by the Congress would be needed
                  only if DOT did not act. In our 1990 report, we had suggested several
                  options to DOT aimed at promoting entry at the slot-controlled airports.
                  These options included keeping the Buy/Sell Rule but periodically
                  withdrawing a portion of slots that were grandfathered to the major
                  incumbents and reallocating them by lottery. Because DOT had not acted
                  on any of our suggestions and the situation had continued to worsen, we
                  recommended in our October 1996 report that DOT hold periodic slot

Perimeter Rules   At LaGuardia and National airports, perimeter rules prohibit incoming and
                  outgoing flights that exceed 1,500 and 1,250 miles, respectively. The
                  perimeter rules are designed to promote Kennedy and Dulles airports as
                  the long-haul airports for the New York and Washington metropolitan
                  areas. However, the rules limit the ability of airlines based in the West to
                  compete because those airlines are not allowed to serve LaGuardia and
                  National—airports that are generally preferred by more lucrative business
                  travelers—from markets where they are strongest. For example, the rules
                  keep the second largest airline started after deregulation—America
                  West—from serving those airports from its hub in Phoenix. By contrast,
                  because of their proximity to LaGuardia and National, each of the seven
                  largest established carriers is able to serve those airports from their
                  principal hubs.

                  While the limit at LaGuardia was established by the Port Authority of New
                  York & New Jersey, National’s perimeter rule is federal law.9 Thus, we
                  suggested that the Congress consider granting DOT the authority to allow
                  exemptions to the perimeter rule at National when proposed service will
                  substantially increase competition. We did not recommend that the rule be
                  abolished because removing it could have unintended negative
                  consequences, such as reducing the amount of service to smaller
                  communities in the Northeast and Southeast. This could happen if major

                   The Metropolitan Washington Airports Act of 1986 (P.L. 99-591, sec. 6012).

                  Page 4                                                                        GAO/T-RCED-97-120
                           slot holders at National shift their service from smaller communities to
                           take advantage of more profitable, longer-haul routes. As a result, we
                           concluded that a more prudent course to increasing competition at
                           National would be to examine proposed new services on a case by case

Long-Term, Exclusive-Use   Opportunities for establishing new or expanded service also continue to
Gate Leases                be limited at other airports by restrictive gate leases. These leases permit
                           an airline exclusive rights to use most of an airport’s gates over a long
                           period of time, commonly 20 years. Such long-term, exclusive-use gate
                           leases prevent nonincumbents from securing necessary airport facilities
                           on equal terms with incumbent airlines. To gain access to an airport in
                           which most gates are exclusively leased, a nonincumbent must sublet
                           gates from the incumbent airlines—often at non-preferred times and at a
                           higher cost than the incumbent. Since our 1990 report, some airports, such
                           as Los Angeles International, have attempted to regain more control of
                           their facilities by signing less restrictive, shorter-term leases once the
                           exclusive-use leases expired. Nevertheless, our 1996 report identified
                           several airports in which entry was limited because most of the gates were
                           under long-term, exclusive use leases with one airline.

                           Although the development, maintenance, and expansion of airport
                           facilities is essentially a local responsibility, most airports are operated
                           under federal restrictions that are tied to the receipt of federal grant
                           money from FAA. In our 1990 report, we suggested that one way to alleviate
                           the barrier created by exclusive-use gate leases would be for FAA to add a
                           grant restriction that ensures that some gates at an airport would be
                           available to nonincumbents. Because many airports have taken steps since
                           then to sign less restrictive gate leases, we concluded in our 1996 report
                           that such a broad grant restriction was not necessary. However, to address
                           the remaining problem areas, we recommended that when disbursing
                           airport improvement grant monies, FAA give priority to those airports that
                           do not lease the vast majority of their gates to one airline under long-term,
                           exclusive-use terms.

                           Figure 1 shows the six gate-constrained airports that we identified and the
                           four slot-controlled airports. All of them are located in the East or upper
                           Midwest, and as a result, affect competition throughout those regions. In
                           1995, these 10 airports accounted for approximately 22 percent of the
                           nation’s 517 million scheduled passenger enplanements.

                           Page 5                                                     GAO/T-RCED-97-120
Figure 1: Airports Identified as Having Limited Entry Due to Slot Controls, Perimeter Rules, or Exclusive-Use Gate Leases




           Slot Controlled Airports
           Gate Constrained Airports

Marketing Strategies                       Even where airport access is not a problem, airlines sometimes choose not
                                           to enter new markets because certain marketing strategies of incumbent
                                           airlines make it extremely difficult for them to attract traffic. Taken
                                           together, these strategies have created strong loyalties among passengers
                                           and travel agents and have made it much more difficult for competing
                                           airlines to enter new markets. In particular, they deter new as well as
                                           established airlines from entering those markets where an established
                                           airline is dominant.

                                           Two strategies in particular—booking incentives for travel agents and
                                           frequent flier plans—are targeted at business flyers, who represent the
                                           most profitable segment of the industry, and encourage them to use the

                                           Page 6                                                                GAO/T-RCED-97-120
dominant carrier in each market. Because about 90 percent of business
travel is booked through travel agencies, airlines strive to influence the
agencies’ booking patterns by offering special bonus commissions as a
reward for booking a targeted proportion of passengers on their airline.
Our discussions with representatives of the nation’s largest travel agencies
confirmed the importance of these booking incentives. For example, a
senior travel agency executive told us that when one established airline
attempted to enter a number of markets dominated by another established
airline, the nonincumbent complained that the travel agency was not
booking passengers on its flights in those markets. The travel agency,
according to the executive, told the nonincumbent that it could not
support it in those markets because the agency had an incentive
agreement with the incumbent airline involving those markets. As a result,
the nonincumbent later pulled out of those markets.

Similarly, frequent flier programs solidify the dominant carrier’s position
in a market. Since their inception in the early 1980s, these programs have
become an increasingly effective tool to encourage customers’ loyalty to a
particular airline. The travel agencies with whom we spoke noted that
business travelers often request to fly only on the airline with which they
have a frequent flier account. As such, entry by new and established
airlines alike into a market dominated by one carrier is very difficult,
particularly since a potential entrant must announce its schedule and fares
well in advance of beginning service, thus giving the incumbent an
opportunity to adjust its marketing strategies. In many cases, we found
that airlines have chosen not to enter, or quickly exit, markets where they
do not believe they can overcome the combined effect of booking
incentives and frequent flier programs and attract a sufficient amount of
business traffic.

In our 1996 report, we found that the effect of these marketing strategies
tends to be the greatest—and fares the highest—in markets where the
dominant carrier’s position is protected by operating barriers. Overall,
fares were 31 percent higher in 1995 at the 10 airports affected by the
operating barriers than at the other 33 airports that comprise FAA’s large
hub classification. Moreover, the highest fares were at Charlotte,
Cincinnati, Pittsburgh, and Minneapolis—markets where a single airline
accounts for over 75 percent of passengers and operating barriers persist.
However, we also noted that the marketing strategies produced consumer
benefits, such as free frequent flier trips, and concluded that short of an
outright ban, few policy options existed that would mitigate the marketing
strategies’ negative impact on new entry.

Page 7                                                     GAO/T-RCED-97-120
                        In its January 1997 response to our report, DOT stated that it shared our
While DOT’s Recent      concerns that barriers to entry limit competition in the airline industry.
Actions Represent       The agency indicated that it would include competitive benefits as a factor
Positive First Steps,   when determining whether to grant slots to new entrants under the
                        exceptional circumstances criterion. While this is a positive step,
Additional Actions      additional action will likely be needed because the number of new slots
Will Likely Be Needed   that DOT can grant is very limited. Recognizing this, DOT committed to
                        giving careful consideration to our recommendation that it hold periodic
                        slot lotteries.

                        DOT  also agreed with our position that action may be needed at some
                        airports to ensure that nonincumbents are able to obtain competitive
                        access to gates. However, DOT did not concur with our recommendation
                        that FAA make an airport’s efforts to have gates available to nonincumbents
                        a factor in its decisions on awarding federal grants to airports. According
                        to DOT, the number of airports that we identified as presenting gate access
                        problems is sufficiently small that the agency would prefer to address
                        those problems on a case by case basis. The agency emphasized that in
                        cases where incumbent airlines are alleged to have used their contractual
                        arrangements with local airport authorities to block new entry, the agency
                        will investigate to determine whether the behavior constituted an unfair or
                        deceptive practice or an unfair method of competition. If so, the agency
                        noted, it will take appropriate action.

                        Finally, DOT expressed concern about potentially overly aggressive
                        attempts by some established carriers to thwart new entry. According to
                        DOT officials, since our report, several smaller carriers have complained to
                        DOT that larger carriers are employing anticompetitive practices, such as
                        predatory pricing—the practice of setting fares below marginal cost in an
                        effort to drive competitors out of markets. According to DOT officials, the
                        agency has expressed its concern to the established carriers involved and
                        has notified them that it is investigating the allegations.

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

                        Page 8                                                     GAO/T-RCED-97-120
Page 9   GAO/T-RCED-97-120
Appendix I

Percentage of Domestic Air Carrier Slots
Held by Selected Groups

Airport      Holding Entity                                                             1986                 1991                 1996
O’Hare       American and United                                                           66                   83                    87
             Other established airlines                                                    28                   13                     9
             Financial institutions                                                          0                   3                     2
             Post-deregulation airlines                                                      6                   1                     1

Kennedy      Shawmut Bank, American, and Delta                                             43                   60                    75
             Other established airlines                                                    49                   18                    13
             Other financial institutions                                                    0                  19                     6
             Post-deregulation airlines                                                      9                   3                     7

LaGuardia    American, Delta, and US Airways                                               27                   43                    64
             Other established airlines                                                    58                   39                    14
             Financial institutions                                                          0                   7                    20
             Post-deregulation airlines                                                    15                   12                     2

National     American, Delta, and US Airways                                               25                   43                    59
             Other established airlines                                                    58                   42                    20
             Financial institutions                                                          0                   7                    19
             Post-deregulation airlines                                                    17                    8                     3
                                      Notes: Numbers may not add to 100 percent due to rounding. Some airlines that held slots have
                                      gone bankrupt, and as a result, financial institutions have acquired slots.

                                      Source: GAO’s analysis of data from FAA.

                                      Page 10                                                                    GAO/T-RCED-97-120
Related GAO Products

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

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

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

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

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

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

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

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

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

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

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

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

              Page 11                                                    GAO/T-RCED-97-120
           Related GAO Products

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

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

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

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

           Airline Competition: Impact of Computerized Reservation Systems
           (GAO/RCED-86-74, May 9, 1986). Airline Takeoff and Landing Slots:
           Department of Transportation’s Slot Allocation Rule (GAO/RCED-86-92,
           Jan. 31, 1986).

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

(341528)   Page 12                                                   GAO/T-RCED-97-120
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