AAI Statement to Senate Commerce Committee Urges That Airline Downsizing Be Through Competition Rather Than By Cooperative Consolidation

Jan 09 2003
Testimony and Interventions

January 7, 2003

The Hon. John McCain, ChairmanSenate Commerce, Science & Transportation CommitteeRoom SD-508United States SenateWashington, DC 20510

By FAX 202 228 0303

Re: The Airline Industry and the Current Economic Situation

Dear Chairman McCain and Members of the Committee:

The American Antitrust Institute is an independent non-profit research, education, and advocacy organization that supports the laws and institutions of antitrust. Our website is www.antitrustinstitute.org. We believe that in a deregulated airline industry consumers rely on competition between airlines to produce the best service and the lowest fares. Likewise, consumers can best rely on competition among providers of travel agent and related services for unbiased advice on routes, carriers and fares, and competitive travel agent fees. All of this is compromised when competition is diminished.

When an industry needs downsizing, there are two principal ways to go. One is to consolidate in a coordinated way. Coordination can be by government policy, by private arrangements, or by a combination of the two. The other, better, way is to allow the competitive process to unfold in an incremental, decentralized way. The major airlines are today attempting to increase their dominance within the shrinking aviation industry by the coordinated consolidation route. Three governmental decisions are pending that, taken together, could give the majors a triumph over the more competitive alternative.

For several years, the major airlines, under economic pressure, have been pursuing a strategy of horizontal and vertical integration. After the rapid fall-off of demand and the increase in security-related costs following September 11, 2001, the major airlines sought government funding and an antitrust immunity, so that they could collectively (i.e., collusively) plan their downsizing. While substantial funding was authorized, the immunity idea never took off. Mergers, which had been going on for years, had, appropriately, become almost impossible to get through the antitrust screen, because the industry had attained a concentrated structure in which competition was in many ways compromised. Only a major carrier, like TWA, that had already entered bankruptcy, would be likely to be able to merge.

In the face of these obstacles, a different, tripartite strategy for consolidation has now emerged. The strategy's salient features are:

1.Horizontal Alliances. Instead of achieving further horizontal consolidation by mergers, the airlines seek a similar result through alliances. The USAirways/United and Northwest/Continental alliances have already been permitted. DOT and the DOJ will shortly determine whether Delta/ Continental/Northwest will create an enlarged second major domestic alliance. (International alliances, which are easier to justify, have already led to the specter of only a few major competing global systems.)

These domestic alliances go beyond simple codesharing. The relationships set up by the Delta/Continental/Northwest plan are complicated, require continual and intimate coordination of virtually all aspects of operation, and are intended to provide the consumer a "seamless" experience. In other words, this alliance is uncomfortably close to being a three-way merger. It is likely to put the remaining non-allied carriers (namely, American, which already made its jump in size by acquiring TWA; Southwest; and other small, low-cost carriers) at a competitive disadvantage that will result in fewer choices for consumers. While the airlines claim they will continue to compete after entering an alliance, how vigorously will a partner attack its partner's business? The question becomes all the more important in the face of the possibility that United and/or US Airways may not emerge from bankruptcy. One or more liquidations would leave the industry with even fewer players.

2. Vertical Integration into Sales. Orbitz, a joint venture owned by the major carriers, is now the majors' joint distribution arm. By obtaining -almost exclusively-- the lowest priced fares offered by their owners and a multitude of allied airlines, Orbitz is jeopardizing the survival prospects of both standard travel agents and on-line travel agents. Both have already been decimated by the purportedly independent decisions of the major airlines to eliminate commissions. DOT has not taken any action to limit the unfair advantage that airline ownership gives to Orbitz and a DOJ investigation of possible antitrust implications is still on-going.

Consumers need independent assistance to navigate through a highly complex ticket distribution system. To the extent that consumers become limited to purchasing reservations either (a) through Orbitz or (b) directly from the carriers, they will end up paying higher fares. Does it make sense to think that it will be in the best interest of the airlines to help consumers save money on airfares?

3. Deregulation of CRS's. Travel agents buy their information from computer reservation systems ("CRS's"). DOT has proposed to revise the well-established CRS rules that were initially needed because airlines owned the CRS's and biased critical information in their own favor. The proposed modifications, largely deregulating the CRS environment, would not only permit airlines to provide selected information exclusively to Orbitz (by holding that an Internet service is not subject to the rules that apply to other companies), but-- by allowing airlines to selectively withhold their information from any CRS provider-would undermine the CRS systems (other than the Worldspan CRS, which works with Orbitz and is owned by Delta, Northwest, and American). The result would be lower CRS fees for large carriers and higher fees for small carriers. Travel agents, who generally cannot afford to participate in multiple systems, will be encouraged to switch to the Orbitz-Worldspan system, thereby making it even more likely that consumers will have to work through the airlines' in-house or captive facilities.

Consumers today benefit from low airfares, the result of competition in the current reduced-demand environment. If the majors are permitted to consolidate through the alliance mechanism in a way that further advantages them against non-allied competitors, and if they are permitted to vertically integrate into ticket sales in a way that gives them market power at the distribution level, consumers will have fewer choices, less objective information, and, ultimately, higher fares.

There is a better alternative. If airlines are forced to operate competitively, on a level playing field -- which is the antitrust tradition-- they will have to make independent decisions about which routes to reduce or abandon, which equipment to sell or retire, and what innovations in service, pricing, or technology are most likely to attract consumers. Downsizing in the competitive scenario will be decentralized and incremental. Firms can shrink individually or, if necessary, go out of business. Airfares will eventually go up as capacity is reduced, and profitability will rise. The airlines that adapt most intelligently, while offering the best values to consumers, will become stronger while others become weaker. The government should not pick winners and losers by its capital allocation or regulatory decisions.

Air transportation has always been a cyclical industry. We should seek to avoid making structural changes in a down-cycle, even the remarkably severe down-cycle we are in, that will be difficult to reverse when demand eventually picks back up. Horizontal consolidation linked to vertical integration will be extremely difficult to reverse. Consumers should take a longer view of what is in their interest and support the competitive alternative to coordinated consolidation


Albert A. Foer President