The irony is obvious. This year is the 20th anniversary of deregulation in the US and the industry should be celebrating two decades of a free market place. Instead, the major carriers are united in a fierce and expensive fight against proposed government guidelines which they view as reregulation.
The majors were caught almost unawares by the turmoil in which they now find themselves, although the warning signs started to flash last year. Small, low fare carriers struggling to exist in the hub-and-spoke environment that has evolved since deregulation became increasingly vocal about what they saw as deliberate efforts by the established majors to force them out of existence. They formed an association of their own, the Air Carrier Association of America, to counter the lobbying efforts of the powerful Air Transport Association. By mid 1997, the issue of domestic airline competition was piled high on the desks of politicians across the US - sent there by new entrant carriers alleging predatory behaviour by the majors; by business travellers no longer able to find cheap tickets; and by city councils worried about the economic future of their towns if air service either disappears or is reduced to a monopoly.
But the majors mostly ignored those warning signs. Confident they had not broken any existing predatory behaviour laws, and distracted by the determination to get rid of the flat rate ticket tax, the majors were enjoying record load factors and profits. Why let the whinings of a few minnow airlines spoil the party?
In April that party came to an abrupt end when the Department of Transportation issued a proposed enforcement policy against predatory behaviour. The new guidelines set out three broad instances of conduct that might trigger a predatory behaviour investigation. Airlines were given until 24 July to file their responses and, with just one day to spare, the ATA released its tirade of hostile comment. The battle to protect deregulation was declared.
What most concerns the DOT, and what prompted the call for an enforcement policy, are the recurring instances of a large, established carrier flooding a market with very cheap seats when a startup arrives. While the DOT acknowledges the US Supreme Court's view that predation occurs only rarely in any free marketplace, it believes that the nature of the air transport industry can allow unfair exclusionary practices to succeed. It therefore requires the special attention that the new guidelines would allow. 'Compared to firms in other industries, a major air carrier can price-discriminate to a much greater extent, adjust prices much faster, and shift resources between markets much more readily,' says the DOT report. 'These characteristics allow the major carrier to drive a new entrant from a local hub market. Having observed this behaviour, other potential new entrants refrain from entering, so the major carrier is free to reap greater profits indefinitely.'
Under the enforcement policy, an investigation could be initiated if a major carrier engages in one or more of three activities: if it adds capacity and sells such a large number of seats at very low fares that local revenues are lowered to below what would be reasonably expected; if the number of local passengers it carries at the startup's low fares exceeds the new entrant's total seat capacity; or if the number of local passengers carried at the startup's low fares exceeds the number of low-fare passengers carried by the new entrant. It is the third trigger that particularly concerns the ATA, which interprets this rule as explicitly denying the incumbent the right to respond to a new entrant.
The DOT says the guidelines would allow a 'reasonable response' by a major to new competition and that its enforcement policy would not guarantee success or survival for new entrants. It would simply level the playing field, insists the DOT.
Carol Hallett, president and chief executive officer of the ATA, is outraged at the notion that the playing field is not already level and argues that the new policy would have a negative affect on competition. 'These rules are bad economics, bad law and bad policy,' says Hallett. 'It would be a tremendous mistake for the DOT to celebrate the twentieth anniversary of deregulation by attempting to curtail the benefits it has brought to consumers.'
As part of its campaign to prevent the policy becoming law, the ATA has armed itself with the reports of a number of independent economists. In a curious twist of oneupmanship, two of the economists the association has managed to summon to its side are former Department of Justice consultants cited by the DOT in its justification for the policy. Robert Willig and Janusz Ordover now say the DOT made 'leaps to judgment' in using their studies on the state of the industry and based the guidelines on 'flawed assumptions'.
Willig, a professor at Princeton University, says the guidelines are not merely a nuisance, but are positively dangerous. They would harm competition, he argues, because the vagueness of the new rules would persuade major carriers to avoid offering bargain fares and risk putting themselves under possible investigation. 'The DOT has stepped off the gangplank and into the waters of negative competition,' says Willig.
The ATA similarly attacks the 'generalities' of the guidelines. 'Terms like "reasonable alternative responses" do not provide meaningful guidance to the carriers,' says Hallett. 'This new definition of unlawful conduct is so constraining and inherently vague that it is likely to dissuade the majors from offering any new competitive fare or service options when new entrants appear.' Hallett says the vague terms will turn compliance into a guessing game. 'Merely by matching the price and seat capacity of another airline, a carrier could violate the rules,' she points out. 'Scratch off the veneer and these rules are nothing less than protectionism for a small group of preferred carriers. It amounts to nothing less than reregulation.'
The call for comments by the DOT has unearthed other reports by independent organisations that also believe deregulation will be eroded by the new rules. The Economic Strategy Institute says it cannot support the guidelines because they effectively reregulate the industry. The existing law already gives the DOT and DOJ sufficient authority to prevent unfair competitive behaviour, adds the institute.
'Established hub carriers respond in a consistent manner to entry, whether that entry is by another established hub carrier, a well financed low-fare new entrant, such as Southwest Airlines, or a newly established low-fare carrier,' points out economist Scott Gibson of the ESI. 'Since it is unlikely that any established hub carrier could drive Southwest out of a market, and such low fares and added capacity [are likely to] continue years after entry by Southwest, one must conclude that this is the rational response of the hub carrier to maximise revenues and profitability. History has shown that failure by the established carrier to match the lower prices of a new entrant has resulted in an erosion of both traffic and revenue in hub markets.'
Southwest, however, rarely goes head-to-head with another major at a hub airport. Its business plan for entering a new market usually hinges on expanding its point-to-point network by going into a secondary, under-used airport. For example, it serves Dallas/ Love Field rather than Dallas-Fort Worth and Chicago/Midway rather than Chicago/O'Hare.
Janusz Ordover of New York University argues that more startup carriers would be successful if they too began with sound business plans that recognised the inherent advantage of incumbent carriers at their major hubs.
Yet another controversial report backs up this view.
According to a study by Darryl Jenkins, director of the Aviation Institute at George Washington University, the majority of blame for the recent high failure rate of startups lies squarely with the startups themselves. 'New entrants don't need help failing - they do a pretty good job on their own,' says Jenkins. 'By comparing the efficiencies of new entrants with the demonstrated operational success of Southwest, we came to the conclusion that the failure of new entrants can be attributed to internal factors, such as poor business plans and faulty management of growth.'
The main reason that new entrants fail, says Jenkins, is because they choose their routes poorly and do not build up frequency between key city pairs. 'Where you fly and what type of equipment you use is the most fundamental part of a business plan,' he says. His study, which looks at more than 129 airlines that have failed since deregulation began in 1978, found that new entrants consistently price below their costs and that more than 97 per cent of the carriers that filed for chapter 11 bankruptcy in the 1990s had senior executives who had been involved in a previous chapter 11. 'One person had been involved in five airline bankruptcies,' adds Jenkins. The study also points out that many new entrants do not control growth, unlike Southwest. 'The striking fact is that Southwest only goes into one or two new cities a year. This is the most impressive fact about Southwest - they carefully manage and control growth,' says Jenkins. Southwest, he adds, is the 'shining crown' of deregulation and proof that startups should not look to blame their failures on others. 'What we are hearing today from many quarters in the industry is a throw back to the days when I was in college and we blamed our woes on our parents and the Nixon administration,' he says.
Southwest Airlines, although an ATA member, has disassociated itself from the association's multi-million dollar campaign to kill the new policy by maintaining a neutral position.
Not surprisingly, studies like the Jenkins report have infuriated the startups. The ACAA, which represents many of these new entrants, is fighting the ATA every inch of the way as the proposed policy works its way through the Congressional system so that it can be made law. The ACAA's argument is that predatory behaviour is preventing startups from becoming established. They say the new guidelines would be a 'step in the right direction' towards redressing the balance and creating a more open marketplace.
The DOT, meanwhile, has dismissed ATA claims that it does not have the statutory authority to introduce the new rules and that deregulation is being jeopardised. 'The proposed policy does not attempt to regulate the market in any way, but instead seeks to ensure that free market principles and competition continue to thrive in commercial aviation,' says the DOT.
The ATA disagrees strongly and says it will spend whatever is necessary to prevent the policy from becoming law. Hallett points out that a number of airlines have already been required to open their books to the DOT in recent months as a result of the charged environment that has evolved in Washington DC. And yet, since deregulation was first released on an uncertain industry, no single case of predatory behaviour has been successfully brought against a major carrier.
Now those same carriers are realising, 20 years too late, that business in the US may never again be that straightforward.
Source: Airline Business