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Flying the unfriendly skies, II.

Flying the Unfriendly Skies, II

Big airlines smother the competition through unfair gate leases, total control of slots, stacked computerized reservation systems, and other dirty tricks of the trade.

Ask any executive at a major airline about the dwindling number of carriers in the industry, and you'll probably get the same reassuring explanation: The airline industry is vigorously competitive, just as the founding fathers of deregulation intended. The airlines that failed were forced out by their own ineptitude. "People may look at the numbers and say there aren't enough carriers, but the carriers that are there are fighting tooth and nail," says US Air spokesman Dave Shipley. At American Airlines, the attitude is even more defensive. "What we keep saying to the regulators is, `Look, you keep telling us to compete, but every time we do, you complain," says David Schwarte, American's associate general counsel.

The airlines do compete--if your idea of competing is locking your rivals out of the stadium. Since deregulation, the major carriers have learned to survive by making up new rules. They've figured out how to exploit the natural barriers to entry at airports--limited gate space and limited airspace--in order to lock out new competitors or to charge enormous fees to let them in. And they've come up with clever marketing scams to lure customers away from other airlines, often by manipulating the information the customers receive. These tricks of the trade may have started out as attempts at honest competition, but they're smothering the smaller, would-be competitors--and not because the little carriers offer lousy service, but because they simply don't have the leverage or the resources to play the same tricks. The result is clear: The airline industry is becoming less and less competitive all the time.

All of this is happening because Congress didn't back up its experiment in deregulation with enough safeguards to control the inevitable excesses of a free-market aviation environment. The airline industry isn't like the restaurant business. The demand for flights is certainly out there, but the supply can't match it. Why not? Because space for flying, to a much greater degree than space for eating, is a limited commodity; an airport can serve only so many customers at one time before the safety of the system goes out the window. And as access to the "marketplace" becomes more limited and more precious, it becomes easier for the big guys to muscle the little guys out of the sky.

Now, government and industry officials are starting to talk about how to correct the problems. As usual, the debate is getting clouded by ideology. If you're on the left, you probably never liked the idea of deregulation to begin with, and you'd just as soon go back to the old system. If you're on the right or work for a big airline (or both), you'd throw yourself off a cliff before you'd listen to a word about new regulations. Both sides are overreacting. The answer isn't simply to keep the new system or to go back to the old one. The answer is to make the current system more competitive through some smart, limited government controls. To figure out what new rules the industry needs, would-be regulators need to take a long, hard look at the games that only big airlines can play. Call them "scams of scale."

Barred gates

For starters, Congress forgot to follow through on one important front: the airlines' contracts with their host airports. Even before deregulation, airlines had gotten some powerful advantages in writing--long-term gate leases and contractual agreements that give a dominant airline a strong voice in an airport's expansion plans. Once the industry was deregulated, these contracts gave the entrenched carriers an overwhelming advantage: the ability to box out competition.

Take gate leases. At many airports, the airlines that grabbed up gates will hold them for a long time; some of the leases last from 20 to 30 years. In fact, according to a General Accounting Office study, 54 percent of the current leases won't expire for at least 10 years. Why so much time? Because airport operators needed capital investments in their facilities, and they knew airlines would be more likely to cough up if they held exclusive rights to their gates for long enough to justify their investment. Now, however, the leases let airlines hang onto their gates for another reason: to keep them away from potential competitors. Airlines sometimes won't give up their gates even if they're not using them. Continental did this at Denver, holding on to 14 idle gates rather than returning them to the city. That's why Midway Airlines is pushing for minimum-use agreements at all airports, which would simply require airlines that own gates to use them or lose them.

But the present system doesn't mean a new airline can never get its hands on a gate. It can, sometimes, sublease gates from an obliging owner ... for a small fee. In Detroit, Southwest Airlines subleases gates from Northwest at a rate of $150 per flight--19 times what Northwest pays for its gate space. And the owning airline may insist that its tenant sign a "handling" contract, which forces it to use the owning airline's staff at the gate instead of its own. In his testimony before the Senate aviation subcommittee last year, the GAO's Kenneth Mead said these contracts can force a tenant to pay four times as much as it would if it used its own people. But the new airlines go along, for a good reason. "It's one thing to be able to enter a market," Michael Conway, the president of America West, told me, "but you have to have a gate to pull up to when you get there."

Besides handing out long-term gate leases, airports lured airlines with the "majority-in-interest" clause. This clause rewards the dominant airline for its capital investments by giving it veto power over airport expansion plans it doesn't want to pay for. Imagine that--at a time when the nation's airspace is getting more crowded, and everyone in the industry is looking for ways to expand the capacity of the system, an airline can simply stop an airport from building gates. If an airport were to propose a new terminal designed to make room for other airlines, the dominant carrier could kill the idea. "They may not feel that it's in their best interest to bring in competition," observed Leonard Ginn, vice president of economic affairs at the Airport Operators Council International. So far, there is no case on record of an airline using its majority-in-interest clause single-handedly to block an expansion plan. But then, the airports haven't been on any crusade to build space for competitors, either.

Airports have not been the only unwitting accomplices of the big carriers. Uncle Sam also set up an elegant scam for entrenched airlines to exploit: the buying and selling of airport "slots." These are the landing and takeoff reservations that the Federal Aviation Administration created in 1969 to control crowding at four airports: Washington National, Chicago's O'Hare, and New York's JFK and LaGuardia. The idea was to limit the traffic at these rapidly growing airports by assigning each airline a limited number of departure and arrival slots it could use per hour. That system certainly holds down the traffic. But, thanks to deregulation, it also sets up a barrier to the airlines that weren't around when the FAA was passing out slots. So in 1986, the FAA tried a new tactic. It told the airlines at those airports that they could sell their slots--the ones they got for free in 1969--to other airlines. That way, new airlines could come in any time they wanted.

Nothing wrong with that idea, right? Why shouldn't you, an entrenched airline, sell one of your slots to a new carrier so it can come in and draw away business? Well, the airlines didn't fall for it. By 1988, approximately 80 slots were being sold annually. That's out of 3,800 slots. This doesn't mean slots weren't available; the airlines were quick, as usual, to figure out the system. The buy-sell rule, you see, doesn't allow just buying and selling. It also allows leasing--as in short-term leases that allow you to take your slot back if the lessee starts competing with you. You can probably predict the results: 109 slots leased in 1987, 151 in 1988. The leases usually last 90 days or less and rarely go to a direct competitor. According to the GAO, 15 percent of the leased slots reserved for jets actually go to small turboprops owned by regional carriers.

Without more sales, new airlines can't get access to these major markets, which are badly in need of competition. Midway spent about three years looking for someone willing to sell slots at LaGuardia and Washington National, until it was finally able to buy a total of two at each as part of a $200 million transaction it made with Eastern in September 1989. America West, meanwhile, has never found a seller. "I'm sure that if we offered someone $10 million for a slot, we'd be able to buy it in a second," says a disgruntled Conway. The buy-sell rule just isn't working--a sobering thought when you consider that more airports may soon have to go to slot controls, as their airspaces fill to capacity.

Frequent suckers

In addition to manipulating access to airports, the big airlines have learned to manipulate demand for service with tricks smaller carriers lack the resources to match. You're probably familiar with the most prominent marketing scheme, the frequent-flyer program. That's aimed directly at you, the passenger, and there's no mistaking the message: Fly our airline often enough, and we'll give you a prize. An airline often adds a twist by weighting the mileage points it offers, so that the more you fly with the carrier, the more you will want to fly with it. Your payoff is greater after the second 20,000 miles than in the first 20,000 to discourage any ideas you might have of switching to a competitor. On the surface, there's nothing insidious about these programs. In fact, they seem like exactly the sort of perk one would hope to get out of a free-market airline industry. Unfortunately, beneath the surface, frequent-flier plans--which are aimed principally at business travelers--make no economic or moral sense.

Here's how this scam of scale works: The deal often carries no stipulation that the free flight be used for business travel; since a business customer doesn't care what his flight costs--after all, his office foots the bill--he picks the most attractive frequent flier program, not the cheapest ticket. Then he uses the free flight for a weekend in Cancun, where he gets to lie on the beach and feel pretty clever at the same time. To his thinking, he's managed to pull a fast one, first on his boss (for the first ticket) and then on the airline (for the free one). But the truth is that he's just ripped off his fellow taxpayers, since his boss wrote off the cost of the first flight. And then he's ripped off his fellow air travelers, since the airline has to make up for the cost of the free ticket somehow. Frequent fliers who aren't flying on business don't exploit other taxpayers, but they do take advantage of their fellow travelers. As The Wall Street Journal recently reported, airlines offering frequent-flier plans are "clearly borrowing from the future to pump up their business now." Big airlines hope that by the time that debt comes due, their competitors will have been thoroughly undercut. And then you can pay off that debt--in the form of higher fares.

Big airlines have come up with other ways to mold demand that are even more sophisticated than frequent-flier plans. They've gotten control of the means by which you find out who's flying where you want to go, at the time you want to go, at a price you can afford. Let's start with computerized reservation systems. Ideally, a travel agent would be hooked up to automated flight schedules for all airlines, put together by a neutral party, right? Well, there's no Easter Bunny, and each of the four existing CRSs is owned by one or more domestic airlines.

Most of the 33,000 travel agencies in the country use just one of these systems. Agencies that want to use two or more may run into one of several obstacles--they may be penalized by the owner of their main system for trying to add a second one, for example, or for trying to switch altogether. All the airlines that don't own a given CRS must pay to have flights booked off of it, generally $2 a booking. As a result, the systems, said H. Wayne Berens, president of Revere Travel in New Jersey, "have become kind of a cash cow for the airlines." A cash cow, that is, for the airlines that own them; a cash drain for everyone else.


If an airline has the resources to put together a CRS, it can coast on profits from the system. American Airlines' Sabre system--which, along with United's Covia system, controls about 74 percent of the CRS market--netted the airline $445 million in revenues in 1988.

The stiff penalties for switching systems now make it practically impossible for a smaller airline to get its own system into the marketplace--if it could afford to put one together in the first place. "The technological investment is just astronomically in excess of anything we could put forward," said John Tague, vice-president of marketing and planning for Midway. "Even if you could fund it, the entrenched dominance of the larger carriers would be hard to combat." That dominance won't be letting up any time soon. In fact, American and Delta almost merged their systems in a joint venture last year--until the Justice Department threatened to slap them with an antitrust suit.

CRSs opened up whole new vistas of manipulation for airlines. In 1986 Delta accused American of keeping two sets of flight schedules--one for the CRSs, the other for its own use; the CRS version showed shorter flight times so American's flights would be moved up in the computer display. American backed off of the practice the next year, but said it used the maneuver only because other airlines, including Delta, did it first. (Indeed, the Department of Transportation in April 1987 accused Delta and Eastern of publishing deceptive schedules of their own.) The owning airlines supposedly have rid their CRSs of bias toward themselves, after much wrangling with federal regulators. But travel agents still have to scramble to find you a truly competitive deal on a flight, because the systems remain biased in favor of the dominant airline at an airport. "For example, if it's a flight to Chicago, United's going to come up first, because that's the home carrier there," said Stella Rodriguez, manager of Thomas Cook Travel in Dallas.

And if you're not dealing with a large, multi-branch travel agency, you can never be sure that the lowest fare your agent has listed is the lowest fare that's actually available. Nancy Edwards, general manager of Expert Travel, a small agency in Dallas, recalls the time she gave a customer the cheapest nonstop, round-trip flight that was listed under Northwest's flight schedule. The fare was $884. When the customer got back, he demanded to know why the passenger in the next seat, flying the same route, paid a fare in the $300 range. Stunned, Edwards called Northwest to find out why she couldn't find that fare. It turned out the other passenger had bought his ticket from a larger agency--which had access to a lower fare schedule.

CRSs can even distort competition among smaller airlines. Through a technique called "code sharing," a large airline that wants to offer connecting service to destinations to which it doesn't actually have connecting flights will share a two-letter designation with a commuter airline, which keeps travel agents from knowing that part of the route is actually flown by a different airline. This swings a generous part of the business to commuter airlines that "cooperate" with the major ones, giving them a powerful leg up on those that don't.

And then there are old-fashioned forms of manipulation, like freebies for travel agents. The most common is the "travel agent commission override," which is simply a bonus a CRS-owning airline pays the agent for booking seats on its flights rather than someone else's. In a June 1988 survey by Travel Weekly, 51 percent of the travel agents surveyed said these overrides "usually" or "sometimes" influence their decision on what flight to recommend. These commissions take the form of free travel on the airline or other benefits.


Keep in mind that these tricks of the trade--manipulating access to the airports and manipulating the demand for service--are just another layer on top of the other factors that are already making some airports virtually free of competition. As Larry Eichel reported in these pages last month ["Flying the Unfriendly Skies"], airlines have been merging with each other and gaining control of hubs; at these concentrated airports, fares have been going up. At Denver, United and Continental used to face a healthy challenge from Frontier Airlines. Then Continental bought Frontier. Before the buyout, the average fare "yield"--or fare per mile--at Denver was anywhere from 9 to 26 percent below the national average. Two years after the buyout, the yields were 8 percent above.

It's true that airlines don't make a huge profit; the average profit margin for carriers is only about 1.6 percent, and most airlines actually lost money in 1986. But low profits don't excuse the one-two combination of anticompetitive practices followed by unreasonable rate hikes. Even Southwest, which is known for its low fares, couldn't resist a little self-indulgence when it bought Muse Air in 1985. Two months before it completed the buyout, Southwest raised its fares $2 on all of its routes except those on which it was competing with Muse. About three weeks after Muse was out of the way, Southwest raised the rest of its fares. And slim profit margins also don't excuse lockstep pricing. Who could forget when Trump and Pan Am both raised their Eastern shuttle fares by $20--on the same day?


Scams like these are inevitable results of trying to create free-market competition where the market is limited. The constraints imposed by the air traffic control system, combined with the peculiarities of the hub system, make the airline industry an aggregate of regional monopolies waiting for the chance to happen. Trump and Pan Am can raise prices together on the same day and get away with it because they effectively share a monopoly on the Eastern shuttle route.

Don't look to airline executives for solutions. The Air Transport Association, the lobbying arm of the larger airlines, has opposed just about all of the suggested reforms for fear that Congress won't be able to stop at just a few new rules. "Once you start down the path of reregulation, it's that much easier to take the next step," says former Braniff President Howard Putnam. Of course, there always has to be some representative who leaps out to confirm the worst fears about Congress, and this time, it's Howard Metzenbaum. He has introduced a bill that would return the industry to total regulation of fares and routes. But no one in or outside of Congress gives it much chance of passing, and even Metzenbaum didn't seem to like the bill much when he introduced it: "I say with all candor that I am not certain that reregulation is the right solution," he explained, "but I am sure that deregulation was the wrong solution." Thanks a lot.

The best proposal on the table right now is a bill sponsored by Senators John Danforth and John McCain, which in essence calls for limited reregulation. (That's significant in itself: when two Republican senators with anti-government constituencies say we need a few more regulations, we probably do.) Among other things, the bill would allow airports to charge passenger fees to finance expansion projects and ban code-sharing in computerized reservation systems. It would also strengthen the Department of Transportation's power to promote competition among airlines by allowing it to presume that a dominant carrier facing complaints from its competitors has acted in an anti-competitive way, unless it proved otherwise. The DOT wouldn't be able to make this presumption until competition falls below certain levels, which would be determined by the Department of Justice.

The part of the bill that will probably make the airlines scream the loudest is a provision that would force the them to sell their CRSs to neutral parties. An airline that has invested millions of dollars and risked several unprofitable years to develop its own system is not going to want to part with it now that it's turning a profit. But that's the whole problem: The airlines shouldn't be making profits this way. In a competitive environment, no airline should have power over something as crucial as the dissemination of flight schedules and fares. An alternative, suggested by the GAO, is to let the airlines keep their CRSs but simply ban them from charging other airlines for flights booked on their system. But why should an airline that built its own system from scratch let another airline use it for free? No, the only solution is to take CRSs out of the competitive equation entirely by making the airlines sell out--at a fair price that recompenses them for their investment--and by making all airline schedules available to all travel agents. The Danforth-McCain bill should go a step further and ban the freebies for travel agents as well. That way, the major airlines will have to compete without making profits off of their competitors or by bribing travel agents. They'll have to do it by providing better service.

Access to the airways, like access to information, must become more competitive; expansion of the system alone won't eliminate the existing scams of scale, which will only become more efficient as the airlines get bigger. Gate leases should be short-term, no more than six months to a year, and they should be renewed by the airport authority--or canceled--based solely on the airline's performance at that airport. And as unpopular as slots are among even the major airlines, they shouldn't be abolished. Granted, the air traffic at the busiest airports probably could be kept to manageable levels by the FAA's Central Flow Control computer in Washington, the massive network that monitors traffic flow at airports throughout the nation. But that system holds traffic down by ordering delays--which would increase as airlines tried to pump new traffic into airports like LaGuardia and Washington National. A ground delay only inconveniences passengers, but in-flight delays can be deadly. The Avianca jet that crashed on Long Island was given 90 minutes of in-flight delays because of the weather at JFK. Leaving aside the question of how the pilot should have reacted to his fuel shortage, why was he put in that situation to begin with? One can only wonder how long the delays will become as the skies become even more crowded.

Slots are a better means of managing traffic at busy airports. But making these slots permanent was a bad idea, and the buy-sell rule hasn't helped. Even auctioning the slots off--the Danforth-McCain solution--is no answer; the major airlines would just outbid smaller competitors. The only way to keep slots from being a barrier to entry is to take them back from the airlines, then assign them on a rotating basis, with each slot lease up for renewal once a year--again, based on the airline's performance.

The airports, meanwhile, need more freedom to expand to give potential competitors more access to gates. To escape their dependence on the carriers, airport operators are pushing for the collection of passenger fees to finance expansion. The Bush administration rightly endorsed this idea in its budget proposal. (The Airport Trust Fund is already supposed to pay for expansion projects but has become yet another White House bookkeeping smokescreen to hide the size of the federal deficit.) In return for these fees, airports should be held more accountable for bringing in competition. Airports are supposed to recruit a diverse group of airlines, but most aren't in the habit of building new gates and then finding tenants. The result is that most expansion projects involve one airline building 20 gates for itself, rather than airports building terminals that could house six or seven new competitors. The FAA still has to approve expansion plans and improvements, like equipment replacement and technological updates. It should use that leverage to promote competition, giving priority to the airports that have shown the most commitment to bringing in new carriers.

We don't have to go back to the old days of the Civil Aeronautics Board and regulated routes and fares to have a just system. With a few strategically placed controls to eliminate unfair barriers and a real commitment among government and industry officials to building and maintaining competition, the deregulated air system can provide passengers with choices and quality service. These changes would mean that all of the airlines--the big carriers as well as the small ones--would have to work harder to sell their seats and to hold onto their space at the airports. And as they became successful, airlines wouldn't be able to crush their competition with sheer bulk alone. But isn't that the way deregulation was supposed to work?

David Nather is a reporter for The Dallas Morning News.
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Title Annotation:airline deregulation, part 2
Author:Nather, David
Publication:Washington Monthly
Date:Mar 1, 1990
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