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Congressional Testimony
June 14, 2000, Wednesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 4614 words
HEADLINE:
TESTIMONY June 14, 2000 NANCY E. MCFADDEN GENERAL COUNSEL U.S. DEPARTMENT OF
TRANSPORTATION HOUSE JUDICIARY AIRLINE HUBS; UNITED US AIR
MERGER
BODY:
STATEMENT OF NANCY E.
McFADDEN GENERAL COUNSEL U.S. DEPARTMENT OF TRANSPORTATION before the COMMITTEE
ON THE JUDICIARY June 14, 2000 Mr. Chairman and Members of the Committee: I
appreciate the opportunity to come before the Committee to discuss the state of
airline competition and to describe the Department of Transportation s role in
reviewing airline mergers and acquisitions. The principal
subject of this hearing is concern about the inadequacy of airline competition
at hubs dominated by one or two airlines, such as O Hare. With respect to the
announcement by United Airlines and US Airways of a major
merger proposal, on behalf of Secretary Slater, I want to
assure the Committee that this proposed transaction, indeed any major
transaction, will be thoroughly examined by the Department of Transportation
with the goal of preserving competition in the airline industry. My testimony
today will focus on three aspects of airline competition: the background to the
current state of competition in the airline industry, with a focus on the
development of hubs that are dominated by one or two carriers; the Department's
role in reviewing airline mergers and acquisitions; and the
factors that we will look at in analyzing a merger or
acquisition. The structure of the airline business today reflects Congress'
decision to deregulate the industry in 1978. Congress correctly determined that
the public would obtain better service and fares if airlines had to respond to
consumer demands and competition. Congress therefore phased out the economic
regulatory regime that had long authorized the Civil Aeronautics Board to
dictate where airlines could fly and what they could charge. In responding to
market demands and the need to improve their efficiency, airlines reshaped their
linear--point to point--route systems into hub-and-spoke systems. Hub-and-spoke
systems enable airlines to serve the maximum number of city-pair markets with a
minimum number of airplanes and to maximize traffic flow by consolidating
connecting passengers with different destinations on each flight. Operating at a
hub creates service advantages for many travelers, since it gives travelers at
hub cities many more flights and enables airlines to offer more service in
markets that do not have enough traffic to sustain non-stop service. On the
other hand, an airline operating a hub gains such great competitive advantages
on the spoke routes at its hub that other airlines without a hub at one end
point of such a spoke route find it hard to compete with the hubbing airline.
The resulting lack of competition in many hub routes usually causes fares in hub
markets to be higher than fares in comparable non-hub markets. The Suburban O
Hare Commission report rightly notes that airlines are reluctant to compete at
the hubs operated by other airlines. In our view this results from the
competitive advantages created for the hubbing airline by its operation of many
more flights and service to many more destinations than other airlines and the
high cost that any other airline would incur in establishing a competing hub at
the same airport. However, some hubbing airlines may have engaged in practices
intended to further foreclose competition in their hub markets. For this reason,
we are informally investigating several cases where a hubbing airline has
allegedly attempted to eliminate competition in hub markets through
predatory-type behavior. Another development in the first years after
deregulation was new entry - quite a few firms entered the airline business (or
began interstate service for the first time). Relatively few survived the 1980
s, but one of those that did - Southwest Airlines - has since expanded its
low-fare operating strategy throughout most of the country. Two other entrants
of that era - America West and Midwest Express - are also operating successfully
today. The 1980 s saw a wave of airline mergers. At that time,
federal law still required all such transactions to obtain the prior approval of
the Department of Transportation. The Department approved almost all of the
merger proposals submitted to it before the complete phasing-in
of deregulation ended the Department's approval authority over airline
mergers and acquisitions. Since the end of 1988, the Department
of Justice has been responsible for determining whether mergers
and acquisitions in the airline business should be challenged as
anticompetitive. In the 1990's, airlines developed new strategies for delivering
their services. They viewed the ability to offer a broader network of services
as critical. This led to the creation of alliances in both domestic and
international markets that included code-sharing arrangements and frequent flyer
program reciprocity. The development of international alliances has been part of
the larger process of globalization. Responding to this increasing
globalization, the Clinton-Gore Administration has worked hard to open up
international markets to competition and entry by U.S. airlines. In the last
seven and one-half years, the United States has reached open skies agreements
with forty-six countries that allow any U.S. airline to serve points in those
countries from any U.S. point and to set fares free of government regulation. As
a result of these successful efforts, we have seen the development of global
airline alliances that have promoted competition in thousands of city-pair
markets throughout the world. More recently, major U.S. airlines began forming
alliances with one another. In 1998, United planned an alliance with Delta,
Northwest with Continental, and American with US Airways. These
domestic alliances were different from the international alliances. The latter
usually created new networks by linking route systems of U.S. and foreign
airlines on an end-to-end basis and involved airlines that could not enter each
other's domestic markets due to the constraints of bilateral aviation
agreements. The alliances between U.S. airlines, on the other hand, involved
airlines that already had the authority to enter any domestic market. These
alliances were potentially more problematic. In the face of these proposed
domestic alliances, Congress enacted legislation requiring the major airlines to
submit to the Department of Transportation any joint venture agreements between
them that covered frequent flyer programs, code-sharing, and wet leases. The
Department has used that authority to obtain modifications that eliminated
potentially anticompetitive features in joint venture agreements. In addition,
the Justice Department filed suit against Northwest s acquisition of the major
block of Continental stock. The other two alliances - the United/Delta and
American/US Airways alliances - have not gone beyond frequent
flyer reciprocity arrangements and provisions for the reciprocal access to
airport executive lounges. In the 1990's, we also saw increased focus on the
value of new airline entrants, especially their presence in dominated-hub
markets, and the difficulties faced by those new entrant carriers. Congress has
addressed this issue most recently in several pro-competition provisions in
AIR-21, the FAA reauthorization act signed into law in April of this year. And
DOT has taken a number of steps to promote competition and protect against
anticompetitive practices. As a result of all these developments, we have an
industry that, for the most part, has proven deregulation to be a success. But
deregulation can only be successful for the consumers it was meant to benefit if
there is adequate competition in the airline industry. To ensure that airline
competition continues, close scrutiny of the proposed merger
between United and US Airways is critical for the country's
airline travelers. We cannot, of course, discuss the merits of the proposed
transaction. However, we understand the Committee's interest in this matter, and
so I would like to describe generally how the Department examines any such
transaction. Both the Department of Justice and the Department of Transportation
have responsibilities for reviewing the proposed transaction between United and
US Airways. The Justice Department is responsible for enforcing
the antitrust laws and determining whether mergers and
acquisitions in the airline industry should be challenged on competitive
grounds. As you know, the statute now governing airline
mergers, section 7 of the Clayton Act, prohibits
mergers and acquisitions that may substantially lessen
competition in any relevant market or tend to create a monopoly. As the agency
with transportation expertise, the Department of Transportation will conduct its
own analysis of the merger and submit its views and any
relevant information in its possession to the Justice Department, as we have
done in past cases. This process is confidential. We have asked United and
US Airways to provide us all the information necessary to
thoroughly analyze the transaction. In doing that analysis, we will also rely on
the fare and traffic data periodically reported to us by the airlines. In
addition, the Department has separate regulatory authority and must grant its
approval before some parts of the transaction may go forward. First, the parties
have announced plans to spin off most of US Airways' operations
at Washington Reagan National Airport to a new airline. This new airline must
obtain economic operating authority from the Department as well as safety
authority from the FAA. In determining whether to grant economic operating
authority, we will determine whether the firm is "fit, willing, and able" to
perform air transportation and comply with applicable legal requirements. In
making fitness determinations, we review an airline s financial resources,
managerial capabilities, and compliance disposition. The FAA, under its safety
authority, conducts a separate, comprehensive safety fitness analysis of the new
carrier before issuing the Air Carrier Certificate and Operations
Specifications. Second, the proposed acquisition will also involve the transfer
of US Airways' international route authority in some limited-
entry markets. Here too, the Department must first approve the transfer of
US Airways' certificate authority, under 49 U.S.C. 41105. We
may approve a transfer only if we find that it is consistent with the public
interest. The Department by statute must specifically consider the transfer's
impact on the viability of the parties to the transaction, on competition in the
domestic airline industry, and on the trade position of the United States in the
international air transportation market. The Department will also examine any
other public interest issue raised by the transfer. The Department will only
decide whether to approve the transfer of the international route authority
after it has established a formal record and given all interested persons the
opportunity to comment on the proposed transfer. The Department s discussions
with the Justice Department on the overall merger will include
a discussion of the competitive effects of the transfer of US
Airways international routes. If the Department determines that the
transfer would be contrary to the public interest on competitive grounds or for
another reason, the Department may disapprove the transfer in whole or part.
Alternatively, the Department may condition its approval on requirements that
would protect the public interest. Third, the Department additionally has the
obligation to protect consumers from unfair and deceptive practices by airlines.
In carrying out that responsibility, we will review the merger
s arrangements to protect the rights of consumers. For example, the
merger may well affect the existing reciprocity benefits
available to members of the United and US Airways frequent
flyer programs. We will look at whether the airlines will give consumers
reasonable notice and an opportunity to adjust to any changes in such programs.
If we find that the provisions in their frequent flyer agreements fail to
provide adequate notice and an opportunity to obtain award travel, we will ask
the airlines to modify the agreements. Accordingly, we have asked United and
US Airways to provide us with their relevant frequent flyer
program reciprocity agreements, and their plans for accommodating their members
concerning any potential changes. Finally, I would like to outline the factors
we will consider in our competitive analysis of the proposed United/US
Airways merger. We will be looking at the merger s
likely impact on competition in all relevant markets. We will examine such
issues as whether the acquisition will substantially reduce competition in
relevant markets because other airlines either do not offer effective
competition now or will be unlikely to enter if United raises fares or reduces
service. A key question will be whether the proposed spin-off of US
Airways operations at Reagan National to DC Air will create an
effective competitor in the Washington, D.C. markets affected by the
merger. The relevant markets include city-pair markets, both
those served by the parties with nonstop flights and those served with
connecting flights. In examining the markets affected by the
merger, we may well consider flights operated by United from
one airport in the same metropolitan area as competing with flights operated by
US Airways from a different airport in the same area. If a
significant number of travelers strongly prefer to use one airport, the relevant
markets may also include routes between specific airports. In analyzing whether
entry by other airlines into markets served by the combined airlines is likely,
the Department will examine whether the combined market share of the merging
airlines will become large enough at individual cities to discourage entry by
other airlines. We must also consider whether airport facilities will be
available to airlines wishing to enter markets served by United and US
Airways. We will additionally investigate whether the relatively large
size of the airline created by combining United and US Airways
will make entry into the industry by new airlines more difficult. We will also
examine the potential competitive reactions of other airlines. Looking at the
merger's competitive effects will carry out Congress judgment
that market forces, not government regulators, should determine the routes flown
by airlines and the fares charged by airlines. But market forces will enable
consumers to obtain the best service at the best price only as long as the
airline industry is competitive. Members of Congress and local communities have
understandably expressed concern about whether the service now provided by
US Airways will be maintained after its acquisition by United.
For example, some communities have questioned whether they will continue to have
access to nonstop flights to Reagan National. We cannot directly answer these
questions, since we cannot predict United s long-term plans for operating the
combined business, and we have no way to guarantee that United or DC Air would
maintain existing levels of service. Nor can we know whether other
airlines--existing or new--might choose to inaugurate new services to these
communities. Under deregulation, each airline decides for itself which routes it
will fly and what fares it will charge. However, together with the Justice
Department, we will seek to ensure that the proposed merger
does not diminish competition and prevent other airlines from entering and
competing in markets where United may reduce service or raise fares. The key
question in determining whether the United/US Airways
acquisition will lead to better or worse service and fares for consumers is
whether the combined airline will face competition and therefore must meet the
demands of consumers. The Justice Department will address that question by
applying the antitrust laws. We at the Department of Transportation will provide
the Justice Department with the results of our own analysis of that question.
Mr. Chairman, knowing of your interest in the development of a third airport at
Chicago, let me provide an update on that situation. The FAA and the State of
Illinois continue to meet periodically to try to find an acceptable course. At a
January 27 meeting with the FAA, representatives of the State presented a
revised proposal. The State indicated it would now like to proceed only with
landbanking to preserve the Peotone site for future airport development, with
airport construction timed and phased as actual aviation demand develops. On May
23, the FAA advised the Illinois Department of Transportation (IDOT) that the
FAA would begin the preparation of an EIS for site approval and landbanking
only. It was understood that, once the EIS is completed, the State will fund
landbanking and no federal funding will be involved. Most recently, on June 1,
FAA and IDOT officials met to discuss the preparation of an EIS for the State's
landbanking proposal. The goal of the EIS will be to make a case that it is
feasible and prudent for the State to reserve and landbank a new site for future
capacity insurance rather than depend solely on existing airports to meet
long-term needs. It was agreed at the meeting that no airport infrastructure is
currently proposed by IDOT. The EIS will evaluate infrastructure concepts at a
broad brush level sufficient for site viability, but not at a detailed level for
infrastructure approval. Subsequent EISs will be required for any FAA approvals
related to infrastructure. In conclusion, I wish to reaffirm our commitment to
ensuring that consumers throughout the United States continue to benefit from
airline deregulation. That will require us to continue our efforts to promote
airline competition. The need to ensure competition will both guide our review
of the United/US Airways transaction and guarantee that we will
carefully examine its potential impact, and it will underpin the use of our
other economic regulatory authority over the airline industry. Thank you Mr.
Chairman. This completes my prepared statement, and I would be pleased to
respond to your questions and those of the Committee. Accompanying me is Mr.
Paul Galis, Deputy Associate Administrator for Airports, who will be pleased to
answer questions on the FAA s review of proposals for a third airport at
Chicago.
LOAD-DATE: June 19, 2000, Monday
