Mr. Chairman, Members of this distinguished subcommittee, on behalf of United Airlines, I appreciate the opportunity to speak with you today about competition in the domestic airline industry and the tremendous benefits our free market in air service has provided to consumers.
It wasn’t so long ago that our government tightly controlled this industry. They told us not only when and where to fly, but also how much to charge, and even, at times, what meals to serve.
Thankfully, those days are long gone. And the result has been a boon for passengers. Domestic air fares have gone down in real terms over the past 18 years by some 40%. Our own fares increased only 2% per year over the last four years (1993-97), and even unrestricted fares rose by only 3% last year. Passengers have never had as many options for getting where they want to go and at the time they want to travel, and the airline industry has the flexibility to innovate and respond to the dramatically increased demand for air service that our robust economy has created.
Frankly, Mr. Chairman, many of us thought that the results of airline deregulation had proven so beneficial to virtually everyone involved, that we were more than a little taken aback at the recent spate of criticism from some in Washington. We were even more surprised that some are now calling for broad re-injection of government management into the operation of our domestic airline market.
Much of the recent concern has been generated by recently-started air carriers who, for one reason or another, have had difficulty competing both with the major network carriers and with more efficient point-to-point carriers. Some also comes from regulators who, however well-intentioned, don’t always see the forest for the trees. And we have also heard from those who believe that airline prices are either too high, too confusing, or both. As an industry, we need to do a better job addressing each of these concerns, and I appreciate the chance to try to do so here today.
At the outset, Mr. Chairman, it is important to understand that today’s post-deregulation domestic airline system is really a bifurcated one, with two distinct types of carriers offering consumers two different kinds of service. On the one hand, deregulation spawned a generation of air carriers that operate on a point-to-point route system, usually at less congested secondary airports, and target their marketing toward the most price-sensitive passengers. The prime example is Southwest Airlines, now the world’s fifth largest carrier in terms of numbers of passengers boarded.
These point-to-point carriers have largely arisen since deregulation. Since they were therefore never burdened by government-mandated route systems, and the resulting need for major capital investment in particular communities and types of equipment, they are in a position to keep costs to a bare minimum. By concentrating on the efficiencies of quick turnaround services in relatively dense markets, they can offer passengers in these markets fares low enough to compete with interstate bus service. The resulting aggressive price competition has forced network carriers in the same (and even adjacent) markets to dramatically restructure their operations to remain competitive.
These point-to-point post-deregulation carriers captured significant market share -- nearly 18 percent of the total domestic passenger miles flown in 1996. They continue to provide consumers a choice of service that is different from, and complementary to, the service offered by the major “network” or “hub-and-spoke” carriers.
The network carriers, on the other hand, offer a distinct kind of air transportation – one that is more service-sensitive – through the “hub-and-spoke” system. This allows passengers to be carried across the country and throughout the world in an efficient manner, with schedules, facilities, and services designed precisely to facilitate that network. A typical United Airlines flight from Des Moines to Chicago, for example, carries passengers destined for more than a hundred other places that United serves non-stop from its Chicago hub.
As a result of these network hubs, millions of U.S. travelers can, with a single hub connection, travel “on line” -- that is, on the same airline, with the same reservations and ticketing, seat assignments, baggage handling, frequent flyer programs, and the like -- to virtually any major city in this country. Through international airline alliances, like our Star Alliance, these passengers can continue “on line” to destinations around the globe.
These benefits of worldwide on-line service are made possible by network efficiencies which, in turn, derive from, and are enhanced by, strong hubs. Effective hubs can best attract sizeable numbers of passengers from multiple origin points, and transfer them most efficiently to multiple destinations. As the density of traffic through the hub increases, per passenger costs decrease and utilization of facilities (including airline “load factors”) improves. The consumer benefits as the carrier gains efficiencies which enable it to add more frequencies on dense routes, and add more services to link smaller communities to the global transportation network. A recent comprehensive report of the OECD underscores the important role that hubs play in generating significant efficiencies associated with these “economies of density” of traffic.1
While the majority of large domestic hubs do not today support multiple network carriers (with Chicago a key exception), the hubs must compete vigorously between and among themselves for traffic. This is because the vast majority of passengers are traveling not just from one hub to another hub, but rather are going from a city “behind” a hub to a city ”beyond” a hub, and are only connecting “through” the hub. These travelers can choose not only among air carriers, but also among various routings and among different hubs through which to connect to get to their destination. The hub-and-spoke system has afforded travelers today a vastly greater choice of competitive services than was ever the case before deregulation.
Take, for example, the 254 travelers who move each day between the Washington, D.C. area and Albuquerque, New Mexico. They can choose among 30 different flights throughout the day, operated by nine competing carriers, through 10 different hubs. This remarkable consumer choice, made possible by the efficiencies of networking, was impossible prior to deregulation.
Today travelers enjoy this remarkable choice in nearly every substantial air transportation market in the country. In fact, according to Department of Transportation Origin and Destination data, almost 90 percent of passengers today have a choice of competing air carriers; indeed, they often have more than two choices. Some 20 years ago, only 71 percent traveled in markets with any competitive choice whatsoever.
And this consumer choice is not limited to a decision of which major network carrier to use. Consumers can also choose between the service advantages offered by the network carriers and the price advantages offered by the point-to-point carriers. This permits each consumer to make a personal valuation of the trade-off between convenience and price. Mr. Chairman, let me underscore this idea because it also goes to an issue that has been misunderstood – the ability of so-called “new entrant” or point-to-point carriers to continue to compete with the major network carriers.
To use an analogy, competition between these two types of air service in many ways mirrors the competition between door-to-door taxi service and bus or subway service. For a market price, the taxi rider gains convenience, saves time, and avoids uncertainty. (By analogy, the passenger on the network carrier often uses a closer-in airport, avoids the time involved in making connections, and can more conveniently change travel plans and departure times at the last minute.) For a considerably lower price, the hypothetical bus traveler is willing to transport himself to a station or terminal, spend longer total travel time, and enjoy fewer conveniences and flexibility.
There should be nothing remarkable about this kind of trade-off; it’s one that consumers willingly accept all the time. Indeed, the major carriers themselves offer passengers a similar trade-off of price for time, convenience, and flexibility. For this reason fares are typically lower on “connecting” flights than on direct nonstop service, and lower on “non-refundable” tickets than on “refundable” ones.
The same concept has much to do with airline pricing. Some see airline pricing as, at best, a kind of arcane or mysterious science. In fact, it is not, if two basic concepts are understood. First, the price of airline travel, like any other service in a free market, is dictated by supply and demand. Unless or until there is a significant increase in capacity – for example, more aircraft, more airport facilities, more airline personnel – prices will tend to rise as demand increases (as it has) and begins to outstrip supply.
The second basic pricing concept is that a seat that remains unsold when the aircraft takes off is revenue lost forever. Airline seats are in this sense perishable commodities. For this reason, carriers seek to price seats to ensure a mix of low-fare tickets sold months in advance on a non-refundable basis to fill otherwise empty seats, and higher fare tickets, available up to the time of departure, for those who require immediately available service on the day of travel.
The price differences reflect supply and demand, consumer preferences, and the risk that the airline bears in “saving” seats -- seats that might end up “wasted” if the airline guesses wrong about last-minute demand for the flight -- for the most time-sensitive traveler. By so allocating scarce capacity of “last-minute” seats, the airlines offer the “full fare” business passenger the opportunity to purchase the desired convenience and schedule flexibility at a market price. As a March 3, 1998 editorial in The Wall Street Journal observed, in commenting on concerns about higher fares for business travelers: “Business got what it most wanted from deregulation: The airlines have laid on so many flights that they now provide virtual air-taxi service on demand for anybody willing to pay full fare. No longer is valuable executive time wasted waiting for the next flight.”
Conversely, the vast majority of passengers – those who can schedule ahead and take advantage of discount fares -- enjoy fare levels in real (inflation-adjusted) terms far below what they would have paid 20 years ago. These fare benefits are widespread. In fact, more than three quarters of United’s passengers travel on discounted fares. Moreover, as the GAO found in 1996, “the average fare per passenger mile, adjusted for inflation, has fallen since deregulation about as much at airports serving small and medium-sized communities as it has at airports serving large communities.”2
Let me add with regard to concerns about high fares, Mr. Chairman, that per seat profit margins in this industry are hardly extraordinary. In fact, even in the record year of 1996, airline industry profits ranked 43rd among the 60 industries represented in the Fortune 1000. Airline net margins were 3.4% vs. an average of 5.8% for the Fortune 1000. As one Wall Street analyst recently observed, “If airlines are monopolists then they are the worst sort – unsuccessful ones. If a monopoly return for this industry is about 11.5% when capital costs about 9.0%, then the concept of monopoly has been redefined.”3
This brings me to the other side of the pricing complaints we have been receiving – that our prices aren’t just too high; they’re also too low, or “predatory.” The legal issue of what pricing is properly considered “predatory” under the antitrust laws is one for the antitrust legal experts, and it would not be appropriate for me to comment on that in detail here, given the pendency of various regulatory reviews and inquiries. In general, though, the predatory pricing issue appears to be just one part of broader claims of anticompetitive activity by the major carriers.
These kinds of claims have been heard before, and tend to ebb and flow with the shifting competitive fortunes of network carriers and the point-to-point or “linear” carriers. Like a pendulum, after deregulation, the gravitational pull of a free market has shifted competitive advantages back and forth between these two groups. In the years immediately following deregulation, carriers such as Southwest that improved the linear model and targeted price-sensitive passengers were perceived as the wave of the future. In contrast, the large network carriers, with cost structures and route systems reflecting the inefficiencies of years of regulation, were viewed as dinosaurs destined for extinction.
By 1985, many long-established network carriers had in fact gone out of business, and others soon would. Yet the survivors, including United, transformed themselves into more efficient carriers, in many cases based on the sacrifice of their employees, and began to recapture market share.
But this edge, too, proved short-lived. No sooner had Wall Street predicted the end of the era of new entry, but a second wave of point-to-point carriers entered the market with more competitive business plans and often with better financing than their predecessors. They regained the market share they had lost -- and more. Again the commentators concluded that these fast-growing “New Wave” carriers (in the words of one brokerage house) would eclipse the older carriers, with one major analyst predicting in 1993 that “in the next five years [they] could easily account for 35%-40% (market share) of the industry.”4
In response, carriers such as American, Delta, and United undertook major corporate restructuring aimed at reducing costs and improving efficiency. While United became employee-owned, others opted to negotiate major work rule concessions, and carriers like United also launched new products like Shuttle by United in 1994 to respond to competition from point-to-point carriers in California and other Western markets. Nonetheless, by 1996 the new carriers enjoyed an 18% market share.
The subsequent events surrounding the ValuJet tragedy appear to have taken a toll on new entrant carriers and their sources of funding. But there is nothing to suggest that the market will not re-adjust with innovation and new product concepts, as it has repeatedly in the past, and that the long-term upward market trend for these “point-to-point” carriers will not continue. In fact, Southwest alone has 63 new aircraft on order for domestic service and, due to the long range capability of this equipment, aggressive price competition is expected in many new markets. Similar forces are at work in Europe’s recently-deregulated internal aviation market. A recent Wall Street analysis of the European airline industry found that the “low-cost travel segment”, i.e., that served by the so-called “low-cost carriers,” has almost doubled in the last two years, and has the potential to grow 3-4 times its current size.4
This is not to say, of course, that all of these new entrant carriers are guaranteed to prosper in the increasingly mature domestic aviation market. Indeed, as in any mature market, the prospects for new entrants naturally depend on their ability to create and offer a product that is different, better, or cheaper than what is already available. Merely wishing to emulate Southwest, with minimal capital investment and no semblance of innovation, has not made many would-be competitors successful -- either competing against the network carriers or against other linear carriers.
Perhaps not surprisingly, some of these less-than-competitive enterprises have now turned to government regulators, seeking refuge from the harsh winds of free market competition. Some urge government to handicap the competitive strength of the network carriers – from curtailing some kinds of vigorous price competition to even imposing direct output or capacity restrictions, purportedly to “level the playing field.”
Others more directly ask the government to bestow on them special favors. For example, there have recently been numerous requests to the Department of Transportation for special take-off and landing rights and preferred market access, at the cost of limiting network carrier service to and from the slot-constrained airports. And there have even been suggestions that the government should get back into the business of simply dictating fares and capacity.
Mr. Chairman, we respectfully submit that these kinds of government intervention in the market – intervention designed to protect, shield, or subsidize competitors, not competition – are ill-conceived. On the one hand, they penalize the innovation, skill, and long-term financial commitment of carriers who, with the help of their employees, succeeded in re-creating themselves after deregulation into tough, global competitors. But even more important, government action that would return this industry to the regulated market model can only jeopardize the many consumer benefits – the consumer choice, the array of service offerings, the low cost options -- that our aviation system today offers millions of Americans.
We strongly disagree with those, including some in government, who think that our domestic airline industry is in need of broad new regulation in order to provide consumers with reliable, safe, cost-effective, and competitive air transportation. That, rather than the protection of any particular set of competitors, is surely what the ultimate goal has to be. And in the absence of a fundamental “problem”, imposing a “remedy” is neither necessary nor wise. The history of government market regulation speaks to the well-worn aphorism: “Beware the cure that is worse than the disease.”
Mr. Chairman, I don’t want to leave you with the unrealistic impression that we are in “the best of all possible worlds” in the airline industry, or that there could never be a legitimate concern raised about the competitive actions of any specific carrier in a particular market. But as the Subcommittee knows, the government is well-armed with statutory antitrust authority, and private parties have their civil remedies, to deal appropriately with such situations and resolve these matters on a case-specific basis.
This makes sense, in the long run, from the standpoint of both consumers and industry. Indeed, this kind of approach makes much more sense than attempting to create a whole new regulatory regime whose consequences – intended or unintended – promise to undermine the very consumer benefits that airline deregulation was designed to, and has, achieved.
Thank you.