Written testimony of
Gordon Bethune
Chairman and Chief Executive Officer
Continental Airlines, Inc.
1350 I Street NW, Suite 1250
Washington, DC 20005
(202) 289-6060
Before The
Senate Committee of the Judiciary
February 7, 2001
Good morning, Mr. Chairman and Members of the Subcommittee. I am Gordon Bethune, Chairman and Chief Executive Officer of Continental Airlines. It is a pleasure to be here representing the 54,300 employees of Continental. It is a special honor to be able to appear before a Subcommittee headed by Chairman Mike DeWine of Ohio, who represents our Cleveland hub. Continental is honored to have such strong representation in the Senate and we thank you for your leadership.
I thank you for your invitation to discuss the important topic of aviation industry consolidation, and specifically, the proposed mergers between United Airlines and US Airways, and between American Airlines, TWA, and US Airways. As the fifth largest airline in the United States, Continental has a unique perspective on the two proposed mergers and the effect these mergers will have on the U.S. aviation system and on the passengers that utilize air travel every day.
My goal today is to explain to the Subcommittee why we at Continental believe that the proposed airline mergers should not be approved. The mergers will harm competition and consumers. Moreover, federal approval of these mergers today would be directly at odds with positions taken by the government just a few months ago when the Department of Justice successfully opposed a much smaller airline acquisition: Northwest’s purchase of 51% of Continental’s voting stock. While I know that it is ultimately the Department of Justice’s decision as to the future of the proposed United and American mergers, it is important that everyone be fully briefed and that everyone understand the inevitable outcome if these mergers are permitted to occur. I intend to explain why other airlines will be forced to grow to remain competitive and to discipline the two new mega-carriers. I will show why this growth can only be achieved through further industry consolidation.
Continental itself is an airline that emerged from a series of mergers in a very different era and a very different industry structure. Texas International, New York Air, PEOPLExpress and Frontier all merged into what is now Continental Airlines. As a result, Continental went through years of delivering poor service to customers, treating employees poorly and managing its finances poorly (including two bankruptcies). However, in 1995 Continental implemented a sensible plan and motivated its employees to turn things around, and over the past six years things have been very different at Continental. Continental is now recognized as the best major airline in the industry. In fact, over the past five years Continental has won more JD Power and Associates/Frequent Flyer Magazine awards for customer service (this year taking top honors for both long and short haul flights) than any other airline in history. Just two weeks ago, Continental was named 2001 Airline of the Year by Air Transport World, the second time Continental’s worldwide peers have recognized it in five years. Finally, I am especially proud of the fact that we have been ranked in the top half of the past three Fortune magazine lists of the 100 Best Places to Work in America, this year ending up in the top twenty. No other major airline, except Southwest, is even on the list. It is from this perspective that I want to give you my thoughts on what is currently facing the U.S. airline industry.
The Airline Industry Currently is Characterized by a State of Competitive Equilibrium
Allow me to describe the current environment within the U.S. airline industry. There is currently a competitive equilibrium among the major airlines in the United States. Major reviews of the airline industry since deregulation have concluded that the major network carriers provide effective competition. Air travel has skyrocketed since deregulation, airfares (adjusted for inflation) have declined and the current system of carriers has been able to offer a wide variety of competitive services. The levels of concentration in the airline industry since deregulation have remained relatively low for a network business. Even after the airline mergers of the 1980’s, concentration in the airline industry has stayed below critical levels. While each major airline has strengths in specific regions of the country, none is truly strong in every U.S. region. Thus, national competition has been balanced and effective.
The major carriers can be split into three distinct groups: very large national carriers (the “Big Three”), medium national carriers, and small national carriers. United, American, and Delta make up the very large national carrier group. Each of these three airlines has over 16% of domestic system capacity and traffic. They are the largest three airlines in the world. They already have the largest frequent flyer programs and distribution channels, and they control more airport real estate than any other carrier. While the Big Three are considerably larger than the next group of carriers, they provide equilibrium for each other. Moreover, the medium national carriers can remain competitive because their scope and scale disadvantage is not so large that it cannot be at least partially overcome by offering superior service or lower prices compared to the Big Three.
The medium national carrier group consists of Northwest, Continental, Southwest, and US Airways. Each of these carriers maintains between 7% and 9% of domestic capacity and traffic. These four airlines, while not as large as the Big Three, offer strong competition on a national basis and have found a niche in which they are able to compete. For example, US Airways holds many slots at the four federally slot-controlled airports and has a strong position in the important Northeast region of the country. Southwest competes based on price. Northwest has a strong North Central and Asia market position. Continental competes based on our internationally recognized superior customer service. Each medium sized carrier has found a way to be successful, even though they are about half the size of their larger counterparts.
The final group, small national carriers, consists of TWA, America West, and Alaska. These carriers are each between 2.5% and 6% of domestic capacity and traffic. While these carriers have found it more difficult to compete against the seven larger airlines, all but TWA have been successful in their regional focus. TWA has historically shown strength at its Midwest hub, while both America West and Alaska have shown similar strengths in the West.
Finally, there are currently a number of successful new entrant/low cost/niche carriers that help in maintaining balance and competition in the airline industry. Airlines such as Midway, Midwest Express, Air Tran, and JetBlue all compete vigorously with larger carriers in a limited number of individual markets.
The Proposed Mergers Will Harm Competition
Against this backdrop of a competitive environment that is at equilibrium is the proposal of United and American to split up US Airways and for American to also absorb TWA. This will create an unbalanced competitive environment in which the two resulting mega-carriers are significantly larger than their next largest competitors. Clearly United and American’s plan is to reach détente, build a cartel, and carve up and dominate the U.S. air travel market. Look closely at the proposals; they include sharing the Northeast shuttle and sharing the Northeast region between the cartel members. Ultimately, the same way United and American have split Chicago O’Hare and London (Heathrow), they will split the rest of the U.S. (and maybe even split global aviation). The two mega-airlines have even incorporated a provision in their agreement that restricts American’s ability to merge with other carriers and puts limits on American’s growth. Should American grow faster than United wants it to, United would have the right to terminate the Northeast shuttle agreement the two airlines have proposed. United would also have the right to repurchase certain US Airways assets being divested to American and a right of first refusal for any assets American divests as part of a subsequent transaction. This provision is clearly a horizontal restraint between major competitors. It allows United to restrict American’s future growth by acquisition, requires cooperation between United and American on future acquisitions, and has the effect of stabilizing the relative shares of the two largest airlines.
After consolidation, United and American will each be of such vast scale and scope that other U.S. airlines will be unable to offer effective competition against them. The airline industry will change for the worse, adversely affecting competition, consumers, communities and employees. Other airlines will be forced to combine, be carved up, or be put out of business by the onslaught brought on by the United and American cartel.
After the current wave of proposed consolidation, United and American will control nearly 50% of the U.S. airline industry and have twice as many hubs as Delta, Northwest, or Continental. The new United will serve one hundred more domestic destinations than its nearest competitor. Additionally, American and United will each become more than 50% larger in terms of capacity, traffic, and revenue than the next largest non-merged carrier (Delta), and they will be almost three times as large as Continental. After the mergers, United and American will also be the #1 and #2 airlines in the largest regions with the most revenue and business traffic, the Northeast and West regions. Via the mergers, United and American will have created the only two truly national networks. While other airlines may continue to maintain some regional presence, their ability to compete nationwide will be lost. Consummation of these mergers will allow United and American to ensure that they have eliminated competition on the national (and even on the global) stage. In conjunction with their national presence, the two mega-carriers will have frequent flyer loyalty programs two or three times as large as their nearest competitors, and distribution and marketing systems that no other airline will be able to match. The combined effect of this will be to produce a quantum shift in the distribution system that squeezes out other carriers in a manner that has never occurred before.
Finally, the two airlines will operate almost 80% of all slots at the four federally slot-controlled airports (Washington Reagan, New York LaGuardia, New York JFK, and Chicago O’Hare). At Washington Reagan, where slot restrictions are expected to remain in place in perpetuity, and at New York LaGuardia, where the FAA has already stopped expansion and slot restrictions are likely to be reinstated, the two airlines will control over 65% of all slots. By way of comparison, Continental operates only 3% of all slots at the four airports, with less than 5% of the slots at Washington Reagan and New York LaGuardia.
In order to compete with the two mega-carriers, other airlines will need to grow to at least a scale that is near that of the market leaders. Independent growth to the scale of United or American will be nearly impossible. An airline like Continental, with just over 8% of the current domestic capacity, would need nearly twenty years to grow to the size of United and American even if Continental could grow at a very aggressive average annual rate of 10% (2-3 times expected GDP growth) and if the two mega-carriers grew at expected GDP levels of about 4%. By comparison, over the past six years that I have been the CEO, Continental has only been able to grow at an average annual rate of just under 5%. Hyper-growth of 10% annually for Continental is not realistic over the long term.
First, as I mentioned earlier, slot restrictions at Washington Reagan, New York LaGuardia, New York JFK, and Chicago O’Hare limit growth in major eastern markets. Not only is access to these airports limited, but United and American will hold the keys with their combined 80% share of the slots. Additionally, the limitations on the supply of capital, mechanics, pilots, and aircraft, and limitations on the capacity of the air traffic control system, will also impede the ability of airlines to grow at such a hyper-rate for extended periods. More importantly, however, Continental is concerned that faster than historical growth will limit our ability to do what we do best, which is providing passengers with quality customer service. With hyper-growth, an airline runs a serious risk of spoiling its product, something Continental is not willing to do.
The destruction of the competitive equilibrium that is the obvious and direct result of these proposed mergers means that independent growth to compete with United and American is virtually impossible. Airlines will be left with no choice but to merge in order to compete effectively with the two mega-carriers. Additional airline mergers will be required to restore a competitive playing field to an airline industry that would otherwise be split by the United and American cartel.
The Proposed Mergers Will Harm Consumers, Communities, and Employees
The labor and service disruptions coupled with reduced customer service brought on by the integration of the four merging airline systems will, in the short run, benefit Continental as we attract passengers looking to escape the uncertainty and problems they will experience with the mega-carriers. The service disruptions and customer service complaints of the past few years are nothing compared to what is coming if the proposed mergers are approved. Think back over the past few years. American has been through pilot and flight attendant slowdowns. United also has been through work slowdowns which created some of the worst operational and customer service problems this industry has ever known. United ranked last in Department of Transportation on-time performance statistics seven times this past year, with an average quarterly on-time performance (in the second and third quarters) of barely 50%. Continental, by way of comparison, ranked in the top three each quarter of the year. I might add that Continental’s on time performance last summer was better than previous years and in December we beat our closest competitor by almost seven percentage points in on time performance. Continental was also the #1 airline in on-time performance for the entire year 2000, out of all major network carriers. With regard to baggage performance, United again had poor performance, finishing each quarter in ninth or tenth place, with statistics at least 25% worse than the industry average. And regarding customer complaints, let’s just say that United’s record is so bad that by the third quarter of last year, United’s number of complaints per 100,000 enplanements was more than double the industry average. Now think about the same service disruptions and service problems aggravated by the incredibly difficult task of integrating four systems, four aircraft fleets, and most importantly four distinct groups of fragmented and hostile workforces. If you think that the problems this industry has seen over the past few years have been bad, you have not seen anything yet! And while Continental stands to gain in the short run because we offer an attractive alternative to surly and unreliable service, we will simply not be big enough to offer a truly competitive alternative in the long run. The vast majority of passengers will have no choice but to be forced to suffer whatever service, or perhaps more accurately, lack of service, United or American may offer.
Understand that this is not a call for legislation to re-regulate the airline industry. That is exactly the wrong way to go. I have long said that customer service is a competitive issue, not a legislative one; you simply cannot legislate whether someone enjoys coming to work. Continental has made great strides in customer service, and we have received much recognition for it. We are proof of what a competitive response to customer service issues can be. We have even gone to federal court to stop United from installing baggage sizing templates at security screening checkpoints here at Dulles Airport, which prevented Continental passengers from utilizing Continental’s flexible baggage policy and large overhead bins. These bins were installed at a cost of many millions of dollars to accommodate customer expectations and desires. In its ruling in favor of Continental and finding that United violated antitrust law, the court said “Indeed, if there is proof of failure in the market to be gleaned from the record, it is United’s failure to provide what its customers desire.” The court agreed that customer service is a competitive issue (it said “…the record unambiguously discloses that airline carry-on policy is not an insignificant aspect of airline competition.”), and it is worth noting that the carrier attempting to carve up its smaller rivals (United) is one of the least competitive with regard to service.
The proposed mega-mergers are bad for consumers, bad for communities, and bad for employees. The picture I have painted clearly explains the problems that consumers face. Operational disruptions will be widespread. Customer service levels at the merging carriers will continue to tumble as those carriers will be able to do nothing more than keep just their systems running.
The proposed mergers are also bad for communities. According to the General Accounting Office, in its report “Aviation Competition, Issues Related to the Proposed United Airlines-US Airways Merger”, released December 2000, 290 markets will have reduced competition or have competition eliminated completely because of only this one merger. The report goes on to state that “About 16 million passengers traveled in those 290 markets in 1999…” Last week in testimony before the Senate Committee on Commerce, Science, and Transportation, the GAO reported that “the United and American proposals would each reduce competition in approximately 300 markets, with each affecting over 10 million passengers.” As a point of comparison, the Northwest/Continental transaction opposed by the Department of Justice entailed reduced competition in only 63 markets affecting 2 million passengers. Finally, many more markets and passengers will be affected by the two proposed mega-mergers if the GAO analysis is expanded to include all markets.
Communities will not only be affected by a loss of competition and deteriorating service, but also could face service cutbacks and route elimination as United and American rationalize their systems. By merging all of the routes each carrier serves from their pre- and post-merger hubs, it is highly likely routes will be eliminated to reduce overlap. While United has given a “commitment” that it will not eliminate routes, this “commitment” is for only two years, does not hold for American, and does not extend to reductions of service on routes short of route elimination.
It is clear that the proposed merger will be bad for consumers and bad for communities. The mergers will also be bad for employees. Unlike Continental, which prides itself on its excellent management-labor relationships and on the fact that it is a great place to work, history has shown that both United and American have different views on how they treat employees. The United and American mergers will occur on the backs of the employees of both the acquiring and acquired airlines. The ramifications of poor labor relations that we have felt over the past few years will be amplified and continue for years to come. Significant labor integration issues have accompanied virtually every major airline merger in the history of our industry, and these proposed mergers will not be exceptions to this rule. Think of how disruptive a relatively simple merger like American/Reno Air was. Now think of the complex issues raised by American merging with not one but two airlines much larger than Reno Air.
US Airways and TWA Have Other Options Readily Available
There are other options for the two acquired companies. While it is clear that TWA has significant problems, allowing it to merge with American and parts of US Airways is not its only option. A truly level process for competitive bidding, which Continental has fought for in the bankruptcy court, could provide alternatives for TWA. As an aside, as I have said publicly before, if American were to follow through with its statements and unconditionally commit in writing to hire all of the TWA employees and protect the benefits of all employees and retirees of TWA, and if this commitment were not contingent on the US Airways deal, then Continental would step aside and not oppose the American/TWA transaction. Of course, the Department of Justice would still face the task of prescribing remedies to restore competition, such as requiring the divestiture of some slots and facilities to smaller national network carriers, like Continental.
Turning to US Airways, it is unclear to me that any merger is necessary, as US Airways has one of the richest pools of valuable assets in the industry. Their cache of lucrative slots and their Northeast strength cannot be matched. If Continental was able to turn itself around (with its more limited assets yet intensely focused management team) and become the financial and commercial success it is today, there is no reason that US Airways, with the right incentives and appropriate management, utilizing US Airways’ crown jewels of assets, cannot do the same. But if US Airways is determined to sell itself, allowing the airline to be split by United and American is not the only option. Continental made an offer for US Airways’ Washington Reagan position that was for a much higher price than the current DC Air/American deal. Continental’s offer was turned down, not based on the economics, but based on the fact that it would put a crimp in the cartel’s plan. Continental is also very interested in the significant slot and facility holdings of US Airways in New York. These assets were never even offered to anyone except American.
If the Proposed Mergers are Approved, Then Remedial Action Must be Taken to Preserve What is Left of Competition
So what is the answer to the proposed mergers that will create two mega-carriers that have the ability to dominate the market, reduce or eliminate competition and are bad for all constituencies? JUST SAY NO!
The conspiracy by United and American to reach détente, create a cartel, and control the U.S. domestic market (thereby tightening their stranglehold on foreign markets as well), if implemented, will be so devastating that it should be disapproved outright. The government should stop trying to find fixes to mergers that should not be approved in the first place. And the government needs to clearly understand that it cannot fix, after the fact, the problems these mergers will create.
It is important to note that, just last month, the Department of Justice prevailed in its antitrust challenge of Northwest’s proposed acquisition of 14% of Continental’s stock (representing a little more than 50% of Continental’s voting rights). This case was brought to trial notwithstanding the fact that Northwest signed a governance agreement limiting its control of Continental for at least six years. The government brought the case because it believed that Northwest’s partial ownership would lessen competition primarily on routes between the six Northwest and Continental mainland U.S. hubs. Today we are faced with the prospect of a combined United/US Airways (10 hubs) and American/TWA/US Airways (7 hubs). Consolidation of these carriers would give the combined firms more than 90% of the non-stop traffic on the routes between their respective hubs. Moreover, unlike the Continental/Northwest transaction in which Continental and Northwest would have continued to compete, United and American will actually have eliminated their primary competition between those important hubs.
While the facts should compel the government to reject the proposed acquisitions, I am not confident that the right thing will be done to protect airline consumers and competition from the United and American cartel. Because of my skepticism, I must impress upon you that if, against all of the best wisdom, United and American are allowed to move forward with their plans, further airline consolidation is inevitable and will be required to assure effective competition. The U.S. aviation industry will require at least three or four large national network carriers to recreate the equilibrium that we currently have and that will be lost if United and American are allowed to complete their proposed transactions. Only through the smaller airlines’ ability to grow and their ability to further consolidate will marketplace protection be possible.
If the proposed mega-mergers are approved, as I fear they will be, action must be taken by the Congress, the Department of Transportation, and the Department of Justice to give some small glimmer of hope that competition in the aviation industry can survive. The ability of airlines to obtain assets in order to create networks of similar scale and scope is key to disciplining the United and American cartel.
Congress, the Department of Transportation, and the Department of Justice must ensure that appropriate slots, gates, and other facilities at slot and capacity constrained airports are made available to smaller network competitors by the two mega-carriers. Special attention must be paid to airports such as New York LaGuardia, Washington Reagan, Chicago O’Hare, Boston Logan, Los Angeles International, and San Francisco International.
The Department of Transportation must also exercise fully its duties and responsibilities in determining whether the international route transfers occurring in these mergers are consistent with the public interest and what impact they have on competition in the domestic airline industry. The Department of Transportation should re-award those international routes to competitors of the mega-carriers as necessary to preserve competition.
It is crucial that the U.S. ensure that government operating privileges, such as slots, are not used to create monopoly power at the very airports necessary to provide effective competition among networks. Specifically, the U.S. must be prepared to insist that a concentration of slots by the largest of carriers does not occur and that a process exists so that competing networks can get the needed slots. As discussed above, post-merger United and American will control nearly 80% of the slots in the highly significant business markets of the Northeast and North Central. Competition simply cannot survive in those cities with that level of concentration between two carriers who actually are cooperating with each other.
If the proposed mergers are allowed to proceed, there must also be assurances that the remaining U.S. airlines have more access to the capital they will need to sustain continued growth. Currently, U.S. carrier access to new capital is severely limited by unnecessarily low limits on foreign investment. The foreign ownership limits on U.S. carriers should be increased to 49%. This will provide new sources of capital while maintaining U.S. control and protecting U.S. employees.
Finally, as United and American strengthen their domestic positions, the ability of other U.S. carriers to compete internationally will be reduced. For example, United and American are already the only two airlines with the right under the U.S.-U.K. bilateral to fly into London Heathrow airport, the most important business airport in Europe. United and American’s growing control of the domestic market will make this already huge disadvantage to Continental and other U.S. airlines even greater. The U.S. should renew its efforts to negotiate more access to London Heathrow for competitors of the mega-carriers or negotiate to substitute other carriers at London Heathrow for the two mega-carriers. Additionally, United and American have a large array of foreign partners with which they have alliances, making their control of world air transport even greater. The ability of small network carriers to offer foreign partners enough scale and scope in the U.S. is limited, and it is clear that given a choice of partnering with a member of the cartel or partnering with a smaller carrier, foreign airlines will choose the cartel. As antitrust immunity only exacerbates this problem, I call for a serious re-evaluation and possible revocation of the antitrust immunity already granted to the mega-carriers and their foreign partners.
Conclusion
Mr. Chairman, I know what I have discussed today will not be popular with many people, especially my peers at United and American. But I have no choice but to make sure that the U.S. Senate, your constituents, and all Americans are aware of the consequences that the proposed United and American mergers will have on consumers, communities, employees, and on the U.S. aviation industry as a whole.
While I know that it is not ultimately this Committee’s decision as to whether the deals are allowed to proceed, it is within this Committee’s power to ensure that all of the facts are available and that the consequences are known. If the Department of Justice nonetheless decides to allow these mergers, you must insist on the action items I have proposed today. If these two mega-deals are permitted, other airlines will be forced to merge and those mergers will be necessary to restore effective competition. Therefore, once the Department of Justice approves the pending merger others will follow and must be approved.
Mr. Chairman and members of the Committee, I thank you for giving me the opportunity to discuss this very important issue with you and for your attention. I would now be pleased to answer any questions that you may have.