testimony

 

Before the National Academy of Sciences National Research Council Transportation Research Board

Committee For A Study Of Competition In The Airline Industry

January 20, 1999

Mr. Chairman and Members of the Committee, I was honored to have been asked to appear before your distinguished Committee.  The thrust of my verbal presentation to you was that U.S. DOT competition guidelines are the least intrusive, most promising first step in returning functioning competition to the air transport industry. 

I am submitting this Supplemental Statement to call your attention to a recent industry development which illuminates a central problem for corporate purchasers of air transport services, and which can further strengthen the case I outlined in detail today for DOT guidelines.  

BACKGROUND

Last week Delta Air Lines instituted a surcharge of one dollar per segment for U.S. travel not booked through Delta’s Internet site.  Most airlines receive 1 to 1-1/2 percent of revenues from ticket sales through their Internet sites.  If other airlines match Delta’s move, BTC estimates the airline industry would receive, on a pro forma basis, some $485 million dollars in new revenues—(1998 passenger enplanements of 615 million less an aggressive 5% for Internet bookings).

Delta’s stated rationale for the surcharge is to recoup rising distribution costs--even though these costs, as a category, have been declining dramatically since 1995.  Travel agency commission restructurings in 1995, 1997 and 1998 transferred distribution costs in excess of an annualized $1.6 billion dollars from airlines to their agency distributors and to their customers. 

Indeed, Delta’s action appears designed to leverage market power vis-à-vis its customers, who as I will illustrate below, will have little choice but to pay the surcharge.  Tellingly, the financial gain from such a surcharge is far greater than would be an incentive program.  For example, if the initiative were based on a $1.00 per segment inducement to travelers for booking through an airline’s Internet site, airlines would pay out $30 million dollars, versus receiving the $485 million dollar windfall mentioned above.

AT ISSUE

There are a number of potentially anti-consumer concerns associated with Delta’s action such as price discrimination against older Americans and the poor who perhaps cannot afford, or otherwise access the Internet. 

However, I want to use Delta’s surcharge to specifically focus on the more narrow issue of airlines’ interchange with corporate customers.  An analysis of the surcharge can:  1) underscore the immense market power of major network airlines;  2) illustrate consequences from inadequate competitive alternatives for all airline customers; and  3) add further support to why a renewal of robust competition in air transport is inextricably linked to DOT competition policy and a return to high levels of new entrant competitors.

 CORPORATE CUSTOMER FRUSTRATION

Admittedly, it is counterintuitive to think that corporations that spend tens, and even hundreds of millions of dollars, on air transport services lack parity at the negotiating table with airlines.  Nevertheless, this is the case; corporations are constantly surprised, disrupted and frustrated by their airline suppliers—especially at Fortress Hubs. 

Large corporations can pay ten times airlines’ costs per available seat mile for a ticket.  For this privilege, corporations are offered contracts wherein discounts are relatively marginal, market share goals are high and prices are pegged to a floating “Y” fare—which airlines can raise at will during the term of a contract. 

Furthermore, the fact that corporations that spend hundreds of millions of dollars per year on air transport services formed the Business Travel Coalition to advocate their concerns is tacit evidence of a serious problem.  Likewise, Detroit automakers recently were forced to take the extraordinary step of intervening in the supply-side of the market to create strategic alternatives with start-up ProAir.  Some markets for business travel services are not working well; some are apparently not working at all.

LACK OF COMPETITIVE ALTERNATIVES

Customary business practices found in other industries are anathema to most major airlines.  For example, corporations are denied benefits typically provided to customers in return for their volume purchasing commitments including prices guaranteed for the term of contracts, simplified pricing structures and choices regarding product features such as frequent flyer programs.  Moreover, the surcharge shows that corporations are subject to sudden and arbitrary pricing policy changes.

This win-lose relationship between airlines and their best customers stands in vivid contrast to the mutually beneficial relationships corporations enjoy with their other suppliers of services from other industries.  A necessary condition for productive relationships with any supplier is adequate buyer choices.  I want to stress emphatically, if Fortune 100 corporations are disadvantaged at the negotiating table with airlines, the other nine million U.S. businesses without large purchasing volumes or procurement expertise are in real trouble.

Delta Air Lines’ surcharge policy is merely symptomatic of systemic competition problems in domestic U.S. air transport.   Consider the following observations.

1.        Corporations control travel costs and fulfill market share obligations through centralized policy, which includes a designated travel agency for ticketing.  As such, most corporations will have little choice but to pay the surcharge--if they intend to achieve market share goals.  Moreover, Delta provided no mechanism for corporations to secure booking data from its Internet site to verify market share fulfillment obligations.

2.        Even though the surcharge will cost individual corporations from tens of thousands to millions of dollars—including additional federal taxes and interest expense, most corporations learned of this action from press reports, versus from Delta.  So complacent have some major airlines become, corporate travel executives had to inform their Delta sales representatives of the new policy.

3.        The Internet can be an efficient alternative distribution channel for airlines.  However, corporations, and indeed individual consumers, are at great risk if the travel agency distribution channel is disintermediated—which appears to many expert observers to be an objective of some airlines.  Travel agencies, a.k.a. travel management companies, provide travel choices, technology expertise and resources necessary for corporations of all sizes to manage their travel programs. 

4.        The surcharge is representative of some major airlines’ disregard in recent years for their best customers.  Corporate travel executives view Delta’s action as a misuse of market power and a harbinger of more pernicious future policies as airlines continue to frustrate new entrant competitors and seek to further consolidate the industry.

5.        Some major airlines have exercised market power in new and contemptible ways to protect monopoly-like positions from new entrant competitors.  According to press reports during 1998, major airlines doled out new routes to influential lawmakers’ districts, upgraded service to jets from turboprops, and reportedly, in some cases intimated a downgrade to turboprops from jets.  This is in addition to spending millions of dollars on political campaign contributions and PR attacks to derail proposed DOT competition guidelines.

LEGACY AT RISK

Deregulation has produced many consumer benefits.  Many more millions of Americans are flying today than in 1978.  Average fares, adjusted for inflation have fallen 36%.  (Note: Fares would have likely continued their downward trend even without deregulation.)

Nevertheless, as we enter the third decade of deregulation, in the absence of functional competition, business travelers are routinely discriminated against.  The Delta Air Lines’ surcharge is just the latest action which demonstrates that even the largest purchasers are held hostage to airlines’ policies.  Part of the problem has been that the business traveler has not been of paramount concern for Washington.

Until recently, federal policy makers rarely considered the business traveler as the “consumer” that deregulation was intended to benefit.  Moreover, conventional economic theory suggests that discrimination against one class of customers--e.g., business travelers--can have offsetting benefits such as capacity increases and lower prices for another class—e.g., leisure travelers.

To be sure, leisure travelers have more choices and better prices over various hubs than do business travelers.  However, according to U.S. GAO and DOT studies, the recent near-collapse of the low-fare segment of the industry has left demand for air travel from millions of consumers unmet.  Nearly 50% of the top 1,000 city-pair markets do not benefit from low-fare competition.  So, while the business traveler is discriminated against, society is not receiving the offsetting benefits.

DOT POLICY CONCERNS

Critics of a DOT competition policy reject its efficacy because of the potential for unintended consequences.  However, this is a hollow argument.  There were many unanticipated industry developments that the supporters of deregulation never foresaw including:

Fortress hub and spoke networks.

High levels of industry concentration; low levels of new entrants.

High-density airports effectively off limits to new entrants.

The theory of contestibility rendered all but meaningless.

Highly successful strategies of predation.

Virtual airline mergers and code sharing.

Communities at severe competitive disadvantage due to excessively high business airfares.

The consequences of DOT inaction, in the face of exclusionary practices, will exact a greater cost on air transportation system customers.

CONCLUSION

Mr. Chairman and Members of the Committee, government intervention in the marketplace is anathema to the business philosophies of the corporations BTC represents.  We are indeed convinced that the marketplace, if allowed to work, can solve each of the problems outlined in this Statement, and in my presentation to you today.

However, to protect consumer gains to date from deregulation, and to induce additional latent benefits, government policy must emphasize increasing the freedom of market entry and ensuring the existence of a level competitive playing field for new entrants. 

We view DOT competition guidelines, which will deter the most extreme competitive responses to new entrants, as the least intrusive first step that government can take to unshackle market forces.  Leisure travelers, businesspersons and entire communities can all share in the benefits of a fully deregulated airline industry if competition is allowed to flourish.

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Committee Members

  1. Elizabeth E. Bailey, Professor of Public Policy, Wharton School of Business, University of Pennsylvania, Philadelphia, PA
  2. Jonathan B. Baker, Assoc. Professor of Law, American University, Washington, DC
  3. Roden A. Brandt, R.A. Brandt and Associates, University City, MO
  4. Darius W. Gaskins, Jr., Partner, High Street Associates, Inc., Ipswich, MA
  5. Jose A. Gomez-Ibanez, Professor of Public Policy, JFK School of Government, Harvard University, Cambridge, MA
  6. Cornish F. Hitchcock, Attorney at Law, Washington, D.C.
  7. Alfred E. Kahn, Robert Julius Thorne Professor of Political Economy, Emeritus, Cornell University
  8. Randall Malin, Independent Transportation Consultant, Los Gatos, CA
  9. John R. Meyer, Professor Emeritus, Harvard University
  10. Steven A. Morrison, Professor of Economics, Northeastern University, Boston MA
  11. Sherwin Rosen, Bergman Distinguished Professor of Economics, Department of Economics, University of Chicago, Chicago, IL

Tom Menzies, Committee Executive Director