'It's a free-for-all out there,' complains Robert Rowen, Reno Air's general counsel. 'We see major airlines tailoring their competitive response depending on who enters their market. If it's a long-term player with a strong balance sheet like Southwest, they react moderately compared to a Kiwi or Reno Air. Then they trash the market with low fares. The majors are engaged in blatant predatory activity, and the government is doing nothing about it.'
'You can't tell us to compete differently against a low cost operator than we do against Delta,' replies Anne McNamara, senior vice president and general counsel for American Airlines. 'They're both our competitors and our job is to compete against them. This is really a societal debate about the benefits of deregulation.'
Maybe so, but it is a debate inflamed by uncertainty over the meaning of predatory conduct. Some new entrants think any response to them by incumbents amounts to predation. Incumbents complain that they cannot give a competitive response to an upstart without someone accusing them of violating the antitrust laws.
In the past six months ValuJet, Frontier Airlines, and Reno Air have all complained to the US Justice Department that major US airlines are defending their fortress hubs by unfairly underpricing them. The big disparity in viewpoints largely stems from uncertainty over what constitutes predatory conduct by one airline against another. As Kenneth Quinn, Washington lawyer and chair of the American Bar Association's air and space law forum, notes: 'Drawing the line between tough competition that is beneficial to consumers, and predatory tactics that are harmful to competition, often is difficult.'
In the US anybody can sue anyone at anytime over anything. That includes private parties suing under US antitrust laws. Those laws may only apply to the US, but it only takes an allegation that your conduct outside the US affected competition within it to land you in a US court. Still, the US Department of Justice is Washington's main antitrust enforcement agency, and upstart airlines usually take their complaints there rather than file their own cases. Not only is this cheaper, but the DOJ is a formidable enforcer, and its views on antitrust issues are widely respected.
Roger Fones, chief of the transportation section within DOJ's antitrust division, wants airlines to understand where his agency draws the line between competitive and predatory conduct. The failure of an upstart following competitive responses from an incumbent does not in itself, he insists, prove the incumbent acted improperly. If the competition was fair, there is no foul. Fones hopes to avoid intervening where that might chill rather than promote competition, but he also warns that 'our antitrust division has a strong interest in assuring that new entry is not thwarted by anticompetitive behaviour by incumbent airlines.'
Fones stresses that in the DOJ's view fare discounting by an incumbent in response to an upstart is usually not a concern. 'This is the essence of the competitive process, and we are unlikely to pursue a predation complaint where the incumbent made few or no changes to its network operations post-entry, even if it cut fares significantly.'
While matters are rarely that simple, the starting point is that network changes plus fare cuts are the quickest way for an incumbent to get into trouble with the Justice Department. Some operational changes are less likely to raise suspicions than others. 'Expansion of capacity by an incumbent on a route it already serves might be a normal response if the new entrant forced prices down enough to stimulate demand,' explains Fones. He recalls cases where a 50 per cent drop in fares more than doubled traffic and says an incumbent airline is clearly justified in adding capacity to carry that extra traffic.
But that incumbent moves closer to the line when it schedules added flights to bracket the new entrant's flights or adds more capacity than traffic projections reasonably justify. An incumbent probably crosses the forbidden line when it decides to enter routes launched by the new entrant which it has not served before.The best known example of this was the Northwest Airlines' decision to revive its formerly abandoned Minneapolis-Reno service, and create a mini-hub in Reno overlaying much of Reno Air's network, after Reno Air decided to launch Reno-Minneapolis in 1993.
'Our starting presumption is that the incumbent's pre-entry schedules are efficiently operating its network,' warns Fones. Thus, an incumbent may find itself explaining to government investigators the bona fide competitive reasons for its changes in capacity, schedules, or routing when those reasons are not self-evident.
The Justice Department may focus more on an incumbent's network changes than on its price cuts, but it also examines price cuts to see if they are predatory, either alone or in combination with other actions. The basic test, according to Fones, is whether an incumbent's price strategy makes sense only if it is designed to drive the new entrant away. If that is its only apparent rationale, that pricing may be predatory. If the strategy is rational on other grounds, the prices are legal.
In applying this test, the key seems to be whether the incumbent can only justify money-losing fares by hopes of recouping those losses after driving off the new entrant. 'If there is no prospect for recoupment, then we can be confident that the incumbent's pricing strategy benefits consumers,' Fones says. But if the incumbent charges "irrationally" low prices in the short run, but can more than make up for them with higher prices in the long run, illegal predation may be occurring.'
Incumbent airlines should be aware that the Justice Department looks broadly at the prospect of recouping losses from short-term fare cuts.'We are mindful that the "demonstration effect" of predation on one city pair can protect or enhance an incumbent's profits on other city pairs it serves,' warns Fones.'Thus, it is not necessary that all recoupment occur in the market where the predation occurs.' For instance, if an incumbent's discounted fares on its Seattle-Reno route are likely to convince an upstart to abandon not only that route but Seattle-Denver as well, then the DOJ would consider whether the incumbent anticipated recouping its short-term losses from higher fares on both routes.
In judging the prospects of recoupment, the Justice Department considers how much flexibility the incumbent will enjoy to raise fares after the new entrant leaves. If the incumbent and another airline on that route were charging pre-entry fares high enough to allow the incumbent to recoup its losses within a reasonable time, the department will consider whether fares are likely to revert to that level after the upstart's exit. The more likely recoupment situation, however, will be where the incumbent enjoys a route monopoly after driving off a challenger. 'We have seen examples where short-term drops in profitability during a post-entry fare war are more than recovered within a few weeks or months following exit,' Fones recalls.
Only if there is a prospect of recoupment does the department proceed with an analysis of whether the incumbent's prices are below its costs. 'We look at the recoupment issue first, and proceed to a cost analysis only if the conduct in question satisfies the recoupment requirement,' says Fones.
The US Supreme Court has said a key characteristic of predatory pricing is that it is below 'an appropriate level of cost.' The court has not defined what that means, and it becomes a tricky question because costs can be measured in different ways.
The Justice Department focuses on what it calls 'avoidable' costs. These are costs an incumbent airline could have avoided had it not embarked on its questioned strategy.
This usually arises when an incumbent has both dropped fares and added flights in response to an upstart's arrival. At least the added flights are an avoidable cost. In the Seattle-Reno example the department could focus on all of the incumbent's costs in operating that route. It could also limit its review to the added flights.
The department will consider costs over the same length of time as the incumbent offers, or plans to offer, its discounted fares. If its fares strategy spans six months, Fones says the cost of gates and ticket counters should be included. Such costs become avoidable within a six-month period, says Fones, because an airline could discontinue a route and eliminate all those ground expenses within that much time. 'The longer an incumbent anticipated its low-pricing strategy would be necessary, the more the costs of maintaining that strategy become avoidable,' he explains.
The department ignores certain measures of costs. It will not, for instance, consider the marginal cost of filling one more seat which may only be the price of one more gallon of fuel and a bag of peanuts. But this raises the more general question of incremental versus aggregate costs. If the incumbent has added two more flights on a route it formerly served twice daily, should the department look only at the costs and revenue of the two new flights or at all four?
Fones wavers. 'While we are very cautious in drawing legal inferences from individual flights, it is also relevant that the money-losing flights were not operating in the market until after the upstart entered,' he says. The costs of the two new flights were avoidable, he claims, and by inference only their costs should be considered.
When an incumbent adds aircraft as part of its competitive response, the department considers the costs of leasing or owning those aircraft as avoidable because an airline could redeploy them elsewhere or simply not lease them. And what about the revenue an incumbent forgoes by putting aircraft on this route against a new entrant instead of flying somewhere else at a profit? Some courts have held that foregone profit is not a cost in this context, but Fones suggests his office would include such "opportunity costs" 'if there is a clear basis for doing so.'
However they are measured, if the DOJ determines that an airline's prices are below its avoidable costs, it will treat them as predatory.
While the US Justice Department is the public antitrust enforcer in these cases, it is not the only agency empowered to act.
The Department of Transportation also has jurisdiction under the Federal Aviation Act. This was the law DOT used to convince Northwest Airlines to back down in its 1993 face-off with Reno Air. The Federal Aviation Act authorises DOT to order an airline to cease and desist from anything the department concludes is 'unfair competition'. The law does not define that phrase. In the Northwest-Reno case, DOT's threat of a cease and desist order convinced Northwest to retreat voluntarily.
John Dasburg, Northwest Airlines president, has since argued that the Federal Aviation Act 'should be consistent with antitrust laws and no greater.' He and other major airline executives claim the relatively untested Federal Aviation Act is too broad and gives DOT too much discretion.
Nancy McFadden, DOT's general counsel, concedes her agency has broad authority under this law, but adds: 'We are mostly working with the Department of Justice and have not decided whether to use our statute as a separate means of enforcement.' She rebuffs requests that DOT specify by rule what constitutes 'unfair competition.' In short, the Transportation Department is willing for now to defer to the Justice Department's antitrust division, but DOT still holds its own broad statute in reserve, and refuses to adopt rules defining its scope.
The Justice Department has investigated a number of predatory conduct claims against incumbent airlines over the years, but has never filed suit over one. During such investigations the department often demands confidential information from the target airline about its costs, pricing and practices, and that seems either to satisfy the investigators or convince the incumbent to modify its behaviour. However, in those cases it is hard for outsiders to assess who won.
The DOJ says it is now investigating one airline predation complaint but will not confirm that this is the Frontier case versus United Airlines at Denver. Investigations into complaints by Reno Air and ValuJet have apparently been suspended or closed. In the meantime, Reno Air has filed its own antitrust lawsuit against Northwest to recover damages for its conduct in 1993.
A common complaint among major US airlines is that predatory conduct complaints could lead to backdoor re-regulation of fares and frequencies. United Airlines says: 'The measures that low cost carriers seek - regulated price supports, schedule restrictions, capacity controls - are the same protectionist practices the US is aggressively seeking to abolish internationally.'
But Justice Department officials see no tension between antitrust enforcement and deregulation. 'The success of deregulation doesn't preclude an antitrust investigation,' says one. 'The point of an investigation is to assure that competitors don't impose restrictions that would restrain competition.' Robert Kuttner, author of 'Everything For Sale: The Virtues and Limits of Markets,' agrees: 'The alternative would not be a free market but a series of private cartels.'
'No one is arguing for re-regulation,' says Reno Air's Robert Rowen. 'But one assumption of airline deregulation was the contestability of markets. In fact the barriers to entry are very high. You must enter a market with scheduled service and a commitment of millions. And yet the predatory response of a major incumbent can threaten the viability of a smaller airline. Without protection against such conduct, deregulation can't work.'
Source: Airline Business
