Airline Predatory Pricing

How the Airlines Kill Their Competitors, Screw Their Customers, and Get Away With It

Leah Platt
The American Prospect

The biggest anti-trust suit since the Microsoft case is set to open in a federal court next month. The particular complaint is against American Airlines. Three of its smaller competitors -- Vanguard, Sun Jet and Western Pacific -- are accusing the huge airline of conducting a ruthless campaign to oust them from the Dallas-Fort Worth airport. But the entire airline industry might as well be on trial.

Since Congress deregulated the industry in the late 1970s, the promise of lower prices and smoother service -- which has only intermittently been fulfilled -- owes more to the effort of scrappy low-cost carriers like Southwest than to competition between the major airlines, whose hub-and-spoke networks hardly overlap. The Big Six -- United, US Airways, American, Northwest, Continental and Delta -- have divided the country into local fiefdoms centered around "fortress" hubs. United, for instance, flies more than half of the passengers leaving from San Francisco, Denver, and Chicago O'Hare, but only 6 percent from Philadelphia (which is dominated by US Airways) and 2 percent from St. Louis (TWA's headquarters). If approved by the Justice Department, a proposed merger between United and US Airways and a post-bankruptcy deal, in which American will acquire the assets of ailing TWA, will further consolidate the industry. When the dust clears, the two largest airlines -- United and American -- may control half of the domestic market.

Mergers aside, the established airlines are already able to shuttle travelers from one coast to the other in their self-contained networks without ever landing in rival turf, leaving travelers no choice but to pay monopoly prices -- and put up with monopoly service. That is, unless a regional airline steps in. When Frontier Airlines set up shop in Denver in the mid-90s, prices on some United flights from its Denver hub plunged. In a letter to The Denver Post, a disgruntled businessman complained that a flight to Boston cost him $1,667, while a round trip to Minneapolis cost $146. Why? Because Frontier had recently entered the Denver-Minneapolis market. JayEtta Hecker, the director of physical infrastructure issues at the General Accounting Office, confirms that fares at airports monopolized by one major carrier are 41 percent higher than at airports that benefit from some form of low-cost competition.

Dallas-Forth Worth is the third largest airport in the United States, serving 55 million passengers each year. American Airlines, the airport's resident Goliath, flies 61 percent of these travelers, and, according to a complaint filed by the Department of Justice, uses its dominant position to deprive consumers of competition's benefits. "When small airlines try to compete against American," the brief continues, "American typically responds by increasing its capacity and reducing its fares well beyond what makes business sense, except as a means of driving the new entrant out of the market."

Consider the case of Vanguard Airlines, a small company based in Kansas, that started service from Kansas City to Dallas in January, 1995. By April, American had flooded the market with near-hourly service -- upping eight daily round-trips to 14 -- and matched Vanguard's one-way fare of $80. After a year and a half of war -- in which American used similar tactics against Vanguard on flights from Dallas to Wichita, Cincinnati and Phoenix -- the smaller airline finally pulled out of American's Dallas-Fort Worth hub altogether. American quickly cancelled the extra (and unprofitable) flights and raised the routes' fares by 50 to 80 percent. After Vanguard fled Dallas-Fort Worth, American execs bragged that the Kansas City route went from being one of the airline's "worst performers" to the "best in the West."

But American is hardly alone in pursuing what Paul Dempsey, director of the Transportation Law Program at the University of Denver (and Vice Chairman of Frontier Airlines), describes as the airline industry's "homicidal mission to destroy the low-fare airlines." The only difference is that American got caught. According to Mark Cooper, the president of the Consumer Federation of America, "any of the Big Six airlines could have been sued, but it was the American case that had the smoking gun. In economic crimes, there are no bodies or murder weapons. The real evidence is in the corporate documents."

In this case, the evidence, a number of internal memos all but admitting to American's deliberate campaign of economic sabotage, doesn't point to murder, but to the antitrust equivalent -- predatory pricing. After a 1996 meeting called to deal with the threat of low-cost carriers, American executives concluded, in writing, "the short term cost, or impact on revenue [of the aggressive pricing strategy] can be viewed as the investment necessary to achieve the desired effect on market share." Or, in other words, the airline can suck up the costs of adding flights and lowering fares in the short term in the hopes of driving smaller carriers out of the market.

The problem is widespread. A report released this year by the Department of Transportation documents case after case of established airlines jealously guarding their home airports by undercutting prices offered by small start-up carriers, adding extra flights to challenged routes, and using their economic muscle to convince local business and travel agents to sign exclusive contracts. Chastened and frequently broke, the smaller airline is often forced to withdraw from the market, or even declare bankruptcy, leaving the incumbent free to raise its prices and cancel the added service.

The case against American, filed in May of 1999, may finally see its day in court next month. However, the Clinton Administration filed the suit, and it is up to the Bush Administration to see it through. The charges are at odds with the philosophy of the Bush team, which Cooper describes as "hard-edged trickle down economics." Timothy Muris, the new chairman of the Federal Trade Commission, has publicly criticized the government's case against American, blaming such investigations for having "a chilling effect on the winners in our competitive marketplace." And Attorney General John Ashcroft, who ultimately has discretion over whether the case will be pursued or settled out of court, is a relative "wildcard on enforcement of the antitrust laws," says Dempsey.

Calling the Bush Justice Department a wildcard may be optimistic, however. While it's unlikely that the Department will drop the case entirely, it can easily settle out of court for nothing more than a slap on the wrist. Given the record of Bush's choice for the head of the Justice Department's antitrust division, and the avalanche of campaign contributions from the airline industry, that might just happen. Charles A. James, Bush's pick for the antitrust division, is a pro-corporate lawyer who thinks government should be much more restrained in its antitrust policing. What's more, he represented an executive involved in the proposed United-US Airways merger.

And the airlines -- particularly American -- have been working hard to ensure that they can operate without antitrust interference. In the 2000 election, the industry contributed almost $7 million to federal candidates and parties -- more than two thirds of which went to Republicans, according to the Center for Responsive Politics. American Airlines itself contributed $1.5 million -- 60 percent for Republicans. In fact, American gave $100,000 to George W. Bush's inaugural committee alone. President Bush has already made it clear which side he's on by halting a threatened Northwest Airlines strike in early February.

And when it comes to predatory pricing -- which is always difficult to prove in court -- the Bush team will have plenty of leeway. The Supreme Court has established three criteria for proving an instance of predatory pricing: (1) Prices must be below an appropriate measure of cost, (2) these artificially low prices must be capable of driving rivals from the market, and (3) the perpetrator must have a reasonable prospect of using its monopoly power to recoup its short-term losses. But the government hasn't had the opportunity to apply the standards to the idiosyncratic airline industry. Since deregulation went into effect in 1978, the courts have yet to hear a single predatory pricing case against an airline. Without an established precedent, it will be easy for the Justice Department to dispose of the case against American.

Take the first condition, that to be "predatory," prices must be below an appropriate measure of cost. In theory, the price charged for a seat should be compared to the cost of filling that extra seat. But, besides an extra package of peanuts, the cost of flying an additional passenger is practically nothing; regardless of the number of travelers on a flight, the pilot and flight attendants still must be paid and the aircraft requires the same amount of fuel. And even if accountants were to agree on an appropriate measure of cost, to which ticket price should it be compared? Business class or coach? Advanced or same day purchase? The very definition of predatory pricing is complicated. What about airlines that offer bonus frequent flier miles on a certain route to edge out a competitor?

Even if the mechanics of trying airlines for predatory practices are not fully worked out, the fact that the Justice Department asked American to answer for its business practices could put the other airlines on the alert. But with Bush appointees at the helm, it's very possible that American will be let off the hook, emboldening airlines to the detriment of hapless passengers. Prices for business travel have already skyrocketed in the past few years. If airlines are confident that the Justice Department is looking the other way, they won't hesitate to use their monopoly power to run smaller competitors out of business and raise ticket prices even further.