Report of the Aviation Committee

Developments in the aviation industry over the last six months have, for the most part, been extensions of prior themes. Congressional and regulatory concern about the alleged predatory practices of larger airlines vis-à-vis their smaller competitors has been building, the U.S. and Japan at last reached a new (but not final) bilateral accord and the debate over funding the vast aviation infrastructure is being spun out through a new budget cycle. The background music, of course, remains the proposed joint venture between American and British Airways, now past the two year point and still awaiting various regulatory approvals.

Meeting Competition From New Entrants, Again

There is no question that new entry into the domestic U.S. airline industry has dramatically slowed since the ValuJet accident in 1996. Stricter regulatory scrutiny of business and operational plans, coupled with more cautious capital markets, has slowed what had been a flow of new competitors down to a trickle.

At the same time, existing small, low fare airlines have been facing difficult times. Few of these companies are operating profitably. For those that are profitable, their margins are razor slim, particularly when compared to those of the major airlines who are enjoying record profits, in substantial part because of very low fuel prices.

The combination of these factors has led to increased Congressional concern about allegations that small, low fare airlines face a variety of predatory practices from the major airlines. That concern manifests itself in three areas: proposed legislation, possible action by the DOT and heightened scrutiny by the Justice Department’s Antitrust Division.

1. Proposed legislation. At least three bills have been introduced in response to complaints by small, low cost airlines.¹ They share common threads: each would reform the process by which the FAA allocates slots at LaGuardia, Kennedy, Reagan National² and O’Hare Airports; and each would require the DOT to act on complaints about predatory practices within a specified period.

In 1994, Congress authorized the DOT to grant exemptions from the slot rules (14 C.F.R. Part 93, Subparts K and S) when a statutory "exceptional circumstances" test was met. 49 U.S.C. § 41714. Last December, the DOT granted exemptions allowing: an additional daily nonstop roundtrip ("flight") by Reno Air in the Reno – O’Hare market; four flights by TransStates between O’Hare and points in North Carolina and Tennessee; three flights by Frontier between Denver and LaGuardia; five additional flights by ValuJet (now AirTran) between Atlanta and LaGuardia; and two flights by AirTran between Knoxville and LaGuardia. DOT Orders 97-10-16 and 97-10-17 (1997). Whether this satisfies Congressional critics remains to be seen.

The push for a deadline on DOT action arises from the fact the DOT’s authority to address "unfair and deceptive practices and unfair methods of competition" presently is open-ended. 49 U.S.C. § 41712. Formal complaints invoking this provision have become increasingly rare as industry participants have realized that unless the DOT is required to act, it will not act. That may soon change, at least to a limited degree.

2. New DOT initiatives. By the time this Report is presented, the DOT should have issued proposed rules providing guidelines with respect to certain practices in the airline industry that it might view as "predatory." It is expected that there will be no bright lines or immediate action. On the other hand, the DOT is expected to address the two most nagging concerns of smaller airlines: the fare-matching practices of the majors; and "shadow scheduling" by the majors. These proposals are certain to be a major subject of debate within the industry.

3. New DOJ initiatives. The Antitrust Division long has been concerned about barriers to entry in the domestic airline industry. This recently resulted in a new round of civil investigative demands directed both at major and smaller airlines and focusing on several hub airports.

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Other Competition Issues

1. The American/British Airways joint venture. This began nearly two years ago with a request for antitrust immunity predicated on an "open skies" agreement between the U.S. and the U.K. The latter has not happened, in substantial part because U.S. and U.K. authorities have been unable to agree on the number of slots that the joint venture would have to give up at London’s Heathrow Airport. That, in turn, has become dependent on the position of the European Commission ("EC") not only on the slot issues raised by the proposed American/British Airways joint venture but also by the existing KLM/Northwest, United/Lufthansa and Delta/Swissair/Austrian joint ventures. The latter concerns arise primarily from slot constraints at Amsterdam and Frankfurt.

Some are predicting that the EC portion of this puzzle will be in place by the end of March. Even if that were to occur, it would take some considerable time to get the other pieces in place. As always, the question remains how long American and British Airways not only can be patient with the governmental authorities but with each other.

2. Computer Reservations Systems. The present regulation governing the computer reservations systems ("CRS’s") that airlines place in travel agencies, 14 C.F.R. Part 255, expired on December 31, 1997. The DOT has extended the rule indefinitely while it considers revisions. 62 Fed. Reg. 47606 (1997).

Renewal is not in doubt. However, the electronic network for the retail distribution of airline tickets has changed substantially in the last decade. The basic agency-located CRS offers many more capabilities, and the CRS’s, themselves, now largely are owned by airline consortia. The exception is SABRE, which remains a sister company of American. This means that issues centering on the charges these systems impose on airlines have less importance, while the relative level of services each CRS is required to provide become more important.

Additionally, the Internet is beginning to account for an increasingly larger proportion of ticket sales. Many airlines now offer online booking and ticketing. Independent online service providers ("OSP’s"), acting either directly or through travel agents, allow passengers to book travel from their office or home. These services largely are unregulated, e.g., there is no requirement for a fair display of all flight and fare options not biased toward one or more airlines. One of the issues facing the DOT is whether to extend Part 255 to online services and, if so, to what extent, e.g., would it be enough to simply require notice that a service does not comply with the Part 255 anti-display bias rules?

The significance of the OSP issue can be seen in a business review letter issued by the Justice Department on February 3. The letter indicates "no current intent to challenge" a new trade group, the Interactive Travel Services Association. The Justice Department’s position is unremarkable. What is remarkable is the membership of the Association, which includes Microsoft, American Express and America Online.

3. US Airways vs. British Airways. When British Airways agreed to form a joint venture with American, it left behind a code-share alliance with US Airways. US Airways brought suit against British Airways and American on antitrust and contract grounds. In US Airways Group, Inc. v. British Airways, 1997 U.S. Dist. LEXIS 20667 (S.D.N.Y. 1997), the court dismissed all but the contract claims against British Airways. In dismissing the antitrust claims, the court found that US Airway’s allegations that the actions of defendants had damaged its future ability to compete in the North Atlantic market did not state the requisite "antitrust injury." The fact that US Airways might be a potential competitor was not material since presently it was excluded from the U.S.-U.K. market by factors other than the conduct of defendants.

4. The Northwest-Republic merger revisited. When Republic was merged into Northwest in 1986, the DOT still had merger review authority. It approved the merger, although it did not grant antitrust immunity. The merger was collaterally attacked in an antitrust action, later dismissed on the grounds that DOT approval had decided the immediate issue. Fischer Bros. v. Northwest Airlines, Inc., 883 F.2d 594 (8^th Cir. 1989). Last year, a class of airline consumers in the Twin Cities brought another challenge against the merger, alleging that it had led to the creation of a "fortress hub." In Midwestern Manufacturing Co. v. Northwest Airlines, Inc., 1998 U.S. LEXIS 365 (D. Minn. 1998), the court dismissed the claims on the grounds that (i) the Fischer Bros. case collaterally estopped the challenge to the fact of the merger and (ii) plaintiffs’ section 7 allegation was based on the initial acquisition of stock, an act which did not by itself create a claim independent of the merger.

5. American’s "other" alliance. British Airways is not the only joint venturer on American’s horizon. On December 31, 1997, the DOT issued an order to show cause why it should not approve a joint venture between American and the TACA Group. DOT Order 97-12-35 (1997). The parties are not seeking antitrust immunity. The TACA Group consists of six Central American airlines, each from a nation that has entered into an open skies agreement with the U.S.: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama. Because of American’s powerful Latin American operation emanating from its Miami hub, there is substantial overlap between the services of American and those of the TACA Group.

Many U.S. airlines and communities opposed the joint venture. In recommending approval, the DOT noted American’s position as the dominant carrier in Central America. Nonetheless, it believed that the joint venture would not be anti-competitive if certain conditions were attached. These conditions would prohibit joint management, pricing and exclusivity, i.e., those mutual actions for which antitrust immunity would have been required in any event. The tenuous nature of the approval recommended by the DOT was underscored by the later comments of the Justice Department. Justice argued that few consumer benefits would be produced by the joint venture while it would raise genuine competitive concerns, primarily because of its horizontal nature. Justice distinguished this joint venture from others that had received immunity on the grounds that the others were largely end-to-end alliances.

A final ruling on this joint venture is complicated by other Latin American joint ventures on American’s plate, including one with Lan Chile.

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International Operating Rights

On January 30, the U.S. and Japan entered into a Memorandum of Consultations ("MOC") amending their 1952 bilateral air transport agreement. The MOC is not an open skies agreement. Instead, it is a long, complex document that produces an incremental increase in operating rights in the U.S.-Japan market – and ample room for confusion.

The basic bargain is this: The "incumbent" airlines – Northwest, United, Federal Express, Japan Air Lines ("JAL"), All Nippon Airways ("ANA") and Nippon Cargo Airlines – receive unlimited operating authority in the U.S.-Japan market and broad authority to operate beyond Japan to other points in Asia. The "MOU" airlines³ – American, Delta and Continental – plus one other U.S.-flag airline get to divide up operating authority for approximately thirteen new flights in the market. In the year 2000, approximately five additional flights become available and one additional U.S-flag airline can enter the market.

There will be a substantial amount of new service this year. United is adding a Chicago-Tokyo flight and a Chicago-Osaka flight. American (Chicago), Delta (Atlanta) and Continental (Newark) each will add a new Tokyo flight. ANA will start service to six new U.S. points. Federal Express will expand its service beyond Japan. But there are restraints on even this incremental growth.

There is a shortage of slots at Tokyo’s Narita Airport, a situation that will not be resolved until a new runway is completed in two, or more, years. This means that the new service planed for this year requires some ingenious slot transactions, to the point where the EC has filed a demarche with the Japanese Government protesting what it appears to be a bias against the slot requests of European airlines.

The MOC also allows a defined level of code-sharing. JAL has entered into a code-share agreement with American. ANA has entered into a similar agreement with United. This means that while there are more competitors, the existing competitors also are becoming stronger. It also offers a peak at what the market may look like if there is an open skies agreement some day and the code-shares are turned into full-scale joint ventures.

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Miscellaneous

1. Asiana Airlines v. FAA. Each nation is responsible not only for air traffic control of its own air space but also for a designated portion of contiguous international air space. In 1996, Congress authorized the FAA to impose user fees for these services "directly related to the Administration’s costs in providing the services rendered." Consultants for the FAA devised a fee formula that took the total costs of providing these services and allocated them based on Ramsey pricing theory, a polite way of saying "charge what the market will bear." Scheduled international airlines bore the heaviest burden under this formula. The D.C. Circuit overturned the fees on the grounds that the FAA had used value, rather than costs, as the ultimate basis for determination. Asian Airlines, Ltd. v. Federal Aviation Administration, 1998 U.S. App. LEXIS 1286 (D.C. Cir. 1998).

2. O&D traffic data. The next time you buy an airline ticket, look at the serial number. If it ends in "0", that ticket will be processed in the DOT’s Airline Passenger Origin and Destination ("O&D") Survey. This ten percent sampling provides the basis for all of the traffic information relied upon by the DOT and also by much of the industry from time immemorial.

The DOT’s Office of Inspector General ("OIG") has concluded that the emperor is, indeed, not wearing any clothes. In an audit report issued on February 24, the OIG stated that in 69% of the nearly 9,000 city-pairs reviewed, the margin of error was greater, often far greater, than the 5% figure generally used for statistical reliability. The OIG opined that this was the result of increased code-sharing and expanded international gateways, i.e., the DOT was becoming as confused as passengers. The OIG suggested that the DOT attempt to shift the basis for the survey from ticket coupons to computerized CRS information.

3. LAX rate cases, on remand. The rates charged airlines at Los Angeles International Airport ("LAX") have been the subject of two rate cases before the DOT. Last year, the D.C. Circuit remanded both cases to the DOT on this issue: should the LAX rate base include imputed rental for the land computed on the fair market value, rather than acquisition value, of thousands of acres of "prime West Los Angeles real estate?" City of Los Angeles v. Department of Transportation, 103 F.3d 1027 (D.C. Cir. 1997).

The DOT answered this question in the negative. Pointing out that no opportunity costs were lost since the City had committed that LAX would only be used as an airport, DOT held that acquisition cost was the only reasonable method for assessing the value of airport land. The DOT also noted that LAX was the only (read "first") airport in the U.S. to claim that a fair market value assessment was reasonable. First and Second Los Angeles International Airport Rate Proceedings, DOT Order 97-12-31 (1997).

Footnotes:

1 S. 1331, 105^th Cong. (1997) (introduced by Senator McCain); H.R. 2748, 105^th Cong. (1997) (introduced by Representative Duncan); and H.R. 3160, 105^th Cong. (introduced by Representative Schumer).

2 On February 6, 1998, the former president’s 87^th birthday, Congress renamed Washington National Airport, this despite criticism that it had been named after a pretty good president in the first place.

3 "Incumbent" refers to the airlines (or their successors) initially authorized to serve the market in 1952. "MOU" refers to the airlines later authorized by memoranda of understanding. One of the more significant features of the MOC, internationally as well as domestically within Japan, is that it recognizes that ANA has been elevated to incumbent status alongside JAL.