The past six months can be summed up thusly: fuel prices have gone up while consumer satisfaction has gone down. For the first time in the twenty-one years of airline deregulation, the quality of airline service has become a dominant issue. This Report focuses on some of these service-related issues, in addition to summarizing developments in other areas,

Are Your Legs Getting Longer?

For those of us who can recall airline service before the mid-1980’s, it may seem that our legs have been growing. There was a time, back in the "prequel" to deregulation as George Lucas would put it, that there was legroom on a commercial flight. The not-so-subtle loss of that space over the years is one of the untold stories of deregulation.

In the days of regulation, jet aircraft had first class and coach sections, uniform, non-discriminatory fares and even food. They also had legroom. The typical "pitch" in the coach section was 36 inches, that is 36 inches from a fixed point on your seat to the same point on the seat in front of you. These configurations were so accepted that when the Civil Aeronautics Board went about the business of dictating seating standards in the early 1970’s, one of the many regulatory excesses that led to deregulation, it found that (i) a 36 inch average pitch should be the standard for coach and (ii) if the average pitch went below 34 inches, the passenger should be charged a lower fare for "economy" service.

Deregulation got the federal government out of the business of interior design and left seating configurations up to the marketplace – which for the most part has meant the airlines and manufacturers. And then our legs began to grow. The standard coach seat pitch today is 31 to 32 inches. The difference of four to five inches is significant. For the airlines and manufacturers, it means substantially increasing the revenue generating ability of an aircraft at a nominal cost. The space lost to passengers becomes, in effect, incremental revenue for the airlines.

For passengers, however, it means discomfort. Think what four to five more inches of legroom would mean to you on your next trip in coach. Air transportation largely has met the deregulation goal of becoming mass transportation. However, in the process, airlines have taken on some of the characteristics of mass transport, e.g., the typical subway seat pitch is 30 to 31 inches. And this has not been limited to the back of the aircraft. Up front, there has been a largely uncommented upon redesignation of service type. Domestic first class service on newer aircraft typically has a 36 to 38 inch seat pitch, although it has remained in the two-abreast configuration. In other words, domestic first class today more or less replicates the "old" coach service. In international markets, domestic first class becomes business class, and it is only international first class that bears any resemblance to the "old" first class. There you have it: new coach is old economy; new domestic first and international business is old coach; and only international first really is "first class."

Adding to the confusion, at least one airline, United, has announced that it is going to reconfigure a portion of its coach sections to a 36 inch pitch. However, these seats will be reserved for passengers who purchase a full fare coach ticket and certain premium frequent flyers. That leads to the possibility of four separate seating configurations on some aircraft.

Consumers have options. There have been several efforts at starting up domestic airlines featuring more legroom at lower fares. For the most part, those efforts were unsuccessful. In a handful of markets, and in particular the Northeast corridor, consumers have a rail option. The success of Amtrak’s Metroliner in the Washington-New York-Boston corridor can be explained by a 46 inch seat pitch as much as by lower fares and door-to-door time roughly comparable to that of airline service. Nonetheless, consumers appear willing to trade off comfort for price and brand loyalty benefits.

This is how deregulation was meant to work. The marketplace has spoken, and tens of millions of people have had air transportation made available to them. Perhaps that thought and three aspirin will help stop your knees from throbbing the next time you fly in the back of the aircraft.

Flight Delays

Flights also have been growing longer. For the first eight months of 1999, U.S. domestic flight delays, i.e., flights arriving more than fifteen minutes after their scheduled arrival time, increased by 19% over the same period the prior year. Since 1997, delays have increased by an astonishing 81%. On average, three out of ten domestic flights are delayed, and that number is understated since airlines often build the delays into their schedules rather than have a flight consistently reported as "late." The problem for consumers is obvious, but it also is a real problem for the airlines. The Air Transport Association estimates that delays this year will cost the industry in excess of $4 billion in additional direct costs.

At the heart of the delay problem is inadequate capacity in the air traffic control system. That system needs to be modernized, not simply expanded. While the direction it must take is clear, progress is hampered by traditional aviation infrastructure funding issues. The latest developments in that regard are discussed in a later section of this Report.

Passenger Bills of Rights

After several well publicized incidents last winter involving delayed flights, a number of bills were introduced in the Congress that would create "bills of rights" for airline passengers. The gist of the Congressional proposals was consistent – require airlines to give passengers both advance and current notice of all unpleasant situations.

In June, the Air Transport Association announced that the major U.S. airlines, working with Congressional leaders and the DOT, had developed a "Customer First" plan that would be implemented by the end of the year. Under the plan, each airline will develop individual customer service plans covering at least the following measures: inform passengers of the lowest available fares; advise passengers of known delays, cancellations and diversions; address customer complaints within 60-days; provide essential services to passengers kept on board grounded aircraft; and disclose all policies with respect to cancellation, frequent flyer programs and seat pitch.

It is obvious that these are minimum standards. Indeed, many already were in place, and several airlines have announced that they will exceed these standards. More significant is the fact that the DOT has made it known that it will view an airline’s failure to abide by its program as either or both a tariff violation and an unfair or deceptive practice.

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Competition Issues

One of the most interesting developments in the last six months has been a shift of the center of gravity on airline competition issues from the DOT to the Department of Justice.

1. United States v. AMR Corporation, CA No. 99-1180-JTM (D.Kan.). On May 13, the Justice Department filed a section 2 complaint against American Airlines and its related companies charging American with attempting to monopolize airline passenger service in certain markets to/from Dallas/Ft. Worth. Specifically, the complaint alleges that American developed and implemented a "low cost carrier strategy." This strategy entailed lowering fares and increasing service in markets where it faced new low cost competition from Vanguard Airlines, Sun Jet and Western Pacific, with the intent of driving those airlines out of those markets and then returning the fares and service to their prior levels.

The fare and service histories of these markets are matters of public record. The unique part of the complaint is the manner in which the Justice Department attempts to address the average variable cost threshold for actionable predatory pricing. The pertinent paragraph of the complaint is set forth below:

In order to increase capacity in response to low cost carriers, American had to allocate additional resources to the low cost carrier routes, thereby increasing its cost of serving the routes. The cost of those resources includes operating and ownership costs of the additional aircraft allocated to the low cost carrier route, and labor, fuel, food, sales, and other costs that would not have been incurred on the route absent the capacity increases. The cost to American of its capacity increases in low cost carrier markets includes all such costs.

Id., Complaint ¶ 49. In other words, the Justice Department argues that when an incumbent adds capacity in a competitive response to new entry, the fully allocated costs of that additional capacity should be included in its average variable costs for purposes of a predatory pricing analysis.

In a speech delivered on July 20, the Deputy Assistant Attorney General for the Antitrust Division expanded on the theories expressed in the complaint. In the Justice Department’s view, the contestable market theory that supported deregulation became a victim of major airline hub dominance. That dominance makes a predatory recoupment scenario in the airline industry, unlike other industries, quick and plausible. In some instances, "a reputation for predation can itself be a barrier to entry."

The Justice Department complaint has rekindled a national debate over pricing practices in the airline industry. In an Op/Ed exchange between Judge Robert Bork, one of the fathers of the average variable cost pricing threshold standard, and Alfred Kahn, one of the fathers of airline deregulation (and author of the phrase "airplanes are marginal costs with wings"), Judge Bork described the "ownership cost" theory as "a figment of antitrust imagination." Professor Kahn responded that the airline industry is "unique" and that while the pricing practices of major airlines "are, on balance, clearly beneficial to travelers . . . no purpose is served by simplistic dismissals of the threat of predatory responses to price-cutting entry."

The final defense in American’s answer, filed on July 13, fairly summarizes the underlying aviation policy issue: "The relief sought is tantamount to reregulation of the airline industry, which is contrary to Congressional intent as expressed in the Airline deregulation Act of 1978." But the complaint also raises a fundamental issue of national antitrust policy – when is competition bad for competition?

2. DOT Competition Policy. The DOT initially intended to finalize its Competition Policy in September 1999, subject to a required three-month Congressional review process before it became effective. It now appears that the prospect of this policy being finalized in the immediate future is slight.

Congress requested the National Research Council’s Transportation Research Bureau to review the proposed policy. In a report released in September, the TRB concluded that while the DOT "should ensure that airlines are not exploiting their advantageous relationships with airports, air traffic control access, CRSs, and travel agents to hinder competition and to limit entry opportunities . . . the committee harbors reservations . . about the DOT’s proposal for identifying and forbidding predation in the airline industry." The TRB committee favored traditional antitrust enforcement, i.e., action by the Justice Department, over "prescriptive regulation" by the DOT.

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International

1. The American/British Airways Joint Venture. Open skies negotiations between the U.S. and the U.K. broke down once again this past summer. At the same time, American and British Airways made it clear that they were satisfied with their existing code-share relationship and did not require antitrust immunity. Accordingly, on July 30 the DOT dismissed the joint application for immunity, an application that had been pending for thirty months. DOT Order 99-7-22 (July 30, 1999).

2. Code-Share Exclusivity. Despite previously expressed reservations about exclusivity provisions in code-share relationships, the DOT reconsidered and reversed prior actions disapproving such provisions. DOT Order 99-8-14 (August 18, 1999).

3. World Trade Organization. The World Trade Organization, the administrator of the General Agreement on Trade and Tariffs, has become an increasingly important forum for the aviation industry. In April, the WTO took two actions with respect to government subsidization of aviation manufacturers, a practice ostensibly prohibited by the GATT. In the first action, a WTO panel found that certain financing assistance provided by the Canadian government to purchasers of Bombardier regional jet aircraft violated the GATT. In the second, companion action, a WTO panel put a substantially heavier shoe on the other foot with a finding that much of the assistance provided by the Brazilian government to purchasers of Embraer’s regional jet aircraft also violated the GATT. Both actions have been appealed.

In May, the U.S. filed a complaint with the WTO challenging a loan in the amount of 140 million francs made by the French government to a company manufacturing a flight management system for Airbus aircraft. The loan had been approved by the European Commission. The complaint alleged that the loan was made on preferential and non-commercial terms.

These actions may be a precursor to the day when air transportation services, themselves, may be subject to the GATT. The next round of GATT negotiations – GATTS 2000 – will take a hard look at the air transport sector, a service sector specifically excluded from the Uruguay Round. The initial exclusion was rationalized on the grounds that liberal bilateral air transport agreements secured more open rights than would the GATT. That condition no longer exists, and some argue that the GATTS would simply be the most convenient multilateral basis for a worldwide open skies agreement.

It is probable that U.S. interests still will oppose putting air traffic rights within the GATT. It is possible that subsidiary rights, e.g., intermodal operations, could get their noses under the GATT tent.

4. EU Hushkit Controversy. The controversy over an EU proposal to ban so-called "hushkitted" aircraft that otherwise are noise compliant has been put on hold until next year, pending further discussions between the EU and the U.S. The DOT has deferred action on Northwest’s complaint until February 1, 2000. DOT Order 99-5-7 (May 18, 1999).

5. Warsaw Convention. On May 28, 1999, the U.S. and fifty-one other nations signed ad referendum the Montreal Convention, a treaty that amends, in certain major respects, the Warsaw Convention. If and when ratified, the Montreal Convention will eliminate passenger liability limits for death or injury in international aviation accidents, raise the strict liability limit (i.e., waiver of the carrier’s defense of proof of non-negligence) to $135,000 with annual inflation adjustments and increase the uninsured baggage liability limitation to $1,350 per passenger (again with annual inflation adjustments). While the Montreal Convention will be of considerable precedential importance, particularly abroad, its practical effect within the U.S. will be minimal, as one might suspect from a treaty that has been endorsed both by the trial lawyers and the airlines.

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Retail Distribution

A July report by the GAO found that U.S. airlines had saved as much as $4.3 billion in commissions since 1995 by (i) reducing the level of commissions and (ii) by by-passing travel agencies, primarily through the internet. Internet sales are increasing rapidly, through the airlines’ own sites and through internet-based travel agencies.

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Infrastructure Funding

This is the debate that never will end. Before the summer recess, the House passed the Aviation Investment and Reform Act for the 21^st Century (AIR 21). AIR 21 would take the aviation trust fund, with its considerable surplus, out of the budget process and make those monies available for expansion and modernization of the aviation infrastructure. The effect would be dramatic. The monies devoted to capital equipment for air traffic control, for example, would increase from $2 billion to $3 billion per year. This would be accomplished without any increase in excise taxes and without the imposition of tax-equivalent user fees. However, AIR 21 also would allow airports to increase the passenger facility charge from $2 to $6 per passenger, a proposal opposed by the airline industry.

On the Senate side, many key Senators oppose taking trust funds out of the budget process. The issue is further complicated by the desire of certain Senators to increase access to Washington National and other slot-controlled airports.

It is probable that a compromise will be hammered out in conference. It also is probable that the end result will be the same as prior years – "just enough" funding and the promise of the trust fund remaining just that, and not a reality.

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Will members of the Aviation Committee be flying on New Year’s Eve? Probably not, but more out of personal preference than any concern about safety. There may be problems, particularly abroad, but those problems will have more impact on the ability of the system to handle the traffic than on safety. In other words, the impact of Y2K on air transportation may resemble that of serious, but localized, weather conditions.

The Aviation Millennium Project, a joint undertaking of U.S. and Canadian airlines, airports and manufacturers, estimates that as of July 1, 95% of their Y2K remediation efforts had been completed. U.S. airlines, alone, will have spent approximately $750 million on remediation before the end of the year. The FAA also projects that its remediation efforts will be completed on a timely basis, and preliminary systems tests to date have been successful.

A recent report by the International Civil Aviation Organization, however, indicates that there may some problems outside the major nations. Only 61% of ICAO states (accounting for 70% of international air traffic) report that their Air Traffic Systems currently are Y2K ready. Only 47% of the 1,320 international airports of member states reported on their Y2K readiness, although this included the top twenty-five airports that account for 84% of international aircraft operations.

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Miscellaneous

1. Criminal Charges Arising From the Valujet Accident. There has been considerable regulatory fallout from the Valujet accident in 1996. It is probable, however, that the accident was the result not of negligence on the part of Valujet but rather negligence on the part of SabreTech, an FAA-licensed repair facility in Miami. The facts suggest that oxygen generators improperly labeled by SabreTech and loaded on the aircraft created the fire that caused the crash.

On July 12, a Florida state grand jury indicted SabreTech on 110 counts of third-degree murder and 110 counts of manslaughter. Hours later, a federal grand jury indicted SabreTech, a company officer and two company mechanics on charges of conspiracy and falsifying documents.

This is the first time that criminal charges have been brought in the U.S. against a company for actions related to an aviation accident. Apart from the difficult question of when does negligence cross over into criminal behavior, the indictments raise issues about the continued efficacy of a safety regulatory scheme that relies, in substantial part, on voluntary disclosures by the participants.

2. Kiwi International. Kiwi was a small airline headquartered in Newark, New Jersey. Started in 1992, Kiwi filed for Chapter 11 bankruptcy protection in 1996 and managed to stay in business through the end of 1998, barely. Earlier this year, Kiwi found itself in dire straits. The failure of a small airline is hardly news, but the manner in which Kiwi’s authority came to an end was unusual.

Late in 1998, the DOT began making inquiries into Kiwi’s ability to continue operations. Of primary concern to the DOT was the fact that Kiwi repeatedly had failed to remit passenger facility charges (PFC’s) to the operator of Newark International Airport. While PFC’s are imposed by the airport with the approval of the FAA, they are collected by the airlines as part of the all-in ticket price. The airline holds PFC’s in a trust account much as an employer does with withholding taxes.

On March 23, the DOT issued an order to show cause as to why Kiwi’s economic authority should not be terminated. DOT Order 99-3-18 (March 23, 1999). The practical effect of this order was to shut down the company permanently. The DOT found that Kiwi was not financially fit to continue and, further, that Kiwi "does not have a management team with the necessary background and experience to continue to conduct its operations safely and reliably without placing an unduly burdensome oversight responsibility on the Department and the FAA." Id., at 8. The DOT’s concern for the burden on the FAA was unusual, particularly since the FAA may, and often does, suspend an airline’s operating authority on essentially the same grounds.

3. Alaska Professional Hunters Association v. FAA, 177 F.3d 1030 (D.C. Cir. 1999). Alaska hunting and fishing guides regularly fly their clients into the backcountry. Relying on a 1963 decision of the Civil Aeronautics Board, the FAA’s Alaska Region consistently treated such incidental operations as not involving "carriage for compensation or hire," a term that confers a more burdensome degree of regulation on aircraft operators. In 1998, the FAA suddenly announced that the guides would have to comply with the more burdensome requirements. The guides challenged the FAA on the grounds that this only could be accomplished through the notice and comment procedures of APA rulemaking.

On brief, the FAA took the position that it was "confident that the Alaska Region’s advice to guide pilots for more than 30 years stemmed from a misreading of the Marshall [CAB] decision and so could not have represented the view of the agency." The court was not impressed. Finding for the guides, the court held that the "FAA’s current doubts about the wisdom of the regulatory system followed in Alaska for more than thirty years does not justify disregarding the requisite procedures for changing that system."

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Footnotes:

1 Domestic Passenger Fare Investigation, 62 C.A.B. 613 (1973).

2 The Importance of Entry Conditions In Analyzing Airline Antitrust Issues, John M. Nannes, Deputy Assistant Attorney General, Antitrust Division, before the International Aviation Club, Washington, D.C. (July 20, 1999).

3 This Antitrust Theory Won’t Fly, The New York Times, editorial page May 17, 1999; American and Predatory Pricing, The Wall Street Journal, editorial page June 16, 1999.

4 World Trade Organization, WT/DS70/R (April 14, 1999) and WT/DS46/R (April 14, 1999).

5 World Trade Organization, WT/DS173/1 (May 31, 1999).

6 GAO/RCED-99-221, Domestic Aviation: Effects of Changes in How Airline Tickets Are Sold (July 1999).

7 ICAO is the U.N. organization representing the aeronautical interests of 186 nations.