Barriers to Entry – Limiting Competition

One of the biggest reasons for the failure of deregulation to meet its promise of widespread competition has been the existence of barriers to entry of new airlines. Some of the barriers to entry were identified by opponents to deregula­tion, but some were not anticipated. After some 20 years of actual experience in the deregulated environment, the Government Accounting Office and the Transportation Research Board released the results of studies on anticompetitive develop­ments in the air carrier industry. These reports classified barriers to entry for new airlines as “operational barriers” and “marketing barriers.” Operational barriers include takeoff and landing slots at high-density airports, access to boarding gates, access to ticket counters, the availability of ground handling and airport apron facilities, baggage handling and storage facilities, and perimeter rules. Marketing barriers include strategies designed to bind travelers to a particu­lar airline through frequent flyer programs and loyalty incentives, computer reservation systems, and code-sharing alliances.

Slots

Historically, arrivals and landings at U. S. airports have been on a “first-come, first-served” basis. In 1968, the increase in commercial air traffic at the nation’s busiest airports caused the FAA to institute limitations on arrivals and departures under a regi­men known as “High Density Rules”(HDR). This procedure capped the number of hourly arrivals and departures at five airports, Washington National (now Ronald Reagan National—DCA), O’Hare (ORD), and the three New York City area airports, Kennedy (JFK), LaGuardia (LGA), and Newark (EWR). This system of required reservations was implemented at that time by scheduling committees set up by the airlines themselves to allocate “slots” for arrival and departure operations. A “slot” is a reservation for an instrument flight takeoff or land­ing by an air carrier. A small number of slots were set aside for general aviation use.

During regulation, the slot system worked well since the number of air carriers, routes, and access to these airports were controlled by the CAB. With deregulation, however, new startup airlines appeared and established airlines sought out new markets for themselves, greatly increas­ing the demand for access to these airports. In 1985, DOT revised its rules and procedures to allow slots to be bought and sold by airlines.1 Slots became a limited commodity, subject to being traded like a commodity. Under the buy/ sell rule, DOT explicitly stated that slots were not carrier property and that DOT retains owner­ship of the slots, so that they can theoretically be withdrawn at any time, but DOT grandfathered all slot allocations to airlines holding them as of December 16, 1985. Under the buy/sell rule, slots have taken on the look of property rights and ownership that resides with the airlines. DOT retained about 5 percent of outstanding slots and, in early 1986, distributed these in a random lot­tery to airlines having few or no slots.

After 10 years, by the end of 1996, the Gen­eral Accounting Office (GAO)2 found that estab­lished (grandfathered) airlines had increased their total number of slots, while airlines that went into business after deregulation had lost slots. Slots held by startup airlines that went out of business were often acquired by lenders (banks and other financial institutions) since these slots had been pledged as collateral to the lenders. The lenders were then free to transfer ownership rights in the slots to the highest bidders, which were often the established airlines, although Southwest was able to gain access to LaGuar­dia by purchase of AT A slots out of bankruptcy court. Established airlines also acquired slots by absorbing startup airlines by merger or buyout.

By 1999, slots had become concentrated among incumbent carriers. The four largest carri­ers controlled 87 percent of all slots, and the larg­est six airlines controlled 98 percent of all slots.3 Because the number of slots is limited, slots have become very expensive, even if they can be bought at all. This unforeseen development is a disincentive to competition.

As an alternative to sale, established airlines have leased slots to startup airlines. This proce­dure is anticompetitive, as well, since the estab­lished airlines often lease slots in order to avoid the “use or lose” rule, also known as the 80/20 rule, imposed by the FAA. This rule requires the airline to use the slot at least 80 percent of the time or the slot will revert to the FAA. When the established airlines do lease slots, they typically do so only on a short-term basis, from 30 to 90 days. Entrant airlines find it difficult to justify startup costs of new service at an airport with no guarantees of the right to continue to use slots, which are its only means of access to the airport and its market.

In 1994, by the FAA Authorization Act,4 Congress authorized DOT to grant slot exemp­tions to new entrants where DOT found it to be in the public interest and based on “exceptional circumstances.” Slot exemptions, unlike regu­lar slots, could not be transferred. DOT inter­preted this authorization narrowly and granted very few exemptions until GAO issued its 1996 report to Congress on the anticompetitive effect of the DOT’s failure to grant slot exemptions. By 2000, DOT had amended its criteria such that, for example, slot exemptions at LaGuardia had been awarded to startup airlines Frontier, Spirit, Pro Air, AirTran, and American Trans Air. DOT also awarded 75 slot exemptions to startup JetBlue. Although major airlines con­tinued to oppose it, the revised DOT practice of awarding slot exemptions stimulated competition at these airports.

In April 2000, Congress passed the Wendell H. Ford Aviation Investment and Reform Act for the 21st Century (AIR-21). (See Figure 33-1.) AIR-21 mandated the phasing out of the slot rules at LaGuardia, JFK, and O’Hare. The effec­tive date for the elimination of all slot restrictions at O’Hare was July 1, 2002, and at the New York airports, January 1, 2007.

Upon expiration of slot controls at O’Hare in 2002, resulting congestion during peak hours caused serious delays at that airport. In consul­tation with affected airlines, the FAA issued an order limiting scheduled operations at ORD. This order is under periodic review, and the arrange­ment in place is not viewed as a long-range solu­tion to congestion nor a substitute for slots. The construction of a new runway (9L/27R) in 2008, however, provided significant relief to the prob­lem of congestion since there are now seven pri­mary runways. Pre-construction projections were that delays would be reduced by as much as 66 percent by this new runway.

This kind of renovation and reconfiguration is not an option at LGA (and possibly other HDR airports) due to physical land constraints. LGA is located eight miles from downtown Manhattan and bordered on three sides by water and by a multilane highway on the fourth side. It is, how­ever, central to flight operations in the United States. One study showed that on one particular day, “some 376 flights traveling to 73 airports experienced flight delays because their aircraft had passed through LaGuardia at least once that day.”5 It is clear that delays at LGA are propa­gated throughout the National Airspace System on a daily basis.

In October 2004, DOT and FAA contracted with NEXTOR6 a cooperative group of univer­sity departments named the “National Center of Excellence for Aviation Operations Research.” to carry out research on the question of congestion management alternatives, centered on operations at LGA. The NEXTOR results were reported back to the FAA in 2005.

As the date approached for expiration of slot allocations for the New York airports, mandated

by AIR-21 to take effect on January 1, 2007, it was clear to the FAA from prior experience that chaos would result if those expirations were allowed to go into effect as scheduled. On August 29, 2006 the FAA proposed new slot rules for the New York airports. Relying partly on NEXTOR study results, the proposed rules for LGA not only continued HDR caps, but also sought to impose minimum aircraft size require­ments for much of the fleet, to limit the duration of slots (OAs),7 and to employ market principles (probably auctions) for the reallocation of slots/ OAs. Under this proposal the stage was set for the airlines to not only lose their implied property rights in the slots/OAs (and their value) but also to be told how large their aircraft must be if they were to service LGA.

The storm of protest was universal, and it came from every quarter, including the Port Authority of New York and New Jersey, the air­lines, Congress, community groups concerned about losing service, and even the Canadian Embassy. Needless to say, this proposal would not fly. Fligh Density Rules, therefore, remained in effect either partially or completely for the HDR airports in spite of the provisions for lifting those allocations as required by AIR-21. This was done under the escape clause in the Act that implemen­tation of its provisions was subject to FAA discre­tion that placed safety in the National Air Space as a primary consideration under the Act.

In 2008, during the last year of the Bush administration, the FAA tried again to revise slot rules for the New York airports.8 As to LaGuardia, the FAA proposed to initiate a detailed non-mone­tary “leasing” arrangement for a majority of slots with “historic” operators for 10 years, coupled with an annual auction of additional slots. While too detailed for discussion here, the plan was a first step, to be reviewed over the 10-year period and discussed by all stakeholders over that term. The proposal made two uncontestable points: (1) LGA required a cap on operations and (2) the allocation of available slots needed to be more efficiently and fairly applied. But it also contained changes that the airlines were not ready to con­cede, including (1) that the FAA has authority to allocate slots in connection with its authority to determine the best use of the national airspace and (2) that the reallocation of slots by the FAA do not constitute a “taking” of property from the airlines in violation of the 5th Amendment.

This effort was met not only by objections, but also by lawsuits. In December 2008, a United States Court of Appeals entered a temporary stay order to the proposed rule pending further hearings on the effects of the rule. After the Obama Administration took over in 2009, Sec­retary of Transportation Ray LaHood unilater­ally rescinded the entire congestion management plan incorporated in the proposed rule. At LGA, slot authorizations established in 2006 remain in effect. Temporary slot extensions continue to be made at JFK and EWR.

It is clear that the airlines are asserting own­ership rights to slots in spite of the expressed reservation by the FAA at the time of their issu­ance that the FAA retained full authority over the allocation of all slots. This slot “property right” carries not only inherent value, but the right to make operating decisions incident to its use, like the size of aircraft the carrier wishes to use when filling the slot, where the airplane comes from when landing, and where it goes after takeoff. While the FAA has obviously not acquiesced in the airlines’ position, it does appear that the FAA is not, at this point, will­ing to completely contest the issue—witness the withdrawal of the proposed rule to modify the HDR regimen on at least the two occasions in 2006 and 2009.

As this contest plays out new developments continue, and in the process maybe some insight is being offered on the question of ownership and control of slots. In 2011, Delta Airlines wanted to expand its presence and create a hub at LGA. At the same time, US Airways wanted to grow at DCA. The solution was a swap of slots between

the two airlines; this was a deal that required DOT approval. Here is what happened: The DOT agreed to approve the Delta-US Airways pro­posal as long as the airlines agreed to give up and sell off, at auction, 8 daily slot pairs at DCA and 16 daily slot pairs at LGA, with the additional condition that bidders would be limited to air­lines with less than 5 percent of the slots at either airport.

In November 2011, it was announced that JetBlue had submitted the winning bids for the eight LaGuardia slots (for $32 million) and for the eight Reagan National slots (for $40 million). The other eight LGA slots went to WestJet (for $17.6 million).

Several things are obvious here; Two new entrant airlines got bigger at two HDR airports; that is good for competition. The DOT forced two big airlines to divest slots to smaller airlines, asserting government control over slot allocation; that is good for competition. The two big airlines got a big payday for something (slots) that they did not pay for and the purchasing low-cost carri­ers had to pay that bill; assuming those costs are to be passed on to the traveling consumer, that is not good for competition.

While the FAA-supervised slot control issue affects only designated high-density airports,9 congestion and delays are increasing through­out the National Airspace System. Because of this combination of issues, DOT and FAA have coined a new approach to the problem: conges­tion management.

“Congestion management” is a concept that encompasses a number of different poli­cies designed to reduce congestion and delay. Among these policies are (1) the imposition of landing fees during peak hours; (2) the expan­sion of the airside (runway) environment of the airport; (3) reconfiguring runways and taxi – ways, especially to eliminate or minimize run­way crossings; (4) incentives to airlines to use larger aircraft; and (5) the use of secondary and reliever airports.

The implementation of such a system will necessarily have to be the result of a cooperative effort among the DOT, the airlines, and the air­ports. Each of these entities has its own priorities and its own primary responsibilities. Revamping of the air traffic control system through NextGen, airport privatization or modification, and a work­able revision of the slot allocation program will all be necessary.