Predatory Practices and Anticompetitive Responses of Airlines

A government study begun in 19907 found that the hub and spoke system, adopted by all major airlines after deregulation, resulted in airlines charging premium prices to local passengers originating from dominated hubs. But it also found that low-cost point-to-point service, such as that developed by Southwest Airlines, pro­vided an effective counter to local hub and spoke market power. Further, DOT concluded that the rapid growth of Southwest and the entry into the market of other low-cost carriers appeared to be correcting the lack of price competition at hubs. Thus, governmental action was not warranted.

By 1995, nearly 40 percent of domestic pas­sengers flew from hubs with low-fare competi­tion, causing some major carriers to emulate the low-cost point-to-point carriers by forming their own low-cost divisions, like Delta Express, United Shuttle, and Metrojet. In 1998, the DOT concluded that the competitive stimulus supplied by new-entrant carriers had decreased, and that the number of new-entrant carriers had signifi­cantly declined. The reason, according to DOT, was because of anticompetitive activity on the part of some major airlines.8

Predatory activity by incumbent airlines his­torically has occurred when other airlines, usu­ally smaller discount airlines, attempted to enter a market already served by the incumbent airline. The incumbent airlines may respond to this new competition by fare cuts, capacity increases by adding aircraft, or capacity increases by add­ing routes. The purpose of the response is to maintain market power and to diminish or elimi­nate competition. Since the cornerstone of a suc­cessful air transport system under deregulation depends on fair competition among the partici­pating air carriers, predatory activity is harmful to the success of the system and to the ultimate interest of the consumer. Maintaining competi­tion requires the assurance that carriers can enter new markets fairly.

It has been argued that the competitive responses of major hub carriers differ depending on which airline is supplying the competition. Major carriers’ responses as to each other reflect a “live and let live” approach, that is, there is an implicit recognition that relatively equal finan­cial strength and market power provide a control mechanism that allows a peaceful coexistence to be maintained in the competitive process.

The competitive response to new entrant airlines, however, is territorial and aggressive, including matching and even undercutting the smaller carrier’s low-cost fares and adding capacity on the routes of the interloper. Histori­cal examples may include United versus Frontier, American versus Vanguard, Delta versus (the former) ValuJet, Northwest versus Sprint and Reno, and Continental versus Kiwi.

In 1998, the DOT said:

m DOT believes that the responses of some large, established major car­riers at their hub cities to service by small, new-entrant airlines have inhib­ited competition, resulting in higher prices for many passengers and pre­venting a large sector of air travel demand from being efficiently served. These responses, which protect major carriers’ ability to charge higher prices in local hub markets, involve tempo­rarily selling such large numbers of seats at low fares, comparable to new-entrant fares, that by sacrificing profits in the short term, they force the new-entrant carriers to exit from the local market» .9

Once the low-cost carrier had been forced out of the market, it was common practice for the incumbent airline to set its fares at least as high as they had been prior to the incursion by the new-entrant airline. It is believed that these anti­competitive practices against low-fare entrants caused new entries to virtually cease, beginning in the middle 1990s.

Having concluded that predatory activity by the incumbent airlines was, indeed, reduc­ing competition, the DOT in 199 810 announced its new enforcement policy directed at curbing predatory activities by the major air carriers. DOT policy regards an incumbent’s competi­tive response to a new entry to be anticompeti­tive and predatory where it initiates fare cuts or capacity increases on the routes served by the new entrant, and where the incumbent’s tac­tics appear to be economically rational only if they force the new entrant to exit the market or reduce service.

Since 2001, however, incumbent airlines have struggled financially. Bankruptcies and mergers of incumbent carriers have been the rule while, at the same time, a new breed of low-cost carrier has entered the market. Low-cost carriers have increased market share significantly, from 5 percent in the 1990s to around 30 percent cur­rently. Incumbents have gone from trying to drive new carriers out of business to attempting to copy their way of doing business. As a result, anticom­petitive practices have markedly declined.