Hubs, Spokes Face Scrutiny

Hubs, Spokes Face Scrutiny
Part III: The Future

By Jay Campbell

As we begin the third decade after deregulation, it appears that the hub and spoke system will grow stronger domestically and proliferate internationally because airlines and investors enjoy its profitability, and many passengers and communities benefit from its service. That's good news for the major carriers.

The downside of the hub concept, meanwhile, could be mitigated if the U.S. Departments of Justice and Transportation, Congress and the European Union are able to recover and preserve a fundamental tenet of deregulation: the opportunity for competitive entry. For travel buyers and travelers, issues caused by deregulation include extremely uneven pricing, depending on location and passenger type (BTN, March 2), and a reduction in service levels for many smaller communities.

Under pressure from communities, airports and business groups, these government entities have spent months and sometimes years wrangling over a number of concerns about hub dominance: the competitive response of hubbing airlines to new entry, with tactics like predatory pricing and capacity dumping; the availability of airport facilities, including gates and slots, to new entrants; and issues such as agency overrides, frequent flyer program dominance and CRS bias.

DOT this week is expected to issue guidelines on predatory practices, and to use its authority to prevent carriers from "unreasonably increasing prices, reducing services or excluding competition," as dictated by the Airline Deregulation Act of 1978.

DOT hopes the guidelines will curtail situations like the infamous exchange that took place between Northwest Airlines and new entrant Reno Air in February 1993, when Reno Air announced plans to serve Northwest's Minneapolis hub with three daily flights beginning April 1. In response, Northwest, which had never served Reno-Minneapolis before, not only said it would begin flying three jets a day there beginning April 1, but also announced new flights close to the heart of the Reno Air operation, from Reno to Los Angeles, San Diego and Seattle. Northwest also matched Reno's lower fares on all flights.

Northwest eventually relented under Congressional pressure, called "jawboning" by DOT deputy assistant secretary for aviation and international affairs Patrick Murphy. But Murphy said jawboning doesn't work any more in light of the weakened position of all new entrants in domestic aviation since the May 1996 ValuJet accident. Hence, Congress has compelled DOT to "be especially vigilant in investigating anti-competitive practices," he said.

Meanwhile, the grip the large carriers have on hub airport facilities is also in DOT's sights. In October, DOT released a number of airport landing rights (slots) to new entrant carriers in two slot-controlled airports, New York's LaGuardia and Chicago's O'Hare (BTN, Nov. 3, 1997). Murphy said DOT hopes to issue additional slots in the near future.

DOT said it also is pondering what to do about airport gate control by hub carriers. At issue is the concept of long-term exclusionary gate deals between airlines and airports, which enable airports to expand but tie the facilities to one carrier for years, if not decades.

"Most long-term leases are a product of regulation," said George Doughty, director of the Lehigh Northampton Airport Authority. "When we entered deregulation, we should have ended that policy."

The General Accounting Office has gathered significant evidence of the anti-competitive effects of such leases. "Exclusive-use gate leases lock up virtually all the gates for years," said GAO's former assistant director of aviation issues, Tim Hannegan, at the BTCC Airline Competition Summit last year. And, he noted, " it is business travelers in particular who bear the brunt of that cost."

GAO said that as of 1990, 85 percent of the gates at the 66 largest U.S. airports were leased under long-term, exclusive-use gate leases. The GAO singled out six airports for having a particularly high degree of exclusivity: Charlotte, Cincinnati, Detroit, Minneapolis, Newark and Pittsburgh.

A number of low-cost carriers have complained that the gate arrangements between hub airlines and airports, which are often highly political deals, amount to a barrier to entry. Sometimes a new entrant can sublease gates from major carriers, but usually at drastically increased prices--and occasionally with the stipulation that the low-cost carrier utilize the major's higher-paid employees.

One solution that has been pursued is that when allocating federal airport funds (such as passenger facility charges), the FAA would give preferential treatment to airports that promote more competitive gate leasing arrangements. Already, PFCs cannot be used to build facilities with long-term exclusive-use gate leases, according to legislation passed in 1990.

DOT has not yet made clear which tack it will take on gates, but sources said it is the next big item on the agenda after predatory pricing guidelines. Congress, too, will take up the gate issue in the form of a hearing later this year.

Already, a series of bills have been introduced in Congress to improve competition along the lines of what DOT is doing, although some of the bills give special attention to certain individual communities, both large and small.

In addition, DOJ said its "antitrust division is investigating predatory or exclusionary conduct among airlines at hub airports." News reports quoting unnamed sources indicate that it is the nation's four largest carriers, United, American, Delta and Northwest, that are under the closest scrutiny by Justice.

Majors' Response

Government's greatest hurdle in the quest to promote competition is the major airlines and their powerful lobbying groups. The majors and the consultants and lawyers they hire are quick to refer to any kind of government action on airline competition as "re-regulation."

The term re-regulation makes for a great sound bite, and the heads of most of the largest airlines have used it time and again in recent months to suggest that DOT is reverting back to something that unacceptable under the Airline Deregulation Act. However, in attempting to bring down barriers to entry, DOT insists it is exercising its authority under the Act to recover the fundamental principle of the economic theory that spawned deregulation in the first place: contestability.

"According to the contestability theory, even in a concentrated market where there are few or no other carriers serving the same city-pair market, incumbent carriers cannot take advantage of their dominant position if it is not costly for other carriers to enter and exit a market," said GAO in a 1989 report on airline competition and the role of DOT. "Therefore, the incumbent is constrained from charging prices above competitive levels because of the potential for 'hit and run' entry."

For the founders of deregulation, this rationale served to satisfy the concern over the economies of scale that exist in the airline industry, and the excessive market concentration that deregulation might cause.

But the DOT and other parties now are saying that competitive pressure does not exist in fortress hubs, or in some other airports, because of the majors' control over airport facilities and their ability to swamp competitors and cross-subsidize low fares with high fares on monopoly routes.

Since these issues are debatable, DOT has vowed to take no action without giving the public fair opportunity to comment. That concept is supported by some of the majors who seem uninterested in throwing around terms like re-regulation.

"A dialogue is healthy," said Lawrence Nagin, executive vice president of corporate affairs and general counsel for US Airways. "It's incumbent on the airlines to make people aware of the service we provide. The rhetoric should be lowered, and a dialogue should move forward."

Continental has made no statements referring to re-regulation, and in fact, its straight-shooting CEO Gordon Bethune made no bones about the domestic competitive environment in a recent interview.

"Since deregulation, you notice American left New York and came down to Dallas and kicked Braniff's ass right out of there. Guess what, you should have been there ten years ago if you wanted to be in Dallas. Go to Dallas today and they kill you," he said. "Oh, and did you want to fly an airline out of Minneapolis? I'm sorry, you should have been there years ago before the Republic-Northwest merger."

Going Global

Interestingly, the major carriers sound much like the low-cost airlines when it comes to international aviation and preserving competition in places like London and Tokyo. The main complaint about the American Airlines-British Airways deal involves access to gates and slots in BA's Heathrow hub.

In the international forum, alliances are enabling carriers to do what they did in the U.S. market in the 1980s--rationalize their route networks around the hub-and-spoke system. In many markets, the future in the international arena could hold a similar fate to the domestic system, with carriers getting out of each other's way.

Alliances already are picking their spots. Speaking at Corporate Travel World earlier this month, John Ash, managing director of Washington, D.C.-based Global Aviation Associates, demonstrated that the United/Lufthansa alliance leveraged Delta out of the Washington (Dulles)-Frankfurt market because of the alliance's dominant feed on either end of those hubs.

Similarly, Ash pointed out, the former BA-USAir alliance forced American out of the Philadelphia-London market in 1995. American also has said that the Delta and United alliances forced it out of transatlantic flights to Brussels, Frankfurt and Zurich last year. Similar examples exist in other transatlantic city pairs as well. Indeed, as alliances proliferate, the North Atlantic is slowly becoming less and less competitive (see chart, page one). Alliances' share of traffic across the North Atlantic has increased from 47 percent in 1994 to 62 percent in 1997, according to DOT figures.

Some say the antitrust immunity for Open Skies exchange, which the United States seems to have adopted as policy, will lead to more control coming to rest in the hands of a few large players or partnerships.

"Antitrust immunity has been the carrot and the prerequisite to Open Skies," said Jeffrey Shane, a partner at Wilmer, Cutler and Pickering, and an architect of the early Open Skies agreements as DOT's assistant secretary for policy and international affairs under the Bush administration. "But that linkage is dangerous. DOT is downplaying the effects of likely monopolization. One should be suspicious of any policy that gives antitrust immunity as a prerequisite."

The European Union certainly is suspicious. It has put every transatlantic alliance under scrutiny, with a verdict to be announced in the coming months. DOJ also has indicated concern over alliances that are overlapping rather than end-to-end.

Depending on how tightly these bodies decide to control alliances, there will be high concentration--and in some cases monopolies--between the gateways of two alliance partners. But, as the hub system in the United States has shown, there also are benefits, such as easier connections and generally better service for time-sensitive passengers. And competition will remain healthy for the many multi-connecting international passengers as there are more gateways to choose from (see chart, this page). Under Open Skies, some airlines also are starting new transatlantic service, including CityBird out of Brussels, Swiss World Airways out of Geneva and perhaps British Midland out of London.

"Hub to hub, you're going to have high fares," said Ash. "But you'd never have a route like Cincinnati-Zurich without an alliance. The local market is less than ten people. Buyers want to have their cake and eat it too, but you can't have both.