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New York Times
May 14, 1999Government Sues American Airlines, Accusing It of Predatory Pricing
By STEPHEN LABATON with LAURENCE ZUCKERMAN
WASHINGTON -- The Federal Government accused American Airlines Thursday of driving smaller competitors out of one of its most important markets by illegally slashing ticket prices below cost and increasing flights sharply.The Government said American used its dominance of the Dallas-Fort Worth International Airport to prevent weaker competitors from gaining a foothold there in the mid-1990's, only to raise prices and reduce service after they departed.
The antitrust case is the first predatory pricing action brought by the Government against an airline since the industry was deregulated 21 years ago. It is part of a broader 18-month examination by the Justice Department's antitrust division of the steps that may have been taken by major airlines, including Delta Air Lines, Northwest Airlines and United, a unit of UAL, to discourage lower-priced competition in cities they dominate.
Following deregulation in 1978, the largest airlines have moved to strengthen their control of major metropolitan airports. While airlines have on occasion sued each other on antitrust grounds, the Government has rarely intervened beyond threats of fines from the Department of Transportation.
But a growing chorus of consumer complaints about rising fares and declining service has led to a strong backlash against the industry in Congress, where lawmakers have introduced measures to force the airlines to disclose more about fares and delays, and offer compensation for inconveniences. In addition, the Transportation Department last year proposed punishing airlines that tried to stifle competition.
Senior officials at the Justice Department said the American case was particularly compelling because company documents showed that American, the nation's second-largest airline, had deliberately embarked on a strategy of selling tickets below cost and incurring significant short-term financial losses in recent years to drive out three low-cost competitors -- Vanguard Airlines, Sun Jet International and Western Pacific -- from Dallas-Fort Worth International Airport.
Executives and lawyers at American said the airline had not violated any antitrust laws but simply matched the fares of its competitors.
In 1998, American flew 70 percent of the scheduled seats out of Dallas-Fort Worth, up from 60 percent in 1991. The Government presented evidence showing that after Vanguard announced in September 1996 that it was adding service to Dallas-Fort Worth from three cities in addition to Wichita, Kan., American responded by cutting prices and adding flights on nearly all of Vanguard's Dallas routes. Two months later, Vanguard abandoned its expansion plans. By June 1997, American had reduced capacity between Wichita and Dallas by 30 percent and raised the average one-way fare by more than 50 percent to more than $90 from about $60.
"American quickly realized that these new carriers could be a significant competitive threat, estimating that as much as a billion and a half dollars of its annual revenues were at risk if they were to succeed," said Joel I. Klein, the Assistant Attorney General in charge of the antitrust division. "To make sure that this didn't happen, American adopted a predatory responsive strategy, saturating the market in which the start-up carriers had begun service with as much new, low-fare service of its own as was necessary to drive out the start-ups."
Attorney General Janet Reno said American "invested in short-term capacity increases and fare reductions to maintain its monopoly -- an investment it was able to recover many times over once its smaller rivals had been driven away."
American Airlines disputed the accusations by the Justice Department that it had priced its fares below cost or flooded the market with flights, and said the lawsuit was little more than sour grapes by smaller airlines, which, unable to compete, had persuaded regulators to bring the case.
"Contrary to the Justice Department's lawsuit, this action today is very potentially anti-consumer," said Chris Chiames, a spokesman for the AMR Corporation, the parent company of American. "It would have a chilling effect on the marketplace if companies felt they could not match prices of competitors. We simply matched the competition."
The Justice Department complaint, filed in Federal court in Wichita, seeks an injunction barring American from cutting prices below cost and increasing flights as part of any effort to stifle competition. The case is being brought under Section 2 of the Sherman Antitrust Act.
Justice Department officials said Federal antitrust law does not permit them to seek any fines or monetary awards, but that smaller airlines that were harmed by American's conduct could file their own civil antitrust lawsuits for money.
The complaint quoted from company papers describing its "Dallas-Ft. Worth Low Cost Carriers Strategy." The Government said the strategy recognized that "it could prove unprofitable in the short run." But, according to a company document, the strategy concluded: "The short-term cost, or impact on revenue can be viewed as the investment necessary to achieve the desired effect on market share."
The Government also quoted from internal American papers that suggested that the carrier intended to add flights to Kansas City to drive Vanguard from the market and that American decided to get Western Pacific out of the Dallas-Colorado Springs route before Western Pacific increased its service there.
Company executives declined to answer questions about the American Airlines documents that the Government has called incriminating but defended them in general terms.
"There is nothing wrong or illegal with tough talk about competition," Chiames said.
Trey Nicoud, a senior lawyer at American, said, "Looking at aggressive conversations in board rooms is very misleading."
To win against any airline, the Government's evidence would need to be strong because predatory pricing cases are difficult to prove. But Justice Department lawyers have argued that it is relatively easy for a large airline to profit after undercutting a rival and driving it out of a market. In the past, the Government has distinguished between legitimate competition and predatory pricing when an airline cut its fares below its costs and added capacity in a strategy that only made economic sense if the smaller rival were forced to leave the market.
Executives from the smaller rivals portrayed as victims by the Government praised the lawsuit. Of the three, Vanguard has since returned to the Dallas-Fort Worth market, Sun Jet no longer serves that airport, and Western Pacific has filed for bankruptcy protection from its creditors and stopped flying in early 1998.
New York Times
May 16, 1999FIVE QUESTIONS
He Freed the Airlines. But What to Do Now?
By EDWIN McDOWELL
The federal government rocked the airline industry on Thursday when the Justice Department's antitrust division accused American Airlines of illegally adding flights and slashing prices at its Dallas-Fort Worth hub in order to drive out low-fare competitors.The action is the first predatory-pricing suit by the government against an airline since the industry was deregulated in 1978, and it follows an 18-month Justice Department inquiry into complaints that the major airlines have acted illegally to thwart lower-priced competition in their hub cities.
American Airlines denied last week's charges, contending that the essence of the lawsuit was to deny it the right to compete with new-entrant carriers.
The suit calls into question a basic premise of deregulation: that, economically speaking, unfettered competition is all the safeguard the flying public needs.
The architect of airline deregulation was Alfred E. Kahn, now the Robert Julius Thorne Professor of Political Economy Emeritus at Cornell University. He is also a member of a National Academy of Science committee that is evaluating airlines.
Because American Airlines is a client of a research firm for which he is a consultant, he would not speak to the specifics of the lawsuit against American, but did agree to discuss its broader implications.
Q. Some economists say there is no such thing as predatory pricing. Do you disagree?
A. My answer is not only yes, but that the airline industry is particularly susceptible to it. Incumbent airlines can increase capacity and then move it back out of the market again at practically zero cost, and it can easily drive a new entrant out of the market, because the entrant can also just move its planes somewhere else. It's not like a manufacturing plant that can't easily be moved.
Q. Does it make sense for the government to be scrutinizing the airlines' competitive practices?
A. A series of developments in the industry are a cause for real concern. Hubs are most definitely an efficient way of organizing the business, but most are dominated by a single airline, and that creates the possibility of monopoly exploitation.
Yield management has resulted in a big spread between discount fares and the unrestricted fares paid by a small group of people. Adjusted for inflation, average fares since deregulation have gone up 39 percent, and it appears that unrestricted fares have gone up 70 percent or more. That spread is not bad in itself, but there has to be some limit short of re-regulation, which would be a mess.
Q. Will the kinds of arguments the government will be making find a sympathetic hearing in the courts?
A. It's difficult to predict, because courts in the last couple of years have become increasingly sold on the idea there is no predation. But the economics profession has moved well beyond that thinking. And you just can't say entry is easy; you have to see how it is affected by the fate of previous entrants.
Q. Is there anything to the claim that the lawsuit is potentially anti-consumer?
A. There's an element of validity to that, because as long as the criteria to be applied to fares are uncertain, it will create some hesitation on the part of incumbent airlines as to how far to respond.
But the answer requires an exercise of judgment on our part. I've seen one case where an incumbent carrier was offering fewer than 1,500 low-fare tickets on a route, and when low-fare competition came in, the incumbent increased its low-fare tickets to 50,000. That's 50,000! And when the low-cost entrant was driven out, the incumbent went back to 1,000.
So there's a balancing that has to be done. Right now it's too much on the side of permitting very deep pinpointed fares temporarily, until the competitors are driven out.
Q. Is re-regulation coming?
A. Not in my view. But the industry usually loves the antitrust laws, and the reason is that they think the doctrine of predation under the Sherman Act has been so attenuated that no one can ever bring a successful suit against them. And if ever a predation suit were brought, they would immediately claim that's reimposing price regulation.
New York Times
May 20, 1999ECONOMIC SCENE
The Problems With Proving Predatory Pricing
By MICHAEL M. WEINSTEIN
The Justice Department's antitrust suit against American Airlines accusing it of predatory pricing behavior is easy to mock.Predation -- by which a dominant company takes unprofitable actions such as cutting prices below costs to drive competitors out of business, then raises prices to recover earlier losses -- rarely occurs. Historians debate whether predation has occurred more than a handful of times over the last 100 years. Even when it does occur, it can be nearly impossible to prove.
Yet, says Prof. Robert Willig of Princeton University, it would be premature to dismiss the potential importance of the government suit. Though a consultant on predation issues to airlines in recent years, Willig nonetheless calls the complaint "courageous and sophisticated."
"It makes smarter economic arguments than plaintiffs have made in the past, bringing the government's philosophy of predation closer in line with the sound economics," he said. Willig remains agnostic about the merits of the case because "beyond coherent arguments, there must also be hard evidence. We haven't seen any yet."
Upstart carriers are vulnerable to predatory behavior because an incumbent airline like American can flood markets with low-cost service merely by switching planes from one route to another. That is precisely what the government contends American did to Vanguard Airlines, Sun Jet and Western Pacific flying from the Dallas-Fort Worth area to Wichita, Kan.; Kansas City, Mo.; Long Beach, Calif.; and Colorado Springs, Colo.
In these cases, the complaint says, American drastically cut fares and added many flights to routes when the upstart began operations. Later, after the upstart's business shriveled or disappeared, American reversed course, cutting service and raising prices. The government says it will prove predatory intent by showing that the extra revenue generated by America's extra flights failed to cover the extra costs. American denies the contention.
Willig points to a novel part of the government's case. It will argue that American incurs a cost, beyond operating expenses, of using airplanes it already owns to add flights to Wichita and the other cities. Those planes could have been used somewhere else, so the revenue lost by not flying more profitable routes should be treated as a cost of expanding service to Wichita. The courts have not yet embraced this way of calculating costs even though it conforms to standard economic analysis.
However, enlightened some of its arguments, the government's case is also riddled with problems.
Start with its focus on American's yo-yo price-setting and scheduling in the face of entry and exit by upstarts. That could reflect predation. But it could also reflect simple competition. Incumbent airlines are allowed to cut fares to match competitors and sell extra seats as consumers respond to the price cuts.
The government's contention that American sacrificed profits by cutting its fares and expanding services to Wichita and the other cities will be hard to prove. Attributing specific costs to specific routes is arbitrary where some costs go to general overhead. Economists generally argue that the government must prove a "but for" argument -- proving that American's price cutting and flight increases would make no financial sense but for their role in driving rivals out of business.
In other words, the government needs to prove that the low fares and extra flights would prove financially ruinous if continued indefinitely. To make the argument stick, the government will have to prove that American could reasonably expect to recover its losses after Vanguard or Sun Jet exits the market by raising fares -- confident that its high fares would not attract another round of upstarts.
Dennis W. Carlton, an economist at the University of Chicago, points to other problems with the government's case. He helped prepare a report by Lexecon, a consulting firm in Chicago, on behalf of United Airlines that called into question the government's contention that predation is a big problem. The data show, he says, "that upstarts are about as successful in establishing new routes as are the major carriers."
Carlton pokes a more profound hole in the government's case. On many lightly traveled routes, there is room for only one carrier. When an upstart takes on an incumbent, they are likely to engage in a price war until only one survives. In this situation, Carlton asks, "Does it make sense for the government to tie the hands of one the competitors -- and not necessarily those of the low-cost competitor?"
But even if Carlton is right that predation is not a problem for the airline industry in general, it does not mean that American did not engage in predation at the Dallas-Fort Worth airport. To make that judgment requires examining the government's data, which it has not released. Based on the past, the odds are not stacked in Justice's favor. But at least it has issued a complaint that gives American fair warning that the level of sophistication that it will bring to the court room will far exceed anything seen in the past.