June 15, 1998
NewsHour's Tom Bearden has the report on the questionable pricing competition between airlines.
TOM BEARDEN: A recent morning at Metro Airport in Detroit. The airline was having labor problems. Flights were being delayed or canceled. The lines were long. Tempers were short. Joseph O'Connor picked up some reading material for his one-day business trip to Milwaukee. Like many entrepreneurs hustling to build up a young business, he's on the road a lot, and like most business travelers in Detroit, he flies Northwest a lot.
JOSEPH J. O'CONNOR, Business Traveler: Frankly, it reaches points of frustration where if you had a choice, you'd jump in a minute. It's-you know-loyalty, when it's defined by a virtual oligarchy here, it's a different definition than how loyalty would be defined in the truly competitive environment.
TOM BEARDEN: But O'Connor really doesn't have much choice. Northwest dominates this airport. O'Connor lives in what airline people call a fortress hub. An airport becomes a fortress hub when one airline uses it as a major transfer point for flights from many different cities. Such an airline usually winds up controlling the bulk of the airport's traffic. Northwest has 75 percent of Detroit's business, 77 percent in the twin cities. Congress has been hearing a growing chorus of complaints that fortress hub airlines are acting like monopolies and grossly overcharging some people.
SEN. MIKE DE WINE, (R) Ohio: Whenever a new airline announces a new service, particularly into a so-called "fortress hub," it faces stiff price competition.
TOM BEARDEN: It's part of a larger debate about where airline deregulation has gone 20 years after it began.
SEN. HERBERT KOHL, (D) Wisconsin: So though consumer choices increased as a direct result of airline deregulation, the benefits have not been distributed equally or universally. This sometimes costs a walk-up passenger over 12 times as much per mile to fly from Milwaukee to Minneapolis as it does from Milwaukee to San Francisco on the same airline and connecting on the very same flight through the same Minneapolis hub.
TOM BEARDEN: Northwest's Michael Levine believes that hubs have benefits, as well as drawbacks.
MICHAEL LEVINE, Executive Vice President, Northwest Airlines: Look, at Detroit now you are non-stop to hundreds of places in the world and one stop to virtually every place in the world. Which would you rather have, lower fares and no-nonstop service, or much less nonstop service, or the fares you have and lots of nonstop service? And he says, oh, I don't like either of those choices-what I'd like is lower fares and lots of nonstop service. And then it's my education failure that he doesn't believe that choice is physically not available.
TOM BEARDEN: Nobody envisioned mega carriers and fortress hubs when the government deregulated the industry in 1978. The vision was of a dynamic marketplace with a lot of medium-sized airlines constantly at each other's throats, keeping fares low. Anybody who tried to gouge passengers would find themselves facing immediate competition. In Detroit, tiny ProAir put that theory to the test when they looked at Northwest's prices and saw an opportunity. Last year the start-up carrier began flying out of Detroit's then deserted city airport. They offered service to some heavily traveled destinations at rock bottom prices. David was slinging cheap tickets at Goliath's customers. That was supposed to bring lower fares to the market. But that was only Act 1. Act 2 came when Northwest hit back hard, illegally hard, ProAir's chairman argued before a Senate committee.
KEVIN C. STAMPER, Chairman, ProAir: They actually matched us all day long, as long as we had two flights a day in the market. So if they had eleven flights a day in the market, and we had two, they'd match us on every flight every day, basically every seat.
TOM BEARDEN: When ProAir entered the Milwaukee market, Northwest was running six flights a day at standard fares. ProAir put in two flights offering a total of a couple of hundred seats at low fares. Northwest then matched that fare on all six of their flights. ProAir believes that Northwest cut the price not only on a few seats but on thousands, flooding the market with cheap inventory.
SPOKESMAN: So, then what did you do, once they did that to you, what happened then? You would then withdraw one flight-or I want to make sure I got the facts.
KEVIN C. STAMPER: Well, in markets that we couldn't make it with that type of price competition, we withdrew from the markets ultimately. We withdrew out of Milwaukee. First we took one flight out, then we took the second flight out.
TOM BEARDEN: ProAir thinks Northwest was deliberately taking losses to drive them out of the market. That's called predatory pricing, and it's against the law.
KEVIN C. STAMPER: I think that the pricing behavior and maybe some of the other behavior has gone over the line. It's hard to totally be sure, without having access to their data and what they're doing, but the kind of price-matching we received, there doesn't seem to be a logic to it, unless you have a chance to recoup the losses later on when we would exit the market.
TOM BEARDEN: Northwest disputes some of those claims and points out that fares in Milwaukee stayed low after ProAir left. Yet, other low-fare airlines have made similar claims. In 1996, Little Spirit Airlines had one daily flight from Detroit to Boston. It dropped out after Northwest matched its low prices on every one of its eleven Boston flights. Other airlines have gone to court, accusing mega carriers of trying to drive them out of business, taking a temporary hit on profits so they can raise prices later. But Michael Levine says Northwest's behavior in these cases was nothing of the sort.
MICHAEL LEVINE: In each case we've satisfied ourselves that we would make more money or lose less money matching those fares than we would have not matching them. That didn't say that we would have made as much-doesn't say we made as much money as we would have made had they never entered the market in the first place, but we don't control that. It's a free country. You can enter those markets. We respond then they are also free to set the price the way they want to set it. We're free or should be and should remain free to respond as we see fit, trying to minimize the damage or maximize the opportunity from that entry, and that's what we did either time. What I can say very specifically is in no case did the calculations include the prospect of driving them out of business.
TOM BEARDEN: In fact, Northwest believes pricing is such a complex issue that it's almost impossible to prove a clear cut case of predatory pricing. Take fares, for example. Average fares are demonstrably lower than they were when airlines were regulated, but, as everyone knows, they're a lot more complicated. Chances are that no two people on a given flight pays exactly the same fare.
FIRST WOMAN: I'm going home to Atlanta. It was $164.
SECOND WOMAN: I'm leaving the Detroit Airport to Atlanta--$245.
FIRST MAN: I'm leaving from Detroit, going to Atlanta, returning tomorrow. My ticket price was $184 round trip.
SECOND MAN: Where we came from was Atlanta, Georgia. We're flying round trip. And it was $384 apiece.
THIRD MAN: $184.
TOM BEARDEN: Round trip?
THIRD MAN: Yes.
FOURTH MAN: A few dollars less than his.
TOM BEARDEN: Why?
FOURTH MAN: They like me better. (laughing) I don't know.
TOM BEARDEN: Airlines track the sale of every seat on every flight. They can watch a graph that shows the plane filling up as the departure date nears. Sophisticated computer programs and long experience tell them how many seats they can sell in different discount categories-like twenty-one day or seven-day advanced purchases-and how many to hold back to accommodate the last-minute travelers who they know will be willing to pay the full fare. Levine has a simplified way of explaining it.
MICHAEL LEVINE: If you imagine that it costs $100 to take a two-seat airplane from A to B and have one customer who will pay $40 and one customer who will pay $70, the only way I can fly that flight is to charge them two different prices. If I try to charge $70, I only have one customer, and the flight doesn't go. If I try to charge $40, I have two customers, but not enough to pay for the flight. The flight doesn't go. I have to charge one $40 and one $70 in order to make that $100 trip go, pay for itself. Now, as soon as they get on the plane and start comparing notes, the guy who paid $70 will say, I don't get it; I'm being gouged.
TOM BEARDEN: So the fare structure provides discounts for most fliers, but cynics say the system is also getting better and better at knowing precisely who will pay those high last-minute fares. On this day Joe O'Connor was flying on a discount fare, but he and others don't forget the many times they've had to pay the full freight.
JOSEPH J. O'CONNOR: There are flights from Detroit to New York and to Boston and to Washington, National Airport, that are either $1,000 or close to $1,000. It seems to me to be expensive.
TOM BEARDEN: But you paid the fare.
JOSEPH J. O'CONNOR: Well, I didn't have any choice, did I? That's what's available to me, and I have to be in Washington to conduct my business.
TOM BEARDEN: Entrepreneurs like O'Connor grumble and pay. Larger firms, like Kelly Services in suburban Troy, can be less ad hoc about it, with full-time travel departments that can systematically search for bargains.
JACK REYNAERT, Travel Manager, Kelly Services: The air fares are typically 24 percent lower on trips that are planned at least seven days in advance.
TOM BEARDEN: But even they have to adapt. Traveler Manager Jack Reynaert now encourages people to hold meetings on weekends to take advantage of Saturday night stay discounts. Once that would have been unthinkable.
JACK REYNAERT: If you look at air fares coast to coast, you've seen some air fares in the two to three hundred dollar range, but if you look at an air fare on an hour and a half flight, from like Detroit to Minneapolis, it's over $900. There isn't much logic to that. There was a case the other day where we had our travel consultant was on the phone with the airline researching a problem with one of the air fares and within the 20 minutes she was on hold working with the airlines, the air fare changed three times on the same reservation.
TOM BEARDEN: But it's more than just a matter of confusion. Critics say that pricing practices are one of the things responsible for the slowdown in new airline start-ups. Some of the criticism has mushroomed in to political activism. Corporate travel managers got a chance to grill airlines and political leaders at a recent airline competition summit in Washington. Kevin Mitchell was one of the organizers.
KEVIN MITCHELL, Chairman, Business Travel Coalition: If an air fare is set truly by the give and take and the supply and demand in the market, then no one is really concerned. What concerns companies is when competition is frustrated and new entrants to airports are blocked, and the consequence of that results in higher air fares. We have gone from one new entrant applicant to the DOT every six weeks to virtually none in the past twelve months. So the discipline that was inherent in the system is no longer there. And we have a series of allegations of predatory practices against new entrants that are again giving concern that that's supporting higher prices.
TOM BEARDEN: The Department of Transportation is listening. It recently announced a plan designed to separate hardball competition from predatory pricing.
SPOKESMAN: We want to promote a pro-competitive, pro-consumer environment.
TOM BEARDEN: The agency's test will be to look at what happens when a new airline enters a market and offers low prices. Normally, the existing airlines respond by cutting prices for seats that previously cost more. The key to the analysis is who flies in those newly cheaper seats. According to the DOT's theory there are three different classes of fliers. Some would have taken the new airline until the existing airline matched the price. Some wouldn't have flown at all until they heard about the new cheap fares. And some were going to fly anyway at the high prices. They're still flying at the low price. That's a dead loss of revenue for the existing airline. The Department's general counsel, Nancy McFadden, says that's the figure they'll be watching.
NANCY E. McFADDEN, General Counsel, Department of Transportation: If a major carrier, in response to new entry, lowers its fares, increases its capacity at those low fares to such an extent that either it is clearly substantially diverting revenue that it would otherwise get at higher fares and clearly taking short-term losses that can't be explained, that don't make a lot of sense just by saying you want to compete, we believe that that is unfair competition, and we will initiate an enforcement proceeding.
MICHAEL LEVINE: The problem with distinguishing healthy vigorous competition from predation is so great that even though there may be occasional instances of predation, there's probably nothing the government can do that wouldn't do more harm than good.
NANCY E. McFADDEN: The kind of behavior that we're aiming at with this policy, the kind of behavior that we saw that gave us the most concern in our informal investigation, was behavior that really reached outrageous levels.
TOM BEARDEN: No one ever predicted the air transportation system we have today. Executives, passengers, and lawmakers all have different views about what the ideal system should look like, or whether that ideal is even reachable. After a generation of experience, airline deregulation is still an ongoing experiment, and its final form, if any, is still unknown.