Fair Fares? U.S. suit seeks to redefine airlines' predatory pricing

The U.S. Justice Department is taking on American Airlines Inc. in a case that many antitrust experts say the agency is destined to lose. But it isn't backing down.<br><br>In what federal regulators

Friday, March 3rd 2000, 12:00 am

By: News On 6

The U.S. Justice Department is taking on American Airlines Inc. in a case that many antitrust experts say the agency is destined to lose. But it isn't backing down.

In what federal regulators call a "key case" this year, the Justice Department will attempt to redefine the formula for predatory pricing in the airline industry.

It is, experts say, a complicated exercise pivoting on the question of whether a carrier priced its fares below its costs in order to drive start-up rivals out of business.

The government accused American of doing just that in fighting back against three low-fare rivals at Dallas/Fort Worth International Airport from 1995 to 1998. American says it did nothing wrong in using "marketing methods that are ordinary in the industry."

Both sides are heading toward a courtroom showdown this fall that analysts say will produce ripple effects throughout the industry. If the government wins a federal judge's backing for its interpretation of the formula, large airlines may become more careful in how they respond to competition from start-up carriers.

That, in turn, could lead to a more favorable environment for newcomers, antitrust experts say.

Such increased competition often drives down fares and increases the quality of service for consumers, said David Stempler, president of the Air Travelers Association, a consumer advocacy group in Washington, D.C., with 20,000 members.

Since the government's lawsuit was filed, Mr. Stempler said, large carriers have restrained their competitive responses to start-up carriers.

"The lawsuit had a positive effect in and of itself," he added. But if regulators lose their case, antitrust experts say, it could discourage future predatory pricing lawsuits in the industry.

Fresh off an initial victory in the Microsoft Corp. antitrust case, top Justice Department officials say they have no intention of forging a compromise.

American also has no plans to settle the case, according to Donald J. Carty, the airline's chairman and chief executive. "It is plodding along," he said in early February.
Expect preparations for a scheduled court date in October to heat up in the next few months, though.

In its lawsuit filed against American in May, the Justice Department seeks to stop the airline from engaging in the alleged practice of predatory pricing in the future and to win unspecified restraints against it.

The case

Start-up carriers have long accused their larger rivals of predatory pricing, but those complaints went unheeded by the nation's top law enforcers.

But the 1996 ValuJet Airlines crash added to the pressure on start-up carriers as travelers and investors became skittish. The Justice Department then began to more closely monitor major airlines' competitive practices.

The Justice Department's lawsuit describes its case against American: The airline matched its start-up competitors' fares on certain routes and quickly added flights to accommodate more passengers. After the low-fare competitor dropped out, American raised fares and cut back the number of flights.

American says the actions were legal and "rational and appropriate behavior in a free market."

The airline says it was simply responding to competition. The lawsuit names three low-fare carriers: Vanguard Airlines, Sun Jet International and Western Pacific Airlines.
Of the three, only Vanguard continues to operate at D/FW, with nonstop flights to Kansas City.

Both Sun Jet and Western Pacific filed for bankruptcy in 1997. Even if the agency can show that American used the strategy described in its lawsuit, that alone will not win the government's case.

To prove predatory pricing, regulators must show that the airline priced its services below what it cost to produce them in order to drive competitors out of business.

So has American offered its service below what it costs to provide it?

Using the long-standing industry formula, antitrust experts say, the answer is no.

"It is extremely hard in this business to show predatory pricing," said James Weiss, a former Justice Department official who now works privately as an antitrust lawyer for several clients, including Delta Air Lines Inc.
Former American chairman Robert L. Crandall has denied that the practice even occurs.

"Predatory pricing is simply something that doesn't happen," Mr. Crandall told the National Press Club in November 1997.
"If it does happen, its results are so uneconomic that they are soon undone."

By the industry's definition, the costs of producing its service have long excluded the value of expensive capital assets such as planes, warehouses or other facilities. Instead, the only costs considered are variable expenses such as labor, fuel and food. These types of variable expenses are so small on a per-flight basis that airfares almost always exceed them.

Breaking new ground

That industry formula for predatory pricing lies at the heart of the Justice Department's lawsuit.

Government lawyers assert that the formula that determines predatory pricing lacks real meaning for airlines and should be revised. Some of the costs of ownership and operation of an airplane should be included as part of the variable expenses, the Justice Department says. American says that it meets the current test - and disagrees with the government's attempt to redefine the standard.

"This case is based on the desire by the Justice Department to change the law as it relates to predatory pricing," said American spokesman Chris Chiames. "We compete very vigorously, but we compete within the parameters of the rules."

Any attempt to change antitrust laws should occur through legislative efforts, not through litigation, he said.

"There's a real desire on the part of the Justice Department to use litigation to clarify laws," said William Kovacic, an antitrust expert and professor at George Washington University Law School.

Justice Department officials believe that "the only way you are going to make these [antitrust] rules come alive is to go into the courtroom and challenge specific rules of conduct."

"This is an effort to do something new with [legal] doctrine," Mr. Kovacic said. "This is a conscious effort to establish the credibility of the government enforcement effort in this area. If this initiative fails, that's a big setback."

The issue of defining predatory pricing in the airline industry is so complex that a recent report issued by the Committee for a Study of Competition in the U.S. Airline Industry "acknowledged the difficulty of developing an empirical test for identifying potential predatory behavior."

Congress requested the report, which was funded by the U.S. Department of Transportation, in response to an April 1998 proposal by the Transportation Department that sought to give new airlines protection from certain pricing practices of larger, well-established carriers. That proposal is still pending.

Complaints without action

The industry remains rife with complaints from start-up carriers that major airlines are acting unfairly to drive them out of certain markets.

Since the industry's deregulation in 1978, only 11 of 46 start-up carriers have survived, according to Roberts, Roach & Associates Inc., an airline consulting firm in Hayward, Calif.

For several fledgling carriers, filing a complaint is often a last step before going out of business. Last year, Access Air of Des Moines, Iowa, complained that Delta Air Lines, Trans World Airlines and Northwest Airlines were using predatory pricing, which they denied.

The start-up carrier asked Transportation Secretary Rodney Slater to launch an investigation. Access Air is no longer flying. Similarly, Kiwi International Air Lines accused Northwest of predatory pricing in the fall of 1998. Safety violations grounded the Newark, N.J., airline last March, and it was liquidated in December.

Reno Air, one of the surviving 11 start-ups, sued Northwest in 1997, accusing the airline of using predatory pricing to drive it out of the Minneapolis market. The lawsuit was dismissed in April. Reno has been absorbed into American's operations.

American was itself accused of predatory pricing in a 1992 lawsuit filed by rivals Continental Airlines and Northwest. A jury exonerated American after a four-week trial in Galveston in 1993.

Past accusations

The Justice Department's lawsuit against American isn't the first time the agency has accused the airline of not playing fair.

In 1982, federal officials received a copy of a taped telephone call from Mr. Crandall to Braniff International president Howard Putnam. In the call, Mr. Crandall urged his Dallas rival to raise prices so that both airlines could avoid a costly price war. The conversation led to a 1983 Justice Department lawsuit that charged American with attempted monopolization.

The lawsuit was later settled without any admission of guilt. Mr. Crandall agreed to keep a written record of all of his contacts with other airline executives for two years.
Around the same time, the agency also investigated American, alleging anticompetitive practices against Braniff, which went bankrupt in 1982. No charges were brought.

"There is a long history of bumpy relations between the antitrust division and American Airlines," Mr. Weiss said. "The people in the antitrust division have long memories."
American officials dismiss the idea that the airline's current lawsuit is linked to previous encounters with the Justice Department.
"People are trying to connect dots that aren't there," Mr. Chiames said.

"We've got working relationships with all types of government agencies. Sometimes they are difficult. Sometimes they are just fine."