Transportation Markets

• Pages: 203-275

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CHAPTER VI

TRANSPORTATION MARKETS

A. Introduction

Transportation includes a number of different industries that may

present very different issues in terms of market definition. The general

principles of market definition, which are described in Chapter I, are the

same for all these industries, but the questions that arise in their

application may be very different. These questions differ depending on

whether the transport in question is of people or freight and whether the

industry provides a fixed infrastructure that serves a network of routes,

such as railroads and pipelines, or operates vehicles over an externally-

provided infrastructure, such as trucking. Despite these differences,

certain issues, such as source competition, occur in a number of these

industries. Moreover, competition between these industries may be at

issue in market definition. The next section of this chapter discusses

market definition in the airline industry. Subsequent sections discuss

rail, intercity trucking, ocean shipping, and pipelines.

B. Passenger Airline Industry

1. Industry Background

Market definition in the airline industry is shaped by the elimination

of most regulation and subsequent developments in revenue management

and route planning, such as the creation of hubs. The industry differs

from many other industries because differentiated pricing (charging

different passengers or freight a different price for the same or similar

services) is possible and may lead to narrow markets. Regulation has

played an important role in airline travel over the years and has affected

the analysis of antitrust markets. It is therefore useful to discuss the

204 Market Definition in Antitrust

history of deregulation and some of the changes that were brought about

by deregulation before discussing markets.

Passenger airlines were deregulated with the passage of the Airline

Deregulation Act (Act) in 1978.1 Before the Act was passed, all mergers

were reviewed by the Civil Aeronautics Board (CAB) under a “public

interest” standard that did not place significant weight on competitive

effects. The Act changed the standard to include traditional antitrust

language similar to that in the statutes for non-airlines.2 The Act also

reduced fare regulation and entry and exit restrictions, and these changes

affected the development of market definition in the passenger airline

industry.

The elimination of regulated airfares led carriers to seek innovative

ways to maximize profits on individual flights. In the early 1980s,

American Airlines, under then-President Robert Crandall, developed one

of the first “revenue management” systems. This system was based on

research that showed that business travelers who were willing to pay

higher prices and were less likely to use alternative means of

transportation were also the ones who purchased tickets at the last minute

and traveled in “prime times” such as early morning and late afternoon.

If airlines filled planes during those prime business hours with

passengers who were traveling on vacation, they would not have capacity

for the business travelers who were willing to pay higher prices.

Furthermore, leisure travelers were more willing to take a mid-day flight

or use alternative means of transportation. Observing these tendencies,

American Airlines began charging the more flexible (elastic) leisure

passengers a lower price, and increasing the price for the less flexible

(inelastic) business travelers.

Other airlines adopted similar systems. To segregate the two classes

of passengers, the airlines developed restrictions on leisure travel, such

as requiring advance purchase or a Saturday stay to obtain a lower price.

1. Airline Deregulation Act of 1978, Pub. L. No. 95-504, 92 Stat. 1705

(current version at 49 U.S.C. § 40101 et seq.).

2. The Act prohibited the CAB from approving transactions which would

result i n, or be in furtherance of, a conspiracy or combination to

monopolize air transportation in any region of the United States. It also

prohibited the CAB fro m approving transactions which would

substantially lessen competition or tend to create a monopoly unless the

CAB found that the anticompetitive effects of the proposed transaction

were out weighed b y the public interest. H.R. REP. NO. 95-1779 (1978)

(Conf. Rep.), summary available at http://thomas.loc.gov/cgi-

bin/bdquery/z?d095:SN02493:@@@D&summ2=m&.

Transporta tion Markets 205

Initially, the airlines were unable to eliminate arbitrage between business

and leisure passengers and thus were unable to capture all of the

revenues from their differential pricing. Exchanges sprang up whereby

leisure passengers who could not use their tickets would sell them to

business travelers who purchased them at the last minute, thus depriving

the airline of the higher fare. Arbitrage ended when the federal

government began requiring all passengers to show identification that

matched the name on the ticket.3 Ultimately, the airlines refined the

revenue systems to offer a host of prices, increasing prices as the time of

the flight approached if seats were filling rapidly, or decreasing them if

they were not.

Before deregulation, airline routes were mostly point-to-point. Entry

or exit onto new routes was regulated by the CAB. Following the

passage of the Act, carriers generally were free to select their domestic

route systems at will.4 Carriers began forming “hubs” or airports from

which a number of “spokes” were flown such that passengers could take

a spoke from one city to the hub, change planes, and continue their trip to

the endpoint of another spoke. For example, connecting passengers

traveling to a variety of endpoints would combine with local passengers

on the flight to the hub, thus increasing the number of passengers flown

on that leg. Similarly, the flight from the hub would hold connecting

passengers from numerous origins traveling to the destination of that

flight. Hub and spoke systems are profitable for airlines because larger

aircraft required to serve an increased number of passengers on each leg

are more efficient per passenger to fly. The increase in the number of

passengers on legs to and from hubs also permits carriers to increase the

frequency of flights, which in some cases offsets the time the passengers

lost changing planes at the hub.

Some supporters of the Act based their position in part on the

economic theory of contestability. Initially, many believed that airline

routes were contestable (i.e., potential competitors could discipline

pricing) because airlines had low sunk costs and could easily shift planes

3. The Federal Aviation Admini stration issued a Security Directive in 1996,

which mandated that the airlines req uest identification. Letter from

Cathal L. Flynn, Assoc. Adm’r for Civil Aviation Sec., Fed. Aviation

Admin., to Robert Ellis Smith, Publi sher, Privacy Journal (Mar. 13 ,

1996), availa ble at http://epic.org/privacy/faa/letter.html.

4. Some restrictions on ser vice to small communities were maintained

following deregulation, and some airports did not have space available

for additional flights.