Segment 2 Of 2 Previous Hearing Segment(1)
SPEAKERS CONTENTS INSERTS Tables
Page 177 PREV PAGE TOP OF DOC Segment 2 Of 2 Mr. HYDE. Thank you, Mr. Feidler.
STATEMENT OF RILEY M. MURPHY, EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL, AMERICAN COMMUNICATIONS SERVICES, INC., ON BEHALF OF THE ASSOCIATION OF LOCAL TELECOMMUNICATIONS SERVICES, INC.
Ms. MURPHY. Thank you, Chairman Hyde and members of the committee for this opportunity to present the views of the true pioneers of local telecommunications competition.
My company, ACSI, and our industry trade association, ALTS, are the ones in the trenches of local telecommunications competition, figuratively and literally. We're laying the fiber optic cable, putting in the switching equipment and other facilities that make local competition possible. We are the entrepreneurs that have collectively raised over $13 billion, based on the fact that Congress has declared local competition to be the law of the land.
My message to you today is the Telecommunications Act is working and it will continue to work if Congress, the Department of Justice, and the FCC stay the course. There are at least 14 specific actions which the Telecommunications Act requires that the incumbent phone companies do in order to qualify for long distance entry. The FCC, with input from the Department of Justice, has created a roadmap that tells these Bell operating companies how to comply with the 14 checklist points if they want to get into long distance. Stay the course and sustainable local competition will become a reality. The evolution to sustainable local competition from ground zero in February, 1996, will take time.
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Passage of the Act was only the beginning of a complex and arduous process. Some of the major steps our industry has done to push the competitive agenda forward are: we have built multi-million dollar networks, we have had to negotiate municipal franchise and rights-of-way deals with public utilities, we have had to design state-of-the-art network management centers for our voice and data circuits, we have to implement new processes for provisioning access lines and to provide customer service. And, of course, we have to obtain the requisite State regulatory approvals. All of this is a very time-consuming process.
One of the most formidable challenges that we have as new competitors is interconnecting our networks with those of the incumbent phone companies. All of this is fraught with problems which we encounter on a day-to-day basis and have to solve and fight on a day-to-day basis. Our industry has always expected a tough fight with the regional Bell operating companies to get the interconnection agenda accomplished, but what we did not expect is their lack of preparedness for that process. Both the incumbents and the competitive industry are working together to develop the systems necessary to allow customers to switch from the incumbents to the new market entrants. We cannot have sustainable local competition until those systems are in place. Yes, they are under development, but they are not ready yet.
Our company has experienced countless problems. I have many war stories to tell about situations where we try to cut over customers and in the process the local service is disconnected to that customer. I don't know if you can imagine being without local telephone service for one, two, three hours, but certainly it would shed a bad light on the new provider, even though the reasons for those disconnections certainly are attributable to the incumbent telephone company.
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In some cases, we have had the same customer have three different potential installation dates in one week, only to be delayed by the incumbent telephone company. In Georgia, we actually had a small barbecue restaurant that was our customer that had several locations throughout Columbus, Georgia. Unfortunately, due to BellSouth errors, that restaurant's business was disconnected at 5 o'clock on a Friday afternoon, just when the orders for food were starting to pour in.
What can we do about these problems? Basically, we already have the solution in place. It's section 271 of the Telecommunications Act which clearly lists what the telephone companies need to do in order to gain long distance market entry.
With a strong and active Department of Justice and an ever-vigilant FCC, we anticipate that the remaining barriers to competition will fall as envisioned by the Act. Stay the course and local competition will become a reality.
Thank you for your time.
[The prepared statement of Ms. Murphy follows:]
PREPARED STATEMENT OF RILEY M. MURPHY, EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL, AMERICAN COMMUNICATIONS SERVICES, INC., ON BEHALF OF THE ASSOCIATION OF LOCAL TELECOMMUNICATIONS SERVICES, INC.
ACSI appreciates the opportunity to testify on behalf of itself and the other facilities-based competitive companies (CLECs) which are members of the Association for Local Telecommunications Services (ALTS) concerning the need for pro-competitive antitrust enforcement in the telecommunications industry. ACSI has constructed local fiber optic networks in 32 cities throughout the South and Southwest. ACSI is using these networks today to deliver dedicated and switched telecommunications services, as well as data and Internet services. With ten switches currently operational and plans to complete installation of six more by year's end, ACSI has made a herculean effort to deliver local services across the southern tier of the United States. As you can see, ACSI is one of the most active pioneers in providing facilities-based competitive local exchange services.
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By my use of the term ''facilities-based,'' I include all of the many companies that collectively have raised over $13 billion in the capital markets since passage of the Telecommunications Act of 1996 (Act or 1996 Act) in order to install competitive switching, transport and local loop facilities that compete with incumbent local telephone companies (ILECs). In addition to ACSI, these companies include ICG, Intermedia Communications, Nextlink, WINSTAR, MFSnow part of WorldComand many others.
Current statutory and administrative mechanisms for implementing effective local telecommunications competition, including the antitrust laws and the associated oversight functions of the Department of Justice (DOJ) and the Federal Communications Commission (FCC), are slowly but surely opening local markets to competition. They do not need, nor would they benefit from, any revamping at this time. Rather, what is required is fidelity to the goal of local competition through vigorous enforcement of the Act and the antitrust laws. Now is the time to stay the course.
The importance of holding fast to existing competitive policies and processes designed to further facilities-based competition is compelling: facilities-based competition fuels positive competitive changes without relying upon particular regulatory and legislative environments; it provides more consumer choices in product and service offerings; it creates new jobs; it promotes faster technological advances: and it helps deter service failures by providing network redundancy. In contrast, mere resale of the ILECs' services gives consumers only limited price competition. In short, facilities-based competition is the ''real thing'' in local telecommunications and it is the goal that should be furthered by all legislative and administrative efforts in this area.
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Although facilities-based competition already was moving forward in several markets prior to 1996, adoption of the 1996 Act greatly accelerated the pace of competitive investment. For instance, before the Act, ILECs enjoyed exclusive franchises to provide local switched services as a matter of state law and policy in many of the states in which ACSI has built local networks. It is therefore not surprising that, on the day after the President signed the 1996 Act, consumers could not immediately order local service from a competitor. Obviously, we also would have welcomed the advent of competition on a flash-cut basis. But, the reality of our industry is that starting service is a long, arduous process involving large up-front investment by competitors, meaningful cooperation from incumbents on many complex technical issues, vigorous regulatory supervision, and plain old-fashioned time.
All of these are formidable hurdles, and the one likely to be of most concern to this Committee involves the extreme difficulty we have experiencedand continue to experiencein dealing with the ILECs.(see footnote 77) Local telecommunications competitorsincumbents and new entrantsmust work with each other. In order to transfer traffic seamlessly, our networks have to be interconnected and unbundled network elements need to be provisioned to new entrants with the same quality as they are provided to an incumbent's retail service customers. This unavoidable and widespread interaction means that when an ILEC fouls-up service to ACSI, ACSI customers immediately feel the pain. Let me elaborate on the severe problems this interdependency has created.
Typically, problems start right from the very beginning when a CLEC attempts to interconnect its network with an ILEC's network for the purpose of providing competitive local exchange services. ACSI's efforts to collocate its equipment in U S West's wire centers in order to interconnect with the U S West network have been stymied by a series of delays and distractions. For example, U S West refuses to support the most efficient use of the state-of-the-art loop concentration equipment which ACSI has deployed in its collocation space. This compels ACSI to operate inefficiently, and to forgo part of the value of its investment in advanced technology. While U S West claims that technical problems preclude it from supporting many of the functions requested by ACSI, engineers who have reviewed the matter insist that the only change required of U S West would involve its making minor additional markings on its equipment. Most significantly, ACSI has been informed that U S WEST has successfully implemented a solution to identical technical issues when requested to do so by its own end users.
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Unbundled Network Elements/Number Portability
After ACSI successfully interconnects its network with an ILEC's network, we have encountered tremendous difficulty in obtaining seamless and dependable installation of the unbundled local loops needed to actually replace the ILEC local exchange services at customer locations. ACSI typically experiences substantial delays in obtaining firm order commitments (FOCs) to install facilities and services to ACSI's customers from the ILECs. Although the ILECs normally can establish such dates for themselves for the purpose of serving their own end user customers within minutesor at the very most a couple of daysACSI often has to wait weeks and sometimes months for the same scheduling commitments. Even then, the ILECs routinely miss these already delayed installation dates. In Florida, for example, BellSouth missed the installation date for one ACSI customer three times in one week. And to compound the injury, ILECs often send their own sales representatives to make ''win-back'' sales presentations to ACSI's customers while ACSI and its customers are suffering these delays. Such sales presentations, not surprisingly, often rest on claims that the ILEC can guarantee a quicker installation date than can ACSI.
Even when the installation scheduling works out, ILECs frequently disrupt ACSI customers' telephone service unduly in the cutover process. We experienced such problems with the first three orders for unbundled loops in our initial service market, Columbus, Georgia. Despite the fact that BellSouth agreed that service interruptions in the cutover process should not exceed five minutes, two of the initial three customers were disconnected entirely for 45 hours each. No outgoing calls could be placed, and persons calling the customer received an intercept message indicating that the number was no longer in service. The third customer was disconnected for the entire day on which conversion was scheduled, causing severe inconvenience and disruption to the customer. Even worse, once the loop connections finally were established, ACSI's new customers neither could dial out nor receive incoming calls because BellSouth had failed to implement interim number portability as ordered. Nearly one year later, BellSouth routinely continues to miss installation intervals. Indeed, disruptions exceeding two hours are not uncommon. This is unacceptable to ACSI and ACSI's customers.
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Unfortunately, ACSI's experience also shows that ILEC provisioning problems do not stop once the initial cutover has been completed. Once service is established, it is often provisioned improperly (resulting in poor service quality) or disrupted without warning or explanation.
The cumulative effect of these provisioning problems is illustrated by ACSI's experience with a Georgia auto parts dealer. The customer had a total of eight locations, served by 37 access lines and had agreed to switch its local service from BellSouth to ACSI, with nine lines to be served by unbundled loops and the remaining 28 via resale. BellSouth initially failed to provide due dates for provisioning these lines, forcing ACSI to escalate the matter with BellSouth. When BellSouth finally provisioned the order, lines for two locations were crossed, causing considerable confusion and disrupting the customer's business. Shortly thereafter, the customer (along with nearly all of ACSI's customers in Columbus, Georgia) experienced false busy signals as a result of BellSouth's number portability errors. ACSI agreed to intervene on the customer's behalf, and the customer agreed to continue using ACSI's service. Nevertheless, the customer continued to experience other service disruptions caused by BellSouth. As a result of BellSouth's continuing provisioning problems, the customer finally switched from ACSI back to BellSouth.
In sum, the ILECs to date have demonstrated (1) an alarming inability to accept and process orders in a nondiscriminatory manner, (2) an even more alarming inability to avoid lengthy disconnections during the customer cutover process, and (3) a troublesome pattern of poor service quality once service actually has been established. All of this has jeopardized new competitors' ability to retain existing customers and to attract new customers to their services.
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Now let me turn to the issue of competitive service for residential customersan issue the ILECs currently are touting as a basis for being excused from meeting the requirements of Section 271. First, it is unreasonable to assume that facilities-based competition for residential customers would arise overnight. Since CLECs were legally foreclosed from the switched services market in most states prior to the passage of the 1996 Act, our networks originally were designed to reach business customers to provide dedicated services. Second, simple economics dictate that we build our networks to reach high volume customers first and then progressively expand to reach smaller users. Recall that, in the long distance market, MCI first served only business customers and introduced service to residential customers years later as legal impediments were removed and its network became more robust. Of course, in the local services market, this natural evolution is being slowed further by the provisioning problems which I discussed earlier and because most ILECs anticompetitively price their unbundled local loops higher than the corresponding retail prices for basic residential service.
Section 271 Roadmap/Mergers
Despite these serious difficulties, we are beginning to see facilities-based CLECs clear the many hurdles in their path, and the major reason or this progress is the 1996 Act and the oversight of DOJ, the FCC and state regulators. Perhaps the most robust pro-competitive portion of the 1996 Act is the specific, detailed pro-competitive requirements contained in Section 271, in which Congress specified the extent to which local RBOC markets must be sufficiently opened to competition before permitting RBOC entry into in-region long distance services. The FCC and DOJ have interpreted Section 271 in a very natural, pro-competitive fashion. In its Ameritech-Michigan Section 271 Order, the FCC provided a roadmap detailing the steps which the RBOCs need to take to comply with this provision. Portions of this map include the following:
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RBOCs seeking Section 271 authority are required to supply statistically-valid evidence showing that the operational support systems (OSS) provided to new entrantsthe automated back office systems that are critical in providing the interconnection services required by new entrantsare commercially able to support competitors' volumes, and are provided at a quality and cost that do not deter competition.
RBOCs are required to show that the prices approved by state agencies for interconnection under Section 252 are not anticompetitive.
RBOCs must show that the trunks used to exchange traffic with new entrants are sized sufficiently to provide the same level of quality as the RBOC provides within its own network.
RBOCs must show that they have implemented E911 access so that the customers of new entrants enjoy the same access to emergency services as do customers of the RBOCs.
Ameritech Executive Vice President Barry Allen recently testified to the Subcommittee on Antitrust, Business Rights and Competition that the FCC had indeed provided a roadmap for Section 271 compliance and, though he challenged the decision as over-detailed, committed Ameritech to full compliance: ''And when we file again to offer long distance, we will make sure the 'I's' are dotted and the 'T's' are crossed.''(see footnote 78) Ameritech subsequently underscored its acceptance of the Ameritech-Michigan Section 271 Order by declining either to appeal the order, or to file a petition for reconsideration at the FCC.
Page 186 PREV PAGE TOP OF DOC Segment 2 Of 2 Like Ameritech, we also are not completely happy with the Ameritech-Michigan Section 271 Order. We believe, for example, that the FCC clearly erred in treating unbundled network elements as part of a new entrant's own facilities for the purpose of permitting an RBOC to comply under Section 271's ''Track A.''(see footnote 79) But like Ameritech, which deserves credit for completing more of the components of Section 271 compliance than any other RBOC, we think the current task for everyone should be to dot the I's and cross the T's, not to try to formulate a new map.
The slow but deliberate progress of facilities-based competition would clearly be harmed if the FCC or DOJ were forced to retrace their steps at this stage. The principal pro-competitive virtue of the Ameritech-Michigan Section 271 Order is its emphasis on objective, quantitative factsnot anecdotes wrapped up in legal and economic window dressing. Any retreat from the current course on Section 271 enforcement in general, and the Ameritech-Michigan Section 271 Order in particular, would unleash further counter attacks from ILEC law firms rather than encourage good faith compliance. The FCC and DOJ got it right in Ameritech-Michigan, as Ameritech has acknowledged, and any attempt to revisit the Ameritech-Michigan Section 271 Order now would have serious anticompetitive consequences.
We also believe that DOJ has an important role in advancing local competition through its consultation with the FCC on Section 271 applications, and in its review of telecommunications mergers. We feel that DOJ has moved far up the learning curve since it approved the Bell Atlantic-NYNEX and SBC-PacTel mergers without adequate pro-competitive conditions. Most importantly, we believe DOJ should use its antitrust powers to impose merger conditions on ILECs, particularly those non-RBOC ILECs already in or seeking to enter the long distance market. Those conditions should be designed to level barriersand particularly government-imposed barriersto local competition that have arisen since the Act was passed or that were not precisely anticipated or resolved by the Act. More specifically, for non-RBOC ILECs, most notably GTE, DOJ first should require it to demonstrate compliance with Section 271 before being allowed to acquire any long distance carriers.
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Beyond the immediate issues of Section 271 compliance and merger review, Congress, along with DOJ and the FCC, should begin to consider long-term solutions to the continuing problem of ILEC control over bottleneck facilitiespossibly by requiring a spin-off of bottleneck facilities to a separate company. Some states already have started to explore this approach, and we believe that this policy, taken to its proper and logical conclusion, will greatly accelerate local competition.
Similarly, the FCC should take vigorous action on issues involving access to buildings and municipal rights of way. Such action is necessary to ensure that consumers get meaningful access to competitive choices. It would be considered outrageously anticompetitive for a property owner to stand in a doorway and try to insist that only a certain parcel delivery service could serve the tenants in that building. Yet this happens every day as telecommunications carriers try to deliver competitive services to potential customers, only to encounter (1) property owners who deny access to rooftops, basements and internal wiring unless a new entrant acquiesces to the conditions or prices they demand and (2) municipalities which delay construction of new facilities and impose unreasonable and discriminatory charges on competitors. Facilities-based competitors must have access to buildings and rights of way, and we are prepared to pay equitable and nondiscriminatory costs, if any, incurred by property owners or municipalities in providing such access. However, what is unfair, and inimical to effective competitive, is requiring new entrants to pay prices that are not only way above costs but also are not assessed to the ILECs. In short, the information superhighway will not spread very fast if highwaymen are allowed to extract excessive tolls and limit consumer choice in the process.
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Again, we appreciate the opportunity to express our views on near-term and long-term issues involving antitrust enforcement and competition in local telecommunications markets. We look forward to working with the Committee, DOJ, the FCC and other interested parties as we move closer to effective facilities-based local competition.
Mr. HYDE. Thank you, Ms. Murphy.
STATEMENT OF ANDREW JAY SCHWARTZMAN, PRESIDENT, MEDIA ACCESS PROJECT
Mr. SCHWARTZMAN. Thank you, Mr. Chairman.
The 1996 Telecommunications Act was supposed to substitute competition for regulation. On that basis, cable TV rates were deregulated, but citizens are not getting new choices or lower prices. Concentration is growing. Prices have gone up, not down.
Telephone companies long ago abandoned talk of interactive video on demand. Most of them no longer do video at all. Those which have tried to enter video markets, like Ameritech and U.S. West, have bought or built very conventional cable systems. BellSouth has attempted to innovate technologically in offering a digital television service, but it's misnamed as ''wireless'' cable. It provides no locally generated programming; it is nothing like the ''video dial tones'' service that this Committee heard about a few years ago.
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Since early 1996, cable rates have increased more than three times as fast as inflation in the absence of competition. That's why Consumers Union and Consumer Federation of America have called for an immediate FCC freeze on cable TV rates. Admittedly, that's a drastic step, but it would simply maintain the status quo while the FCC considers the question of ''how and why did the Nation's five top cable companies leverage their control of more than half the Nation's cable TV homes and their ownership of marquee-value cable programming services to jack up prices?''
In my written testimony, I call upon the Justice Department and the Federal Trade Commission to become more active in FCC proceedings and to start by supporting the rate freeze petition. I would note that this morning Mr. Klein and Chairman Pitofsky both observed that there are circumstances where they find practices that are arguably unlawful but they either lack the resources or a clear enough case to go to court. I would say they should become more active as they did in the past in notifying the FCC, filing comments and entering proceedings and advising the FCC (which has a broader mandate) to try to address some of those potentially anti-competitive situations.
The chart that I brought with me today shows all too clearly the breadth of vertical integration in the cable TV industry. It requires immediate attention from this committee. The nation's largest cable system owners own or control almost every satellite delivered cable service. Common control of programming and the means of distribution enables them to pass on programming costs to consumers and to unaffiliated competitors.
Cable is denying direct broadcast satellite operators and other competitors access to programming they need to subscribers. You've had hearings here and other places on the Hill have had hearings about this.
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There's a bold effort to evade the provisions of section 19 of the 1992 Cable Act. There were two loopholes in that statute. Here's how they work.
Section 19 prohibits vertically integrated cable operators from refusing to sell their major program offeringswhat Chairman Pitofsky referred to as marquee-programmingto DBS and other competitive distributors. It expressly applies only the satellite delivered programming. Regionally concentrated cable systems which are arising are taking advantage of their contiguous location to distribute their programming terrestrially by fiber optic cable rather than by satellite. This permits them to discriminate against DBS and other competitors by refusing to resell this important programming.
There is a second, similar evasion problem. News Corporationthat's Foxdoes not own cable systems. This, News Corporation says, gives it the right to refuse to sell its programming to anyone, including DBS, despite distribution agreements with cable operators and specifically with DBS operators. This evasion, too requires action by the committee.
The latest and most ominous threat to competition is the cable industry's PRIMESTAR DBS satellite service. From the beginning, as a creature of the cable industry, PRIMESTAR has never aggressively competed with its owners or with other cable operators. Now the News Corporation has joined this venture with PRIMESTAR, and abandoned its joint venture with EchoStar DBS. Now that it has joined with the cable industry to obtain the last full U.S. satellite orbital authorization with which it intends not to compete with cable, it intends to undermine the growth of the DBS service.
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PRIMESTAR has little incentive to compete with the cable companies because the cable companies own it. This committee could do well to study these practices and take steps to ensure that the cable industry may not continue to abuse its position through practices of questionable legality.
I see my light is on. If I may indulge you, Mr. Chairman, I do have in my written testimony one suggestion in the telephony area with respect to improving the judicial review process for the 1996 Telecommunications Act. I would urge this to be something very important for this Committee to address so it can eliminate the problem of having everything tied up in one court in St. Louis.
[The prepared statement of Mr. Schwartzman follows:]
PREPARED STATEMENT OF ANDREW JAY SCHWARTZMAN, PRESIDENT, MEDIA ACCESS PROJECT
The Telecommunications Act of 1996 has not provided citizens with a choice of diverse and competitively priced TV offerings. Cable TV rates were deregulated on the promise that new competition would obviate prescriptive regulation. However, what has grown is not competition, but vertical and horizontal integration. And, most importantly, cable TV rates.
The 1996 Act has failed to create competition in any major sector of the telecommunications industries. It hasn't generated technological innovation in video from telephone companies or other video competitors. These shortcomings place ever greater burdens on the antitrust laws to fill the gaps. I hope DOJ and the FTC will become more active in advising the FCC about anticompetitive trends, and in particular, that they will support Consumers Union and Consumer Federation of America seeking an immediate FCC freeze of cable rates.
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Cable industry power is exercised though common ownership of programming and distribution (shown in the accompanying chart), increased control of the cable systems by the major companies, and the refusal to sell programming to competitors. The indutry's newest weapon is its PRIMESTAR satellite service. To the extent that the FCC determines that it cannot or will not use the Communications Act to address this dangerous development, antitrust enforcement is the last protection against destruction of the MVPD market.
The two major high power DBS services, Direct TV and EchoStar, pose the best and, perhaps, the last, opportunity, for serious national competition in multi-channel pay TV. Congress wisely chose to jump start DBS by guaranteeing access to the programming controlled by vertically integrated cable operators. Just as they started to gain a foothold, and just as News Corporation's AskyB was preparing to merge its DBS service with EchoStar to give viewers the option of a new technology that could provide local, as well as national network programming, News Corporation decidedor was induced to decideto abandon the venture. News Corporation and PRIMESTAR have now asked the FCC to approve a multi-faceted deal to merge News Corporation's DBS operation, with its high powered orbital slot, into a mew PRIMESTAR corporation which would be used to complement, not compete with, cable, and to undercut DBS. The new alliance with News Corporation also evades program access rules. Since News Corporation doesn't own cable systems, it can refuse to sell its program services to DBS.
The PRIMESTAR deal also removes the potential of a highly innovative and competitive new technological innovation (local ''spot beams'') and concentrates ownership of cable orbital slots.
Page 193 PREV PAGE TOP OF DOC Segment 2 Of 2 More generally, one area to which I would urge greater attention be paid is the need for the FTC and the DOJ to share expertise and experience with the Federal Communications Commission. Unlike DOJ and FTC, the FCC operates under a broader and more general mandate, with the power and discretion to explore what policies best serve the public interest. Except where the 1996 Act has directed the DOJ to express its views, DOJ and FTC have not often submitted comments to the FCC, even where potentially anti-competitive practices and policies have been under FCC review.
I do have one suggestion of an administrative nature as to local telephony: this Committee should adopt an expedited and consolidated national judicial review scheme. For more than a decade, a single unelected federal judge had, by default, emerged as the primary determinant of competitive entry into local communications markets. Things have changed very little: three unelected federal judges, by default, now preside over competitive entry into local communications markets. Just as Congress provided for expedited judicial procedures in the so-called ''Communications Decency Act,'' and the so-called ''V-Chip'' provision of the 1996 Act, it should take similar action for local competition issues.
The Telecommunications Act of 1996 has not provided citizens with a choice of diverse and competitively priced TV offerings. Cable TV rates were deregulated on the promise that new competition would quickly arise to make prescriptive regulation unnecessary. Experience has been to the contrary. New competition has been disappointingly slow to develop. Instead, what has been growing is vertical and horizontal integration in the cable industry. Prices have gone up, not down.
Sadly, the failure to date of the 1996 Act to stimulate competition in video is not unique. My general observation is that the 1996 Act has thus far failed to create competition in any major sector of the telecommunications industries. I support the concept of substituting competition for regulation. In practice, however, while the law has been quite effective in eliminating regulation, it has been all too ineffective in introducing the promised substitute of competition. These shortcomings place ever greater burdens on the antitrust laws to fill the gaps. Later in this testimony, I offer a few modest administrative suggestions on how to improve the quality of federal telecommunications policymaking.
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THE 1996 IS NOT STIMULATING VIDEO PROGRAMMING COMPETITION
My focus today, however, is competition in pay-TV, generally referred to as the MVPD (''multichannel video program distribution'') market.
I start with what has not happened. The 1996 Act has not generated significant new competition or technological innovation from telephone companies or other potential video competitors. Congress rejected proposals for technologically advanced, common carrier-type, and intensely local ''video dial tone'' service in favor of the ill-fated ''Open Video System'' approach. The handful of competitive local multichannel video providers including, most especially, Ameritech and U.S. West, have (quite rationally) chosen to spurn that option. Instead, they have started to buy or build technologically conventional cable systems which are unlikely to offer truly innovative integration of voice, data and video. BellSouth has been more ambitious in its plans to provide a digital wireless TV service, but its misnamed ''wireless cable'' option does not provide significant amounts of locally oriented and originated programming.
By contrast, here is what has happened: as concentration of ownership in cable systems and programming has increased, so have prices. Cable rates have increased more than three times as fast as inflation since February 1966, when the 1996 Act was signed. This is 50% faster than would have been the case under regulation.
Nothing in the 1996 Act has slowed, much less stopped, this trend. As I discuss below, I would hope that the Justice Department and the FTC will become more active in FCC proceedings to lend their perspective on how government can foster telecommunications marketplace competition and fuel economic growth. In particular, I would like the DOJ and the FTC to express their support for the petition recently filed by Consumers Union and Consumer Federation of America seeking an immediate FCC freeze on cable TV rates while the agency considers increasingly disquieting evidence that cable TV rates are skyrocketing in the absence of effective competition. Petition to Update Cable Television Regulations and Freeze Existing Cable Television Rates, Dockets MM 92264, 92265 and 92266 (filed September 23, 1997).
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Admittedly, a rate freeze is a drastic step. And such action would not by itself remedy these abuses of market power; it would simply maintain the status quo while the Commission addresses rapid enlargement of the market power of the nation's top five cable companies. These companies have leveraged their control of more than half the nation's cable TV homes and their ownership of the major ''marquee-value'' cable programming services to jack up cable prices. Such a freeze will also help mitigate the adverse impact of the FCC's outrageous delay in completing action to implement the limits on horizontal concentration adopted by Congress in 1992, 47 U.S.C. §533(f). These rules have never been put into effect.(see footnote 80) The Department of Justice has signed briefs supporting the validity of such rules; it should take the obvious next step of asking the FCC to effectuate them.
The Cable Monopoly: Vertical Integration
The chart I have brought today shows, all too clearly, the breadth of vertical integration in the cable TV industry. The FCC's last annual report on video competition, released in January of this year, showed that cable MSO's collectively or individually owned a majority interest in 47 national cable programming networks, compared with 45 a year earlier. Annual Assessment of Competition in Delivery of Video Programming, 12 FCCRcd 4358 (1997). Since that time, News Corporation's Fox Television has been brought into the cable industry's orbit. News Corporations' stable of program services includes Fx, the Fox News Channel, an ever-increasing panoply of regional sports program services. It is also acquiring the Family Channel in partnership with TCI. More recently, TCI-affiliated HSN has announced plans to acquire the largest remaining independent cable programmer, the USA Network.
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The common control of programming and the means of distribution enables cable operators to pass on programming costs to consumers and unaffiliated competitors. While the price of basic and expanded basic cable programming shot up 19% in 1995, the price of competitive premium cable channels and non-cable-owned channels rose only 2%.
The Cable Monopoly: Horizontal Integration
The FCC's recent competition report predates the latest round of cable system acquisitions and swaps, which have increased the size and regional strength of the major cable MSO's. Even so, it showed that between 1995 and 1996 the four largest cable operators had increased their collective share of cable subscribers from 55% to 61.4% The HHI has risen from 1098 to 1326. Annual Assessment of Competition in Delivery of Video Programming, 12 FCCRcd at 442425. Regional clusters are growing especially quickly. Without even taking into account recent changes, such as TCI's swapping of systems with Cablevision and other larger MSO's, and Comcast's similar moves, the number of clusters serving at least 100,000 subscribers had increased from 97 to 137 between 1994 and 1995; the HHI of 7905 for the average local market is indicative of a very high degree of concentration.
The Cable Monopoly: Discriminatory Program Access
Recent hearings in this and other Congressional Committees have explored the cable industry's increasingly bold efforts to evade the provisions of Section 19 of the 1992 Cable Act, 47 U.S.C. §548.
Page 197 PREV PAGE TOP OF DOC Segment 2 Of 2 Section 19 prohibits vertically integrated cable operators from refusing to sell their major program offerings to DBS and other competitive distributors. It was predicated on the finding that the cable industry's ownership of, and exclusive access to, top-rank, established news, sports, feature film and premium services had been an effective entry barrier for new DBS and other multi-channel competition.
Similar concerns had also motivated a Department of Justice investigation which resulted in a consent decree shortly after the 1992 Act became law. United States v. PRIMESTAR Partners, 19941 Trade Cas. (CCH) 70,562 (SDNY).
The same barriers which impelled DOJ to obtain a consent decree, and motivated Congress to enact Section 19, are now being reestablished through two different mechanisms: terrestrial distribution and joint ventures.
Section 19 expressly applies only to satellite delivered programming. Regional concentration of cable systems has permitted terrestrial (i.e., non-satellite) distribution of regional sports channels and thus, arguably, relieves operators of the obligation to provide such essential programming to new competitors.
Integration of News Corporation's cable network lineup into the cable industry's distribution system has been used to justify similar access denials. News Corporation has developed partnerships and joint ventures with cable MSO's for program distribution. It would be a 20% owner of the new high-power PRIMESTAR DBS discussed below. However, since News Corporation is not itself a cable system owner, nothing in the 1992 Cable Act specifically precludes News Corporation from assisting its new partners (and itself) by withholding its increasingly important program roster from alternative cable, DBS and wireless cable providers.
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In light of the extensive Congressional attention which has been paid to this issue in recent weeks, I not will elaborate here, other than to observe that, in addition to the 1992 Cable Act, program access discrimination in some cases may also violate the DOJ's consent decree. This is a matter to which I would hope the Committee will afford ongoing attention.
The Cable Monopoly: The PRIMESTAR Initiative
The latest, and most ominous threat to competition is the cable industry's PRIMESTAR satellite service. To the extent that the FCC determines that it cannot or will not use the Communications Act to address this dangerous development, antitrust enforcement is the last protection against devastation of competition in the MVPD market.
The two major high power DBS services, Direct TV and EchoStar, pose the best and, perhaps, the last opportunity for serious national competition in multi-channel pay TV. Congress wisely chose to jump start DBS by guaranteeing access to the programming controlled by vertically integrated cable operators. Just as DBS started to gain a foothold, and just as News Corporation's AskyB was preparing to merge its DBS service with EchoStar to give viewers the option of a new technology that could provide local, as well as national network programming, News Corporation decidedor was induced to decideto abandon the venture. News Corporation and PRIMESTAR have now asked the FCC to approve a multi-faceted deal to merge News Corporation's DBS operation (with its otherwise unavailable high powered orbital slot) into a new PRIMESTAR corporation. Coincident with this transaction, News Corporation has received vastly extended cable TV distribution for its Fox News Channel, regional sports and other services, and it has stopped sharing much of its programming offerings with competing MPVD's.
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The PRIMESTAR/News Corp. applications presently pending at the FCC would magnify the industry's PRIMESTAR into a doomsday weapon which can completely destroy any prospect of competitive threat to cable from the DBS technology.(see footnote 81)
The PRIMESTAR deal turns the cable industry's DBS service from the weakest competitor to the strongest. PRIMESTAR, which presently operates as a partnership of six cable MSO's delivering a medium power signal to one meter sized satellite dishes, would be able to deliver a high power signal to 1218 inch dishes. PRIMESTAR would acquire, and thus deprive true competitors' access to, the third and only remaining DBS orbital slot capable of delivering a signal to the entire continental United States. It removes the potential of a highly innovative and competitive new technological innovation (local ''spot beams'') and concentrates ownership of cable orbital slots.
The harsh conclusion is that owners of PRIMESTAR would be able to use this national distribution capacity to compliment, rather than compete with, cable. Other DBS operators are unable to offer both local channels and national program services. However, in the 60% of the nation where PRIMESTAR's owners control cable franchises, it will be able to bundle a low-cost ''sub-basic'' cable service providing local over the air channels with its DBS offerings. (In its marketing documents, this is referred to as the ''Cable Plus'' service.)
As explained above, the alliance with News Corp. also permits evasion of the program access provisions of the 1992 Cable Act. Moreover, although News Corp.'s TV stations reach 40 of U.S. homes, its ''non-attributable'' relationship with PRIMESTAR would not trigger cable-TV cross-ownership regulations. News Corporation's cable networks, and presumably its over-the-air stations as well, will not be available to DBS competitors.
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PRIMESTAR is designed to undercut market share of DBS competitors. It has little incentive to compete with the cable companies which own it. Plans to limit access to ''Cable Plus'' to the PRIMESTAR companies foretells further inroads by those MSO's into the markets of small cable operators (which have opposed the transaction). Not surprisingly PRIMESTAR's structure insures that control of this vehicle will always remain safely in the hands of the cable industry. Its regional marketing program, arrangements for controlling membership on the board of directors, stock voting arrangements, and the elaborate contractual arrangements giving PRIMESTAR's cable system owners rights of first refusal in the case of a stock sale all manifest the importance placed on this control.
FTC AND DOJ ACTIVITIES IN THE WAKE OF THE 1996 ACT
Things are going in the wrong direction. The FTC and the Department of Justice need to do more, and quickly, to protect competition. This Committee should make sure that happens.
Even adequately funded antitrust agencies could not possibly address all the problems left untouched by the 1996 Act. I understand the heavy budget and legal burdens which antitrust enforcement agencies encounter in trying to monitor the explosive growth in the telecommunications markets. The Department of Justice and FTC have taken care to choose where and how to deploy these limited resources, and on the whole I think their decisions have been wise.
Although I was unhappy at the DOJ's unwillingness to challenge the Bell Atlantic/NYNEX merger, I know this was a close question. Given recent events, I doubt that future transactions of similar scale would receive a favorable reception. I hope that the decision to proceed against Microsoft by enforcing DOJ's earlier consent decree more nearly reflects current DOJ perspectives. The Microsoft action was a timely and efficient way to pursue some of the most important antitrust questions of the decade.
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While I was very disappointed at the FTC's failure to mount a full-bore challenge to the Time-Warner/Turner/TCI transaction last year, the Commission's decision to devote a high level of attention to the transaction was well-conceived and well-executed. Chairman Pitofsky has written eloquently about the importance of promoting the First Amendment goal of diversity in both the marketplace of ideas as well as the marketplace of commerce, and I especially support the FTC's efforts in the Time Warner/Turner case to promote development of competition in the satellite-delivered news channel market.
One area to which I would urge greater attention be paid is the need for the FTC and the DOJ to share expertise and experience with the Federal Communications Commission. Unlike DOJ and FTC, the FCC operates under a broader and more general mandate, with the power and discretion to explore what policies best serve the public interest. Except where the 1996 Act has directed the DOJ to express its views, DOJ and FTC have not often submitted comments to the FCC, even where potentially anti-competitive practices and policies have been under FCC review.
This is something of a change. For many years, DOJ and the FTC were among the FCC's most prolific federal pen pals. During the 1980's in particular, the FTC was especially active in submitting formal and informal comments supporting deregulation of one kind or another. To the extent that antitrust laws do not provide adequate remedies for anti-competitive practices, and where there are questionable transactions as to which DOJ and FTC lack resources to challenge directly, I would hope that the agencies will be more willing to communicate those concerns to the FCC.
A notable exception to this forbearance was the DOJ's opposition to cable industry entry into high-power DBS service. Two years ago, the DOJ submitted what I consider to have been thorough and persuasive comments urging the FCC not to permit large cable operators to obtain high-power Direct Broadcast Satellite Licenses. See, Comments of the United States Department of Justice, Dockets IB 95168 and PP Docket 93253 (filed November 20, 1995). Although the CC did not follow that recommendation at the time, cable industry conduct surrounding the new PRIMESTAR transaction gives these arguments have even greater salience today. These comments underscore the utility of such early participation, as well as the perspicacity of the Antitrust Division.
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EXPEDITED JUDICIAL REVIEW OF FCC ACTIONS IN LOCAL TELEPHONY
Although I have been asked to speak to video issues today, I do have one suggestion for the Committee with respect to local telephony: it should adopt an expedited and consolidated national judicial review scheme. This may be too late to obviate the public policy disasters of the last year, but the lesson should not be ignored for the future.
Perhaps the single most important impetus for the enactment of telecommunications reform legislation was the fact that a single unelected federal judge had, by default, emerged as the primary determinant of competitive entry into local communications markets. His actions were guided by antitrust laws, not the Communications Act. He had neither expert staff nor the right to initiate or change policy where it might have been worthwhile. His decisions were made without clear Congressional direction or oversight. We are fortunate that this Judge, Harold Greene, has been one the most dedicated, hard working and sophisticated of judges in the entire federal judiciary. Even so, no one, and certainly not Judge Greene, thought that it was wise to have vested so much power in him for so long.
With respect to the most important local competition issues addressed by the 1996 Act, things have changed very little. Three unelected federal judges, by default, preside over competitive entry into local communications markets. They are guided by the newly amended Communications Act, but they have neither the staff nor the right to substitute their own policy judgments for those of the expert agency. While the United States Court of Appeals has worked with great diligence and energy to resolve the appeals which have been placed before it, the task is not one they would have wanted, or one for which they have the resources to handle.
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This is not progress, and it could have been avoided.
In Section 561 of the 1996 Telecommunications Act, Congress did provide for expedited judicial procedures in two instances: the so-called ''Communications Decency Act,'' and the so-called ''V-Chip'' provision.
Congress should take similar action for local competition issues. It might simply provide for expedition by means of shortened briefing schedules, filing deadlines and, perhaps, direct Supreme Court appeal. Or it might use the model employed in some prior statutes by creating special multi-circuit panels to hear FCC appeals on an expedited basis. The judges appointed to such courts would develop expertise and provide national uniformity. Geographic balance could be obtained by directing that the membership of the court be composed of judges from each judicial circuit. The need for a special panel might well be transient, and a sunset provision would be useful.
There are those who have been critical of the old Temporary Emergency Court of Appeals established under Section 211(b) of the Economic Stabilization Act of 1970. The Court surely outlived its usefulness, and its abolition in 1992 was surely appropriate. However, my experience with that Court was that the first decade of its operation was highly beneficial, and greatly assisted commerce and the administration of justice by providing rapid and uniform decisionmaking on matters of national import. This informs my suggestion that a similar provision is needed to facilitate the development of digital telecommunications technologies.
Mr. HYDE. We'll give that our preferred attention. Thank you, Mr. Schwartzman.
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I'm going to only ask one question in the hopes I'm setting a precedent, but it will be of two of you, Mr. Welsh and Mr. Feidler. Your competitors say that if the Bells had truly opened up their networks and it is easy to get in, then the Bells should be entering each other's markets for local service. What's your response to this argument? Mr. Welsh?
Mr. WELSH. Well, Mr. Chairman, I think since 1993, when we introduced our Customers First idea, our primary focus has been on opening our local market to competition and I think we've made tremendous strides in that area and then preparing to get into long distance business. Our customers have said that's what they want. They would like to see one-stop shopping and full competition and that has been our number one focus, because that's what customers say they want the most from us.
In the future, will we be looking at other regions? That's a possibility. Unlike, I think one thing that wasn't mentioned here, we don't have a brand name that runs throughout the country and large numbers of customers throughout the country as we sit here today. But when customers want us to expand to compete in other areas, you may see us doing that then.
Mr. HYDE. Thank you. Mr. Feidler, same answer?
Mr. FEIDLER. No, actually we havelet me elaborate a little bitwe've actually created a separate organization to expand outside of our region. We're in the process of obtaining regulatory approval to do that. I would point out, however, that because of the absence of a national brand, our strategy will be to grow as our current customer base leads us outside the region with multi-state customers. Of course, until we can provide them a full complement of services in region, it's difficult to make a good proposition that we're the right party to take care of their business outside the region. So, it's gated somewhat by our inability to offer a full complement of products.
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Mr. HYDE. Thank you. Mr. Conyers.
Mr. CONYERS. Thank you, Mr. Chairman. I'm duty bound to follow my chairman. I am, he says. OK, letsand I'm duty bound to follow my counselhe says, I am, too.
OK, Ms. Murphy, what words of advice would you give to Mr. Schwartzman and Mr. Hoffman. I mean, you're telling everybody to keep a stiff upper lip, that competition is coming, can you help buoy them up with other than excellent rhetoric?
Ms. MURPHY. The ball is really in the court of the regional Bell operating companies. All they have to do
Mr. CONYERS. That's what I'm afraid of.
Ms. MURPHY. All they have to do is comply with the 14 point checklist and bundle their networks, make those elements available, put in the operational support systems and allow us access.
Mr. CONYERS. Well, Schwartzman doesn't understand that, does he? Oh, you're on a different subject? OK, you don't. OK, Mr. Hoffman, where do you weigh in on this stuff?
Mr. HOFFMAN. I agree with Riley completely. I said it in my prepared testimony. I didn't cover it in my opening remarks. There are a number of basic reasons why we're not seeing as much local competition as we all expected a year-and-a-half, two years ago. One of them is that it's very hard to provide local service. It is not easy and there's a lot of capital, a lot of human resources necessary to get the job done and it takes time. Number two, there are incentives, I believe, for the incumbents to maintain their market share, maintain their monopoly positions. They are not yet, I think, facing the kinds of incentives that they need in order to begin opening up their markets to competition. And thirdly, we're bogged down, frankly, in a lot of litigation right now. I don't believe that's wrong, I think that's a natural consequence of Congress passing a massive piece of reform legislation. Parties have got the right to go to court and try to get it interpreted one way or another, and that's what we're doing right now.
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Mr. CONYERS. OK, we're in substantial agreement, I guess. Let me ask Mr. Schwartzman this. You heard me refer to the multi-industry cartel on the video side. Now, the structuring going on restricts programming, encourages evasion of price regulation, encourages ducking around the rebroadcasting restrictions. Can this be documented?
Mr. SCHWARTZMAN. Mr. Conyers, the answer is yes. For purposes of this hearing, the easiest thing I might point to is that companies which are attempting to break into competition against cable, (including, Ameritech, which has been quite aggressive with it's cable systems) have filed program access complaints with the Federal Communications Commission, alleging violations of the program access provisions. The FCC has within the last six or eight weeks decided a few of those cases and found violations of the program access provisions. There are a number of major complaints which have been filed just in the last few weeks, alleging a wholesale pattern of these violations.
Mr. CONYERS. So, there's plenty of evidence around if we
Mr. SCHWARTZMAN. There's plenty of evidence and, now, some findings.
Mr. CONYERS. OK. Now, Mr. Welsh, long distance is coming down, the Bells have 90 percent of their marketlocal marketwhat's happening with the pricing there?
Page 207 PREV PAGE TOP OF DOC Segment 2 Of 2 Mr. WELSH. Well, I think the notion that overall long distance prices are coming down really is a misconception. A lot of people throw out figures over the last 13 years that they've come down, but over the past 5 years we've seen a number of lockstep increases from the major long distance carriers. Even the Department of Justice's own expert said that Bell entry, companies like Ameritech, entering in to long distance, will particularly help competition among low end residential and business customers who are not the ones who are really seeing competition in the long distance business. So, I think, first and foremost, we will bring a lot more competition to the long distance business when we're in it.
Mr. CONYERS. Well, how's that going, the getting in it?
Mr. WELSH. Well, that's what we're here to talk about today. I think, we
Mr. CONYERS. Let's talk about it.
Mr. WELSH. I think at the Department of Justice and the FCC, the balance hasn't been drawn correctly. That they focused on delay of our long distance entry in order to increasesure our OSS wholesale systems will go from 92 percent to 96 percent on some measure over the next year, but I think it's more important to look at the big picture and the benefits of increased competition in long distance rather than those micro-measurements.
Mr. CONYERS. They don't seem to get it do they?
Mr. WELSH. Well that'swe work hard with them and
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Mr. CONYERS. But you keep trying andwhat's his namewhose our guy from DetroitGary Lytleyou've been on an education program for a year.
Mr. WELSH. I can't speak for Gary Lytle.
Mr. CONYERS. Well, nobody speaks for Gary Lytle. We all know that. The point here is that are you going into out of region long distance or where?
Mr. WELSH. Well, actually we do. I mean, ironically, we're in providing long distance.
Mr. CONYERS. You're in a lot of places.
Mr. WELSH. We provide long distance out of our region. I mean, we can complete a call out of our region, but we can't do it to our customers within our region who we serve on a local basis.
Mr. CONYERS. OK, are there any markets where there's a significant facilities based competition that has more than 5 percent of the market? I know the answer to this.
Mr. WELSH. I think the answerI don't know exactly in terms of percentage markI think probably yes in Michigan with Brooks Fiber which is primarily a facilities based provider. In fact, I'm confident they have more than 5 percent.
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Mr. CONYERS. OK, I'll send you the rest of the questions.
Mr. WELSH. OK, thank you.
Mr. HYDE. Thank you, Mr. Conyers. The gentleman from Arkansas will have a question, maybe?
Mr. HUTCHINSON. Yes, thank you, Mr. Chairman. Mr. Welsh, in your written testimony, you referred to a decision of the 8th Circuit Court of Appeals and of course that's the circuit that covers Arkansas, the State which I represent. Could you explain, sort of in layman's terms, the effect of the 8th Circuit decision on what you desire to do?
Mr. WELSH. Yes, the origin of this decision comes really from a legal gambit that the interexchange carriers came up with to rewrite the acts rules for local entry. The long distance companies wanted an even bigger discount than the 20 percent discount that's provided for under resale under the act and it's a 20 percent discount of something that State commissions all over the country, you know, within 15 to 25 percent have come up with. So, the long distance companies came up with this new thing called unbundled network element platform and essentially under that idea, they take all of a local companies facilities, end to end, it's essentially the same as resale, identical to resale in practical terms, but the beauty of it, from the long distance carriers' perspective, is that gives them price arbitrage and under the rules they come up with a 50 percent discount or more under that unbundled network element platform. The 8th Circuit soundly rejected that theory. Said it's not permitted under that act. Said the law was clear: If competitors want to access unbundled network elements under the act, the competitor has to put the platform together themselves, you just can't take the equivalent of resale. They also said, that this theory that the long distance carriers came up with would destroy the careful distinction in the act between the resale pricing formula and the unbundled network element pricing formulas. You know, at those kinds of discounts, you would be killing investment in local networks which is why Time-Warner supported the position we had in the 8th Circuit and I just saw, from Monday, the CEO of Brooks Fiber, which is a competitor that's putting a lot of the numbers up there on the board in our region, they said that the competitive local carrier industry owes a debt of gratitude to the 8th Circuit. The fact that there will be no free ride for interexchange carriers seeking a cheap method of local market entry is a plus for our industry. Another CEO from a competitive provider said, interexchange carriers have been more interested in access price reform and not as interested in investing in the competitive local exchange industry, but with these recent rulings, quite frankly, they're going to have to wake up.
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Mr. HUTCHINSON. I only have time for one more question. You've talked about trying to meet the requirements set by DOJ and the FCC. How long do you think it's going to be before you're going to be able to meet their requirements?
Mr. WELSH. We work hard with them. One of the issues we're grappling with is that the DOJ and the FCC put in place a lot of performance measures that, frankly, we don't have in our business today, and it's very easy for a lawyer to say, here's a new performance measure, we'd like you to come up with that. It's a lot harder when you're literally managing tens of thousands of service calls a day to try to measure all that.
Mr. HUTCHINSON. Can you give us any timeframe?
Mr. WELSH. Timeframe? Months.
Mr. HUTCHINSON. Thank you. Thank you, Mr. Chairman.
Mr. HYDE. Thank you, Mr. Hutchinson. Mr. Delahunt, the last questioner before we go to the next panel.
Mr. DELAHUNT. I promise to be brief, Mr. Chairman. Ms. Murphy, your association is really aI think you described it as the entrepreneurial side of the telecommunications industry. You saidI forget your wordsbut in terms of dealing with the established carriers, do you have a sense that, in the problems that you have, it's a question of capacity and ability to meet your needs or do you have a sense that they're acting in a dilatory fashion to deter you in terms of growing your businesses?
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Ms. MURPHY. Frankly, I don't care if it's a question of malintent or negligence or just plain old delay, because these things take time to role out. I think the point is that we are in a development stage to get these interfaces in place and we have to let the process work itself out.
Mr. DELAHUNT. You have a problem with delay? If you have a complaint today, would your major complaint be delay?
Ms. MURPHY. It's a little more complicated than that.
Mr. DELAHUNT. Keep it simple because we're very simple-minded up here.
Ms. MURPHY. What we're looking for is seamless interconnection which means that from our customers perspective, from somebody that wants to get local service from a competitor, they can't tell the difference between being provisioned by the incumbent or being provisioned by the competitor. For that to happen on a transparent, seamless basis, there have to be complex interfaces between the competitor and the incumbent to allow those
Mr. DELAHUNT. So, is that happening at a rate which satisfies your needs?
Ms. MURPHY. Well, I think it's very telling that in March of 1997, there was an audit that BellSouth had performed internally to look at it's own internal processes and systems for this very provisioning type process. The audit found that there were alarming error rates and that the personnel that were required to implement this were not adequately trained, etcetera.
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Mr. DELAHUNT. OK, thank you, I have limited time and I just wanted to ask the rest of the panel whether when you're dealing with FCC and DOJ, you are frustrated sometimes by delays in getting a response? That'll be my last question.
Mr. FEIDLER. Let me take a shot at that. First, as to the audit. As Ms. Murphy said, that was back in March and we've since been audited twice since by the same firm. The whole point of the audit was to discover where our deficiencies were and they've now said that we've made a remarkable progress and have certified us. I think thoughI raise it as the example of that's what needs to be done, we need to take it seriously, we need to do the work and we're doing the work and we're frustrated that that's going to happen between business people. Trying to figure out how business ought to be done and not by regulators getting down to the level of trying to specify what the functionality of a software system ought to be or those kinds of things.
Mr. HOFFMAN. Congressman, Sprint comes at this a little bit different, I think, than other members of our industry. We try very hard to sit down and work with other companies to solve problems that way rather than go to court which is the preferred approach from a number of other companies in the industry. In fact, we're very proud of the fact that so far in this process, we've only filed complaints against three Bell companies. Unfortunately, two of the three are represented at this table. I kind of feel like a Bell sandwich here. The point I think is that where we want to compete's in the marketplace, not in the courtroom. I don't fault the FCC or the Department of Justice for delay, because we're not being delayed by them because we haven't got very much pending before them. We're trying to work it out in the marketplace instead. I think where the FCC should be aggressive is in the applications that the Bell companies file for authority to provide in region long distance service, not in the complaint process, but in the application process. In there, as been discussed this morning, the Department of Justice plays a role. I'd like to see the Department of Justice be more aggressive in that role. They haven't done some of the things that I have asked Joel Klein to consider doing, like asking questions aboutin Ameritech's case, they filed in Michigan. The evidence they presented was there was competition in Grand Rapids. At the time the Telecom Act was being debated, the Bell companies kept saying, the long distance companies are cream skimmers, they're going to come into our big markets, they're going to take away all our big customers. But, in Michigan, there's no competition in Detroit, most of it is in Grand Rapids. I wonder why? Those are questions I think the Department of Justice should be asking in the context of these applications.
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Mr. WELSH. Well, there is a lot of competition in Detroit, in fact, but to your question, Congressman, on a personal and professional level, to the extent your question is focusing on the energy and commitment put in by the people of the Department of Justice, I'd say that they have worked long and hard with us, going back to 1993 when we proposed Customers First.
Mr. DELAHUNT. It's really a question of do they have the resources.
Mr. WELSH. Well, you know actually this has been an amazing hearing where one Congressman, Congressman Bono, said he hadn't been lobbied enough, and now you. I was corporation counsel of the city of Chicago and no one from the city council ever said I'd like to give you more resources and increase your budget. So that really hasn't been the issue. I think the issue is more one of direction and we think that the talk about delay and going slowly isn't taking into account enough the benefits of our getting into long distance business and I think the benefits in the local market of our coming up to the door and getting into the long distance business.
Mr. CONYERS. Would the gentleman yield? You never let me down before, Bill.
What's the percentage of the market in the Detroit that your competitors have?
Page 214 PREV PAGE TOP OF DOC Segment 2 Of 2 Mr. WELSH. I don't know what the exact percentage is in Detroit.
Mr. CONYERS. How about 7 percent?
Mr. WELSH. It's possible.
Mr. CONYERS. How about 6 percent?
Mr. WELSH. I said I don't know what the percentage is in Detroit or in the State of Michigan.
Mr. CONYERS. How about 5 or 4 percent?
Mr. WELSH. I don't know what the number is, but you know I would say this, that the act you passed expressly rejected putting in a metrics test for when we get into long distance business.
Mr. CONYERS. Well, do me a favor. Sometime between now and next year, let's you and I count the competition in Detroit. OK?
Mr. WELSH. Well, I'd be happy to do that and I think the important point
Mr. CONYERS. We could do it on one hand and it wouldn't take a lot of time.
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Mr. WELSH. You know, I don't think that's true if you look at these numbers there close to 500,000 customer lines being served by our competitors in our region. Most of that is in Illinois and Michigan.
Mr. CONYERS. Well, what's the percentage of the market?
Mr. WELSH. Five hundred thousand as a percent of the total number of our lines isyou know we can do the mathis about 5 percent.
Mr. CONYERS. Well, OK.
Mr. WELSH. I can't tell you how that breaks out for Detroit.
Mr. CONYERS. The speaker's going to let us out this week or next. Let's get together and count them.
Mr. WELSH. Be happy to take you up on that, Congressman.
Mr. CONYERS. Thank you very much. We could let Mr. Lytle in on this, too.
Mr. WELSH. I'm sure he'd love that.
Mr. HYDE. The gentleman's time has expired.
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I want to thank this panel for your patience and for your illuminating testimony. We deeply appreciate it. You may hear from us again through the U.S. Postal Service or other means of communication.
The next panel will please take their places and indulge me for a 5 minute recess. So, the committee will stand in recess for 5 minutes and then we'll proceed.
Mr. HYDE. The committee will come to order.
Our third panel consists of witnesses who will discuss two of our topics of current interest: competitive issues in the airline industry and merger policy generally.
Our first two witnesses will discuss the airline industry. Professor Paul Dempsey is a graduate of the University of Georgia and its law school. He also holds degrees from George Washington University and McGill University. He is currently a professor of law and the director of the Transportation Law Program at the University of Denver College of Law. He is also vice chairman and a director of Frontier Airlines. He has written and spoken extensively about the airline industry.
Professor Steven Morrison graduated from the University of Florida, and he received his Ph.D. from the University of California at Berkeley. He is currently a Professor of Economics at Northeastern University. Before that, he taught at the University of British Columbia. Professor Morrison has written numerous books and articles on the airline industry.
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Our final two witnesses will discuss merger policy generally. Mr. Rick Rule is a partner with the Washington law firm of Covington and Burling. He is a graduate of Vanderbilt University and the University of Chicago Law School. After clerking for Judge Daniel Friedman, he joined the Antitrust Division in 1982, serving as head of the division from 1986 to 1989. He has written and spoken extensively on antitrust issues, and he practices primarily in that field at Covington and Burling.
Our last witness is Professor Robert Lande. Professor Lande is a graduate of Northwestern University and Harvard Law School, and he holds a Master's Degree from Harvard. Professor Lande served for 6 years at the Federal Trade Commission and also practiced law for 4 years. He joined the faculty at the University of Baltimore in 1987 where he became a full professor in 1995.
We welcome all of you and look forward to your testimony.
Mr. CONYERS. Mr. Chairman, before you start
Mr. HYDE. The gentleman from Michigan.
Mr. CONYERS. Could these professors help us with the problemand I know there's a first amendmentbut could we make Northwest stop saying some people just know how to fly? I mean, boy, what a nerve.
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Mr. HYDE. Well, we'll certainly take that under consideration. Talk about a conversation stopper, yes. [Laughter.]
Mr. HYDE. Professor Dempsey, please.
STATEMENT OF PAUL S. DEMPSEY, PROFESSOR, UNIVERSITY OF DENVER COLLEGE OF LAW
Mr. DEMPSEY. Mr. Chairman and distinguished Congressmen, my name is Paul Stephen Dempsey. I am a Professor of Law and Director of the Transportation Law Program at the University of Denver. It's a pleasure to be here today.
Let's talk about concentration at major airports. Today, more than one-half of the top 50 airports in the United States are dominated by a single airline. The empirical research that has been done by the Department of Transportation and the General Accounting Office shows that the impact on consumers is a price which is somewhere in the neighborhood of between 19 and 27 percent higher for travel to or from those concentrated airports than in competitive markets. It is a draconian tax on the consumer.
Studies also show that where there is a code-sharing relationship between carriers, there's an 8 percent tax, in the form of higher taxes, on consumers. Where there's slot constraints, there is another 7 percent tax on consumers. Some studies show as high as 15 percent. Where there are majority and interest clauses at airports, the tax is an additional 3 percent premium above competitive prices. The tax is a regressive tax, from consumers to producers, disproportionately imposed upon business travellers.
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Hub dominance is a product of several features. In part, it's a product of airline mergers. We had 21 of them. All of them were approved by the Department of Transportation. DOT never met a merger it didn't like. This Congress took the jurisdiction away from DOT and gave it to the Justice Department. There have not been lots of mergers since.
Majority in interest clauses at airports and exclusive long term gate leases at airports enable airlines to effectively veto new airport construction or expansion. We also have airlines exercising the opportunity to gain market share by buying or selling slots.
Beyond that, we have a number of predatory activities undertaken by major airlines, largely against their smaller competitors. When they compete against themselves, there's one kind of activity in terms of pricing and in terms of capacity. When they compete against Southwest, there's a similar type of activity. But when a new entrant airline, less well capitalized, enters their market, the major airlines tend to behave in a very harsh, anti-competitive effort which arguably is a violation of section 2 of the Sherman Act.
At Frontier Airlines, of which I am vice chairman, we have seen United Airlines dump excess capacity in Frontier's markets. For example, they increased the number of seats in the Denver-Los Angeles market by 8,600 a week over what they'd flown the year earlier, after Frontier entered that market. We've had below cost pricing. By our estimates, United Airlines has priced its product at 30 percent below its costs, at least, after Frontier entered the market. Then when Frontier withdrew from the market we saw prices go up to levels higher than they were at before the entry of the new low fare competitor. That's not unique to Frontier.
Page 220 PREV PAGE TOP OF DOC Segment 2 Of 2 We face CRS bias in the computer reservation system that United dominates. They add the equivalent of 1,440 minutes (24 hours) to Frontier's connections, vis-à-vis their own connections with their code-share partner. We face travel agent commission overrides which some would argue are a form of bribery. Bribing travel agents to steer consumers their way. We face code-sharing which some would argue is a form of fraud; selling consumers one product and delivering another; and we face exclusive dealing contracts.
Now, in 1996, a number of lowfare carriers presented their cases to the Department of Justice and the Department of Transportation. The DOT has jurisdiction very similar to section 5 of the Federal Trade Commission Act. Frontier Airlines and Western Pacific Airlines alleged that United Airlines was engaging in predatory practices; Vanguard and Sunjet International alleged the same with respect to American Airlines; Valujet alleged that with respect to Delta Airlines; and Reno and Spirit Airlines both have alleged anti-competitive conduct with respect to the activities of Northwest Airlines. To date, neither the Department of Transportation nor the Department of Justice has taken any formal action with respect to any allegation of anti-competitive activity directed at a smaller competitor by a larger airline despite the fact that more than 200 airlines have gone belly-up since the Airline Deregulation Act was passed in 1978. That's 19 years, Congressmen.
We would argue that it's time for these agencies to enforce the antitrust laws and we believe that the lack of enforcement has led the corporate management at major airlines to believe that the antitrust laws do not apply to this industry.
Page 221 PREV PAGE TOP OF DOC Segment 2 Of 2 [The prepared statement of Mr. Dempsey follows:]
PREPARED STATEMENT OF PAUL S. DEMPSEY, PROFESSOR, UNIVERSITY OF DENVER COLLEGE OF LAW
Studies by the GAO and DOT reveal that airline hub concentration results in consumer air travel prices which are between 19% and 27% higher than in competitive markets. Hub concentration is facilitated by several governmentally-imposed restrictions, including airport slot restrictions and perimeter rules. New airport capacity might improve the competitive environment if predatory activities by major airlines were circumscribed.
Major airlines engage in a number of anticompetitive practices designed to deter new competitive entry so as to extract supracompetitive profits from consumers in concentrated markets. These include:
Adding seat capacity and flight frequency to deny competitors of realistic or achievable break-even load factors (in the Denver-Los Angeles market, for example, United Airlines added 8,600 seats per week after Frontier airlines entered);
Dropping prices to below-cost levels (United dropped its prices in Frontier's markets by about 30% below United's costs, while raising prices sharply in its monopoly markets);
Refusing competitors non-discriminatory access to its network (through exclusive and discriminatory ticketing-and-baggage, joint-fare, frequent-flyer program, and code-sharing agreements);
Page 222 PREV PAGE TOP OF DOC Segment 2 Of 2 Biasing its computer reservations system against more convenient competitive offerings (by adding the equivalent of 1,440 minutes to interline flights in order to dominate the connecting market through its dominant hub);
Paying travel agents commission overrides to steer business toward major carriers and away from competitors; and
Entering into ''exclusive dealing'' arrangements with corporate purchasers and regional turboprop carriers.
Within the last year, a number of new entrant airlines have requested enforcement action against the predatory conduct of the major airlines form the Department of Justice and/or the Department of Transportation. The world's largest airline, United, targeted Frontier and Western Pacific Airlines. American allegedly targeted Vanguard and Sun Jet International. Delta allegedly targeted ValuJet. Northwest allegedly targeted Reno and Spirit Airlines.
To date, neither the Department of Justice nor the Department of Transportation has taken formal action with respect to any allegation of anticompetitive activity directed at a smaller competitor by a major airline, despite the fact that more than 150 new airlines have gone ''belly up'' since promulgation of the Airline Deregulation Act of 1978. Effective competition depends both on the elimination of barriers to entry caused by capacity constraints, and the application of the antitrust laws to commercial aviation.
Chairman Hyde, distinguished Congressmen, my name is Paul Stephen Dempsey. I am Professor of Law and Director of the Transportation Law Program at the University of Denver. I am also Vice Chairman and Director of Frontier Airlines, Inc. Thank you for inviting me.
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The new Frontier Airlines is a carrier born in the Summer of 1994. Today, it serves 14 cities with 13 Boeing 737 aircraft from a base in Denver, Colorado. Denver is a concentrated hub airport dominated by the world's largest airline, United Airlines. Frontier is a founding member of the Air Carriers Association of America. The Air Carriers Association was initially formed to deal with the effort of the major airlines to shift the tax burden away from the largest airlines and onto the smaller, affordable airlines. But as we came together, we learned we had something else in common. The major airlines appeared to be on a homicidal mission to destroy the low-fare airlines.
The window of opportunity appeared after the ValuJet catastrophe in the Everglades, on May 11, 1996. The Department of Transportation had been a champion of the competition brought to bear by the new entrant airlines, praising their annual $6 billion contribution to consumer savings as a clear success of deregulation. But the Everglades crash occurred in an election year, and for political reasons, DOT soon found itself neutralized. ValuJet's 53 aircraft were grounded. The question in the industry became, ''Why did Delta allow ValuJet to grow so large? Why didn't Delta kill off ValuJet when it had the chance?''
That mind-set put a number of relatively smaller airlines in the cross-hairs of the majors. It was open season on the upstart airlines. For example, the world's largest airline, United, targeted Frontier and Western Pacific Airlines. American allegedly targeted Vanguard and Sun Jet International. Delta allegedly targeted ValuJet. Northwest allegedly targeted Reno and Spirit Airlines.
Capacity dumping and below-cost pricing were the essential ingredients of this campaign to eradicate competition. In each situation, the tactics differed somewhat, but the purpose was the samedestroy the affordable airlines so as to raise consumer prices.
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The major airlines have falsely claimed that the economic problems which confronted the affordable fare airlines is that consumers shied away from them after the Everglades crash. In Frontier's case, bookings took a modest dip in May 1996, but then were restored relatively quickly. A far more significant hit in bookings occurred for Frontier in the Summer of 1996, coincident with Frontier's announcement of its first and second consecutive quarterly profits. It was at that point that United began a surreptitious campaign to destroy Frontier Airlines, engaging in the following practices:
Adding seat capacity and flight frequency to deny competitors of realistic or achievable break-even load factors (in the Denver-Los Angeles market, for example, United added 8,600 seats per week);
Dropping prices to below-cost levels (United dropped its prices in Frontier's markets by about 30% below United's costs, while raising prices sharply in its monopoly markets);
Refusing competitors non-discriminatory access to its network (through discriminatory ticketing-and-baggage, joint-fare, frequent-flyer program, and code-sharing agreements);
Biasing its computer reservations system against more convenient competitive offerings (by adding the equivalent of 1,440 minutes to interline flights in order to dominate the connecting market through its dominant hub);
Paying travel agents commission overrides to steer business toward United and away from competitors; and
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Entering into ''exclusive dealing'' arrangements with corporate purchasers and regional turboprop carriers.
I have published a study entitled Unfriendly Skies Over Colorado: United Airlines' Fortress Hub Monopoly At Denver, which chronicles United Airlines' activities over a 15-year period designed to establish and maintain a monopoly hub at Denver. Several studies by the U.S. General Accounting Office and the U.S. Department of Transportation reveal that a fortress hub monopolist charges origin-and-destination consumers between 19% and 27% more than consumers are charged in competitive markets. According to some sources, Denver's consumers now suffer the highest unrestricted air fares in the United States.(see footnote 82)
United falsely claims that Frontier advocates re-regulation of the airline industry.(see footnote 83) That allegation is patently absurd. Frontier is an airline born of deregulation, and has never requested re-regulation in any form. Frontier merely asks that the existing competition laws, applicable to every other industry in the United States, also be made applicable to the world's largest airline, United Airlines. One must recall the admonitions of Alfred Kahn, the father of deregulation, who repeatedly insisted, ''When we deregulated the airlines, we certainly did not intend to exempt them from the antitrust laws.''(see footnote 84) Yet the antitrust laws have not been applied with full force to the airline industry. Until 1985, the Civil Aeronautics Board provided antitrust oversight. With the sunset of that agency, it is now time for the Justice Department to fill the void.
Page 226 PREV PAGE TOP OF DOC Segment 2 Of 2 On February 11, 1997, Frontier Airlines filed a complaint with the U.S. Department of Justice alleging unlawful monopolization by United Airlines of Denver International Airport [DIA] and city-pair markets radiating therefrom. Frontier identified eight antitrust doctrines that United appears to have violated:
Dumping excess capacity into competitors' markets;
Refusal to deal;
Refusal to share an essential facility;
Raising rivals' costs; and
Exclusive dealing arrangements.
The following discussion elucidates the legal issues surrounding these anticompetitive activities in the airline industry.
MONOPOLIZATION UNDER THE ANTITRUST LAWS
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Section 2 of the Sherman Act provides that ''every person who shall monopolize, or attempt to monopolize . . . any part of the trade or commerce . . . is guilty of a felony.''(see footnote 85) A Section 2 claim can be brought against the use of monopoly power ''to foreclose competition, to gain a competitive advantage, or to destroy a competitor.''(see footnote 86) Frontier believes United Airlines' activities over the past 15 years have been aimed at destroying competitors, controlling prices, and foreclosing competition at Denver, Colorado. United first targeted its anticompetitive practices at its two Denver hub competitorsthe original Frontier Airlines,(see footnote 87) then Continental Airlines.(see footnote 88) More recently, it targeted the new low-cost/low-fare competitors which inaugurated significant operations at DenverMarkAir,(see footnote 89) Western Pacific Airlines, and the new Frontier Airlines.(see footnote 90)
Monopoly power is the power to control prices or exclude competition.(see footnote 91) The creation or maintenance of a monopoly by illegitimate means is prohibited by section 2 of the Sherman Act.
The offense of attempting to create a monopoly requires proof of: (1) a specific intent to control prices or eliminate competition in a market (objective evidence of intent is sufficient); (2) predatory or anticompetitive conduct aimed at accomplishing this unlawful purpose; and (3) a dangerous probability of success (a realistic danger that if the defendant's conduct runs its course, it would create a monopoly).(see footnote 92) Intention can be proven by establishing either an intent to achieve monopoly power or an intent to drive competitors from the market so that it could later charge monopoly prices.
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United Airlines' ''High On Denver Plan,'' launched in 1982, targeted the original Frontier Airlines with a massive increase in capacity and flight frequency at Denver,(see footnote 93) below-cost pricing, and computer reservations system [CRS] display bias. The result was Frontier's bankruptcy in 1986.(see footnote 94) United's self-proclaimed ''aggressive plan for expansion'' in Denver, launched in 1992(see footnote 95) with another massive increase in capacity and flight frequency at Denver, succeeded in eliminating Continental as a hub competitor at Denver by 1994.(see footnote 96) By the time United had forced these two hub competitors out of Denver, United achieved a monopoly at Denver, controlling 70% of all passengers.
A claim of monopolization requires proof of: (1) the possession of monopoly power in a relevant market; and (2) the exercise of one or more impermissible exclusionary practices designed to strengthen or perpetuate its monopoly position (or put differently, conduct directed at ''smothering competition'').(see footnote 97) Monopolization refers to activities that may be illegal if performed by the dominant firm in a relevant market.(see footnote 98) Thus, practices which do not in themselves constitute an antitrust violation may, in conjunction with overwhelming market power, violate section 2.
Monopoly power is a large amount of market power, or the ability to reduce output and raise prices above marginal costs. Market share in a relevant market is generally accepted as an effective surrogate for direct measurement of market power. Generally speaking, the defendant must have 70% or more of the relevant geographic and product market, which United Airlines has at its Denver Fortress Hub and most city-pair markets radiating therefrom. The following table(see footnote 99) reveals that United Airlines has 100% of the capacity (measured by departures or seats) in 30 of its 52 non-stop markets radiating from its Denver Fortress Hub, and more than 70% in 9 additional city-pairs radiating from Denver. Coupled with its code-sharing affiliates, United controls 100% of 71 non-stop city-pairs radiating from Denver. Clearly United is a monopolist in these non-stop markets, and at its Denver Fortress Hub.(see footnote 100)
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The above data may be summarized as follows:
On February 11, 1997, United increased its frequencies in two important Frontier markets55% in the Denver-Phoenix market, and 71% in the Denver-Las Vegas marketwith its self-described competitive ''weapon,'' Shuttle by United. Frontier was forced to abandon the Denver-Las Vegas market, thought it still provides competition in the Denver-Phoenix market. United's conduct clearly reveals its belief that the competition provisions of the Sherman and Federal Aviation Acts do not apply to it.
A relevant geographic market is an area where the dominant firm can increase its price without large numbers of consumers turning to alternative supply sources outside the area, or producers outside the area can quickly flood the area with substitute products. The relevant geographic market in commercial aviation is certainly city-pairs; it may also include domination of a hub airport, where its large number of banks of flights from numerous cities enable it to dominate the city's local passenger market. In terms of the anticompetitive and monopolistic practices of United Airlines directed at Frontier, the relevant geographic market is Denver International Airport [DIA] and city-pairs radiating therefrom. Colorado Springs' airport, some 75 miles south of Denver, beyond Monument Pass (at an elevation of more than 7,000 feet above sea level), is too far from Denver to provide effective competition to all but the most price sensitive consumers. Extensive studies of the consumer impact of hub monopolization conducted by the U.S. Department of Transportation and the U.S. General Accounting Office conclude that a dominant airline charges prices between 19% and 27% higher for passengers beginning or ending their trips at a monopoly hub airport than prices for similar distances in competitive markets. United and its code-sharing affiliates control nearly 80% of passenger traffic at Denver International Airport, and more than 95% of the connecting market at DIA.(see footnote 101)
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The relevant product requires an assessment of the products which are sufficiently close substitutes to compete effectively in each other's markets.(see footnote 102) Scheduled passenger air transportation is probably the relevant product market in commercial aviation (the competitive alternatives of rail, bus and automobile transport, or freight transportation, likely can be ignored). Since Frontier offers only coach service, the relevant product market that United seeks to dominate at Denver is coach service.
Frontier believes the relevant product markets are non-stop passenger air transportation to and from Denver, and connecting service to and from other cities via Denver. One alternative product market to the non-stop market to and from Denver is connecting service via other hubs. However, connecting service is viewed by most consumers as an inferior product alternative to non-stop service, and has only a marginal competitive impact on non-stop service. One alternative product to the connecting service to and from other cities via Denver is connecting service via an alternative hub. But because of geographic proximity, Denver is unique in its dominance of cities located throughout the Rocky Mountain and western Great Plains region.
Denver is perhaps the nation's most geographically isolated airline hub. Denver is approximately 400 miles from Salt Lake City, 600 miles from Phoenix, 650 miles from Dallas, 700 miles to Minneapolis, 800 miles to St. Louis, and 900 miles to Chicagoall potentially competing hubs. Because most passengers prefer the shortest connecting flights (and CRS algorithms prioritize flights, in part, on elapsed time from origin to destination), sales of circuitous connections are relatively infrequent. For example, most passengers flying from the state capitals of Oklahoma City, Oklahoma, to Laramie, Wyoming, would not likely fly via Dallas or St. Louis. They would instead fly via Denveron United, which has 100% of the flights from Oklahoma City to Denver, and United Express, which has 100% of the flights from Denver to Laramie. Similarly, most passengers flying from the state capitals of Albuquerque, New Mexico, to Des Moines, Iowa, would likely fly directly via Denver on United rather than circuitously through the competing hubs of Minneapolis, Chicago, St. Louis or Salt Lake City. Thus, the geographic scope of United's monopoly domination is vast. Moreover, in the Albuquerque-Des Moines example, Frontier ordinarily would not be allowed to participate as a viable competitor in the Albuquerque-Denver market (though it has two flights a day in this market), because United denies Frontier a joint-fare relationship, a code-sharing agreement, Mileage Plus participation, and saddles its flights with the equivalent of 24 hours in the CRS algorithm so as to shove its flights off the first page of the CRS screen, where 85% of flights are sold by travel agents.(see footnote 103)
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This ''dead zone,'' devoid of significant competition is broader than the circumference described in the preceding paragraph. Generally speaking, the operational economics of jet aircraft with more than 100 seats make them best suited for flights of more than 400 miles. The zone of less than 400 miles is dominated by turboprop and relatively small jet commuter aircraft. Moreover, most passengers prefer jets to turboprop aircraft. Thus, the turboprops generally serve relatively small cities (for larger cities are served by larger jet aircraft). That makes the United dominated zone for connecting traffic in the Great Plains/Rocky Mountain region extend beyond the perimeters described above. Even a 500 mile stage length poses a significant cost penalty for established major airlines:(see footnote 104)
The point is, United's dominance of the connecting market in the Rocky Mountain/Great Plains region encompasses a broader geographic area than the straight-line distances between Denver and these competing hubs.
One who effectively controls a market may not lawfully use any exclusionary practice against a competitor, even though it is not technically a restraint of trade in violation of section 1 of the Sherman Act.(see footnote 105) A monopolist may not legitimately deter potential competitors from entering its market or existing rivals from increasing their output.(see footnote 106) Under certain market conditions, the following constitute illegitimate exercises of monopoly power:
Page 232 PREV PAGE TOP OF DOC Segment 2 Of 2 1. Expansion of output or capacity.
2. Predatory pricing.
3. Pricing discrimination.
4. Monopoly leveraging.
5. Refusal to deal with a competitor.
6. Refusal to share an essential facility.
7. Raising rivals' costs.
8. Exclusive dealing arrangements.
EXPANSION OF OUTPUT OR CAPACITY
Professor Hovencamp notes, ''excess capacity can be part of the entry deterrence strategy of a dominant firm. The dominant firm can hold its excess capacity, plus the threat of future output increases, over the heads of smaller firms thinking about enlarging output or entering the market.''(see footnote 107) In the seminal decision of U.S. v. Alcoa,(see footnote 108) Judge Learned Hand held that Alcoa had actively discouraged new entry into the aluminum production industry by expanding its capacity more rapidly that the demand for its output warranted. Alcoa's program of accelerated development effectively foreclosed entry, and was ''exclusionary,'' because it denied potential competitors a fair share of the market. Similarly, United's 30% increase of capacity in Frontier's markets, at a time when passenger demand at DIA (measured by passenger enplanements) increased only 3% and United's enplanements increased only 7% is prima facie evidence of a capacity expansion which unlawfully deters entry. For example, during the peak summer travel period of 1996 (June, July and August), United increased capacity in the Denver-Los Angeles by an average of 8,600 seats a week compared with the same period a year earlier, before Frontier entered the market.(see footnote 109)
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United increased its frequencies in the nonstop Denver-Los Angeles market from 14 daily round-trips in August 1994, and 15 in August 1995, to 20 in August 1996. That increased United's share to more than 90% of the flights in that city-pair market. The Denver-Los Angeles market is the sixth biggest market in United's system,(see footnote 110) and United was determined to increase its monopoly position in the market. Comparing August 1995 to August 1996, United also added a new daily round-trip flight in the Denver-San Francisco market and the Denver-Salt Lake city market, and two in the Denver-Las Vegas market. Again, flights were added in these markets after Frontier entered.
Comparing 1996 with 1995, in the Denver-Las Vegas Market, United increased its seat capacity up to 71% and flights 37%; in the Denver-Los Angeles market, United increased seats up to 34% and flights 33%; in the Denver-Phoenix market, United increased seats up to 38% and flights 27%; and in the Denver-San Francisco market, United increased seats up to 19% and flights 16%. At cities Frontier departed, United tended to reduce seat capacity and flights, year over year. For example, in the Denver-Billings market, United reduced seats and flights by as much as a third.
The costs of adding capacity to a market are significant. They include the purchase price or lease on additional aircraft (or the opportunity costs incurred when re-deploying existing aircraft), training and salaries of flight crew, fuel, meals, distribution costs (including travel agent commissions, and computer reservations systems fees, and advertising), gate leases, aircraft maintenance, catering, ticketing costs, and so on. As explained below, Frontier believes that the cost of increasing output by one unit of production (an aircraft) is approximately 8085% of fully allocated costs, and higher than that for a large mature carrier, like United.
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Fully allocated costs are used to determine route profitability and unit costs within the airline industry. These costs are adjusted for stage length in order to determine the economics of flying specific routes as there is a cost taper that occurs based upon the intended stage length. Specifically, short haul flying is more expensive to fly than longer stage lengths. Because short hauls require higher fuel burn per mile traveled, less efficient aircraft utilization, and higher cycle related maintenance and ground handling costs, the shorter the distance flown, the higher the cost per mile.
Roberts Roach & Associates, in their definitive work on this subject, ''Scorecard: Airline Industry Cost Management,'' have identified by airline, and by aircraft type, the ASM cost of each major air carrier. Their cost work only addresses fully allocated costs.
Incremental costs are less understood on an industry wide basis, as the specific elements peculiar to each airlines incremental costs are not available to the public. An airline such as Frontier, considering the addition of a specific aircraft to its fleet, uses these costs to determine the impact of this potential addition to its overall costs and upon its specific route revenue analysis.
Route decisions and fare policy are not determined by incremental costs but are made on the basis of fully allocated costs. Similarly, when moving equipment from one route placement into another, only fully allocated costs are considered with adjustments, as appropriate, for changes in stage length.
Each airline would have a set of specific outcomes for each stage length and aircraft type. But if the relationship of incremental cost and fully allocated cost can be said to remain in the 80%85% range of fit (as adjusted for specific stage length) then one can begin to draw some conclusions about fare levels and their purpose and intent. Given the maturity and size of United's fleet, that percentage would likely be higher by a significant measure.
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It is our belief that fares designed to match a competitor's fare are a competitive tool designed specifically to insure that market share is not lost through competitive air pricing. It is also our belief that this is true whether or not air fare matching occurs at levels below either fully allocated cost or incremental cost. (Given United's scheduled departure frequency, market dominant Mileage Plus plan and more expansive meal and customer amenities, one could also argue that a price match is, indeed, a price undercut. Moreover, mileage awards are a de facto form of price rebating, and therefore, price undercutting).
But if prices are lowered below cost and below the competitor's prices, it may constitute anti-competitive or predatory behavior. The sample fares used from UAL's December fare sale are examples of what we believe are predatory prices. These prices reflect a reduction of approximately 10% in the fares charged by Frontier at the time of the sale. United has indicated that these prices reflect a competitive response to Western Pacific pricing in Colorado Springs and were therefore a price matching effort on the part of United. They have also indicated that these prices were designed to pass through the federal excise tax benefits that would be occurring on January 1. Perhaps that rationalization would be plausible had United increased prices in August when the excise tax was re-imposed, but United did not. These specific responses help to blur United's behavior and obfuscate its true motives. In fact, United dropped its $69 fare to $63. Frontier had only one choiceto match United's fare, and to take larger losses in important city pair markets where the two airlines compete.
Throughout the period, August 27 to December 31, 1996, Frontier made seven separate efforts to increase its lowest fares in an effort to recoup the net impact of the excise tax and higher fuel costs. These failed, as United took advantage of this interval to ''lock down'' prices at the lowest fare levels in Frontier's markets, while raising its prices in non-Frontier market prices to fully recoup the tax and fuel cost increases.
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Given the specific cost and tax issues extant during this unique period, we can only conclude that United engaged in a practice virtually identical to price undercutting, unless they were not subject to either the federal excise taxes or to the general fuel price increases.
United's predatory price behavior was not evident until August of 1996. Prior to this time, Frontier price increases and decreases had almost universally been matched by United. We are completely persuaded that United used the excise tax renewal and the fuel price increase as an opportunity to marginalize Frontier while maximizing their new seasonal capacity to draw traffic away from its sole competitor.
The failure to define a rational and comprehensive view on predatory pricing behavior within the aviation markets has led to consistent abuse of this practice throughout the United States. Following deregulation in 1978 we have witnessed the end of competition and even air service in so many markets that the major carriers responsible for this phenomenon believe that they are now insulated from the law and its enforcement. This is morally wrong, and should be redressed if we expect to have a bridge to a 21st century that includes truly competitive air service.
Predatory pricing has been defined as pricing below an appropriate measure of cost for the purpose of eliminating competitors in the short-term and reducing competition in the long-term.(see footnote 111) Stated differently, predatory pricing refers to selling output at an artificially low price to drive a competitor out of business, or dissuade a potential competitor from entering the market.(see footnote 112) Under neo-classical free market theoretical beliefs, such predation is irrational, for the dominant firm engaging in the predatory behavior must be able to recover the short-term losses it incurs in the longer term after it has driven the new entrant from the market; since it theoretically can never hope to recover its short-term losses, it will not likely engage in such predation. Hence, some commentators argue that predatory pricing schemes are rarely attempted, and even more rarely successful.(see footnote 113)
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Despite the theoretical opposition to predation based on its hypothetical irrationality, airline observers have seen numerous examples of predatory behavior in the airline industry attempted since deregulation, with various degrees of success. Airline deregulation's principal architect, Alfred Kahn criticized Northwest Airlines for its ''scorched-earth'' policy of substantially undercutting People Express' price while simultaneously increasing the number of flights in the market, saying:
If predation means anything, it means deep, pinpointed, discriminatory price cuts by big companies aimed at driving price cutters out of the market, in order then to be able to raise prices back to their previous levels. I have little doubt that is what Northwest was and is trying to do.(see footnote 114)
An established carrier which finds its spokes assaulted by a new entrant typically will cut prices below cost to meet the competition. Both will lose money, for such pricing behavior deprives low-cost competitors of adequate load factors to achieve break-even levels. But large carriers have the ability to cover short-term revenue losses from profits derived from less competitive markets.(see footnote 115) Typically, the major airlines offer the low fare only on local origin-and-destination [O&D] traffic on flights in close time proximity to the new entrant's, extracting higher yields from passengers connecting to the assaulted spokes. This revenue advantage may neutralize the new entrant's cost advantage and will deleteriously impact its staying power.(see footnote 116) Deregulation architect Michael Levine notes, ''The ability of an incumbent to respond rapidly and cheaply to the prices and output of new entrants contradicts perhaps the most critical assumption of contestability theory.''(see footnote 117) The theory of contestability posits that the absence of barriers to entry and economies of scale will allow potential entrants to discipline monopolists from earning supra-competitive profits. While many deregulation proponents of deregulation originally embraced this theory, most have since rejected it based on the empirical behavior of airlines in the post-deregulation period. We will address contestability in greater detail below.
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The U.S. Supreme Court last addressed the issue of predatory pricing in a 1993 tobacco industry case of Liggett & Myers v. Brown & Williamson Corp.(see footnote 118) The court re-emphasized that the antitrust laws were passed to protect competition, not competitors, and said a plaintiff had to prove the following:
1. The prices complained of must be below an appropriate measure of its rival's costs.
2. The below-cost pricing must be capable of producing the intended effects on the firm's rivals, such as driving them from the market. This requires an evaluation of the extent and duration of the alleged predation, the relative financial strength of the predator and its intended victim, and their respective incentives and will. The issue is whether, given the aggregate losses caused by the below-cost pricing, the intended target would likely succumb.
3. The competitor must have a reasonable prospect (or a dangerous possibility) of recouping its short-term investment in below-cost prices by achieving longer-term monopoly profits. Once the rival is driven from the market, it must be likely that the predator will be able to raise prices above a competitive level adequate to recover the amounts expended on the predation, including the time value of the money invested in it. In other words, the predator must be able to obtain sufficient market power to set its prices above competitive levels for a sufficient period of time in order to earn excess profits beyond those lost during the period of below-cost pricing.(see footnote 119)
In Brown & Williamson, the Supreme Court sustained dismissal of a $149 million jury award for Liggett, principally because it had failed to show how B&W, with only a 12% market share, could recover its investment in below-cost sales. In contrast, United and its code-sharing ''United Express'' affiliates have nearly a 70% market share at DIA,(see footnote 120) and has been extremely successful in recovering short-term losses by raising prices sharply in markets which competitors have exited.(see footnote 121)
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With respect to the first criterion, some courts have endorsed the ''Areeda-Turner'' test, which uses average variable costs as a proxy for marginal costs, although the U.S. Supreme Court has yet to prescribe which measure of cost should be used. In fact, the Court has held that ''no consensus has yet been reached on the proper definition of predatory pricing'' and left open the question of whether ''above-cost pricing coupled with predatory intent is ever sufficient to state a claim of predation.''(see footnote 122) The U.S. Supreme Court has also emphasized that antitrust claims are to be resolved on a case-by-case basis, focusing on the particular facts before it.(see footnote 123)
The difficulty of using variable costs as a proxy for an airline's marginal costs is that they are extremely small in the airline industry, and nowhere near what would be necessary to attain break-even. An additional passenger on a scheduled flight costs the airline ''peanuts,'' literally and figuratively. If every airline priced every seat on the basis of average variable costs, all would be bankrupt within a year. Because commercial aviation is a capital intensive industry, with an extremely high ratio of fixed to variable costs, the airline industry is unique, and some other measure (perhaps fully allocated costs or, as suggested above, incremental costs) is appropriate. Our analysis has already shown that United prices at least 30% below its fully allocated costs in Frontier's markets.(see footnote 124) And as suggested above, United's incremental costs are likely above 8085% of its fully allocated costs. Thus, United is pricing below an appropriate measure of its costs.
The Denver market is estimated to be about a $5 billion revenue prize. With approximately 300 daily departures and service to 62 cities, United has the market power to influence passenger choices through its schedule frequency and frequent flyer program. United also controls the regional distribution channels through the use of a large corporate discount program and the payment of commission overrides to key travel agencies.
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However, United is a relatively high-cost airline when measured in industry terms of Cost per Available Seat Mile [CASM].(see footnote 125) Airlines enjoy a significant cost taper over distance. Using second quarter 1995 data (the most recent data we could find) produced independently by Roberts Roach & Associates, when adjusted for stage length (the length of the flight), United's system-wide operating costs are as follows:
UNITED AIRLINES DOMESTIC BOEING 737300 AVAILABLE SEAT MILE COSTS(see footnote 126)
Stage Length (miles) United ASM Costs
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These data assume 100% break-even load factors (selling a sufficient number of seats to cover fully allocated costs). But because of hourly, daily, seasonal and directional cycles in demand, no carrier achieves 100% break-even load factors (most major airlines achieve annual average load factors of between 65% and 70%). Thus, these data understate, by about a third, the actual Revenue per Available Seat Mile [RASM] needed to achieve break-even load factors. In other words, United's average prices should be about a third higher than these ASM costs in order for it to break-even. For this reason, the following analysis errs on the side of conservatism.
Comparing Frontier's ASM costs to United's requires an apples-to-apples comparison of stage-lengths. In the second quarter of 1995, Frontier's average stage length was 407 miles; Frontier's ASM costs were 9.29 cents per mile. As the above table reveals, United's ASM costs at a 400 mile stage length were 13.35 cents per mile. Thus, Frontier's costs are at least 30% lower than United's. Operating costs at Denver are likely higher than United's system-wide averages revealed in the above table, somewhere in the neighborhood of an additional one cent per ASM. This suggests the difference in Frontier's vis-à-vis United's costs is even greater than 30%.
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Despite the fact that United's costs are significantly higher than Frontier's, United is pricing not only below its costs, but below Frontier's as well. In several instances, United has lowered prices below Frontier's lowest price. United is pricing significantly below its true operating costs in order to disrupt, disable or destroy its low-fare competitors.
As the table below reveals, the sale fares announced by United Airlines in December 1996 averaged 99.47% of United's unit costs. But in city-pair markets radiating from Denver in which Frontier competed, United's prices were only 68.85% of cost, and in markets where Frontier does not compete, United's prices were 109.04% of costs. Stated differently, in markets in which Frontier competes, United prices its product an average of 31% below its costs. United cross-subsides these losses with revenue derived from non-competitive and international markets.
For three reasons, these data understate the differential between United's costs and prices by a significant margin. First, given that most major airlines fill only about 65% to 70% of their seats annually, these data understate the United's break-even revenue requirements by about one-third. Second, the significant increase in the cost of aviation fuel has not been included. Fuel cost between 5254 cents a gallon in the second quarter of 1995; by the fourth quarter of 1996, it had increased 23%, to more than 70 cents per gallon.(see footnote 127) Third, the above calculations are based on United's system-wide costs which are lower than operations from DIA, for Denver International Airport's fees account for about one cent per ASM higher than other airports. In other words, the difference between United's costs and its prices is significantly greater than these calculations. Finally, these prices are United's lowest. Frontier does not have the proprietary data to determine the size of the inventory over which these seats have been spread. However, Frontier's booking and sales data suggest that United's low-fare seat buckets were opened wide after Frontier announced quarterly profits.
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Even before entering Denver's largest air passenger markets, Frontier had already brought down United's fares here and there. For example, before Frontier's entry into the Denver-Omaha market, United's lowest walk-up fare was $460 round-trip. Frontier entered with a $140 fare, which United promptly matched. According to U.S. Department of Transportation data, in the first quarter of 1994, United's average one-way fare in the Denver-Albuquerque market was $187; in the fourth quarter of 1994, as Frontier entered the market, United's average one-way fare dropped to $87. In the Denver-Bismarck market, United dropped its average $310 fare to $104 after Frontier entered.
Beginning in 1995, Frontier began entering Denver's largest nonstop markets. In the Denver-Los Angeles market, United's average one-way fare dropped from $163 in the third quarter of 1995, to $122 as Frontier entered in the fourth quarter of 1995. In the Denver-Phoenix market, United dropped its average one-way fare from $147 in the second quarter of 1995, to $89 in the fourth quarter of that year.
American Express reported that Denver's cheapest fares fell 44% in November 1996 (compared to a year earlier) for 10 routes out of Denver in which Frontier competed. In contrast, United's business fares increased 21%.(see footnote 128) The unrestricted business fare also becomes a revenue source with which to cross-subsidize below-cost pricing against competitors. In a letter to the editor of the Denver Post, one consumer summarized what more and more Colorado residents are experiencing:
I travel extensively on business, and it is my experience that United is deliberately manipulating prices to put its competitors out of business.
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A recent round trip to Boston on United cost $1,667. The following week, I flew to Minneapolis, again on United, at a cost of $146. The difference is because Frontier flies to Minneapolis. United is charging excessive fares on some routes and using the profits to undercut competition where it exists.
This unethical behavior would be bad enough on its own. But United is using the taxpayer-supported airports, and the taxpayer-funded air traffic control system in its anti-competitive efforts.(see footnote 129)
United's pricing in markets Frontier has been forced to abandon is even more remarkable. In the Denver-Billings market, United's average one-way fare was $168 before Frontier entered (in the third quarter of 1994); United dropped it to $92 after Frontier entered (in the first quarter of 1995), then increased it to $208 after Frontier departed. United's average one-way fare in the Denver-Tucson market was $178 in the second quarter of 1994, dropped to $104 after Frontier entered, then rose to as high as $186 after Frontier departed. United offers high prices before and after low-fare competitors enter its markets, but not while it is trying to drive them out of its markets. Indeed, United uses the high prices it extracts from its monopoly markets to cross-subsidize below-cost predatory pricing in markets in which low-cost carriers dare to enter.
All airlines suffered higher costs in the second half of 1996. Fuel costs increased between 18% and 25%. Congress re-imposed a 10% excise tax in late August. Frontier attempted to raise its prices modestly to recover these costs on six different occasions. United matched only one of those price increases in markets in which Frontier offers service, but raised prices significantly in many markets in which Frontier does not. Of course, Frontier has no choice but to reduce its prices to United's level, even though United has set them at levels below Frontier's costs, and well below United's.
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Taking advantage of this unique intersection of two potentially unfavorable events (the double whammy of sharply higher taxes and fuel costs), United appears to have initiated a deliberate effort to suppress prices at the lowest end of their pricing scale. Simultaneously, year over year, coinciding with the end of Frontier's first two profitable quarters, United dramatically expanded seat and flight capacity available at these lower prices so that Frontier's profitability would turn south.(see footnote 130)
This had the effects of eroding Frontier's market share, causing a decline in Frontier's load factors, eroding Frontier's yield, and creating a higher break-even load factor requirement for Frontier precipitated both by lower average fares and higher unit costs. Frontier's seven consecutive months of profitable operations have turned into significant monthly losses.
This appears to be a deliberate effort to cause Frontier to hemorrhage revenue. United knows that only a fool enters a bleeding contest against a blood bank. While consumers enjoy a short-term benefit in below-cost pricing, they will again enjoy the monopoly pricing of United if it is successful in driving Frontier from the market.
Until May 1996, United matched Frontier's lowest fares only on flights in close departure proximity to Frontier's flights.(see footnote 131) That month, United matched Frontier's fares on all flights, spreading its lowest fare buckets across square miles of seats. To add insult to injury, by the fall of 1996, United was under-pricing Frontier on many routes in which they competed, despite United's significantly higher cost structure.(see footnote 132) United then began to add flight frequencies in several of the markets in which Frontier competed.
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With respect to the second criterion, Frontier's bookings plummeted when United put Frontier in its cross-hairs, beginning in August 1996, shortly after Frontier announced its second consecutive quarterly profit.(see footnote 133) United Airlines is the largest air carrier in the world. Because it earns supra-competitive profits in its monopoly markets, it can cross-subsidize below-cost pricing for an extended period of time in order to drive a smaller competitor like Frontier out of business, unless of course, United is forced to abide by the antitrust laws.
Finally, given United's history in Denver, and its overwhelming market dominance of DIA, its ability to recover short-term losses criteria manifest. Because of the structure and conditions of the Denver market, and the tacit oligopolistic agreement between major carrier rivals not to engage in vigorous pricing or capacity competition in their city-pair markets, United is able to engage in sustained supra-competitive pricing once its prey has been subdued. One need only examine United's pricing behavior in the Denver-Tucson and Denver-Billings market to see evidence of that.(see footnote 134) United's average one-way in the Denver-Tucson market was $172 before Frontier entered, then dropped to $104 during Frontier's presence, then rose to $186 after Frontier departed. In the Denver-Billings market, United charged $168 before Frontier entered, dropped it to $92 during Frontier's presence, then raised it to $209 after Frontier departed.(see footnote 135) As these examples reveal, United has lowered its prices to below-cost levels in order to drive competition out, then raise its prices to supracompetitive levels following restoration of its monopoly in order to recover the short-term losses sustained in its predatory battle.
Contestability theory would suggest that a monopolist would be unable to earn supra-competitive profits after driving a competitor from a market. But most empirical studies have demonstrated that deregulated airline markets are not perfectly contestable,(see footnote 136) and that there is a positive relationship between concentration and fares.(see footnote 137) While ticket prices in city-pair markets with two competitors were about 8% lower than in monopoly markets, and markets with three competitors were another 8% less still, empirical studies reveal that a potential competitor has one-tenth to one-third the competitive impact of an actual competitor.(see footnote 138) The exit of a competitor results in a 10% average price increase for the remaining incumbents.(see footnote 139) Some have insisted that the airline industry is ''imperfectly contestable.''(see footnote 140) Without doubt, imperfection is an appropriate adjective to describe airline economics.
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Although an early proponent of the application of contestability theory to the airline industry, deregulation advocate Elizabeth Bailey has concluded that airline ''. . . markets are not perfectly contestable, so that carriers in concentrated markets are able to charge somewhat higher fares than carriers in less concentrated markets.''(see footnote 141) Michael Levine said it even more strongly: ''Unfortunately, those theories turned out to be wrong as they applied to the airline industry . . .''(see footnote 142) and ''airline markets cannot be modeled by any reasonably pure version of contestability theory.''(see footnote 143) Levine concluded that new industrial organization theory better describes the airline industry.(see footnote 144) Assistant Attorney General Charles Rule concluded, ''Most airline markets do not appear to be contestable, if they ever were. . . . [D]ifficulties of entry, particularly on city pairs involving hub cities, mean that hit-and-run entry is a theory that does not comport with current reality.''(see footnote 145)
The consensus among economists today is that the airline industry does not reflect theoretical notions of perfect competition or contestability. The high degree of pricing discrimination between consumers and markets suggests that the industry may better reflect economist Joan Robinson's theory of ''imperfect competition''(see footnote 146) or Edward Chamberlin's theory of ''monopolistic competition.''(see footnote 147) Hub dominant airlines like United have a multitude of weapons at their disposal to deter new entry, and recover short-term losses by raising prices above competitive levels when low-cost rivals are driven out.(see footnote 148)
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United charges prices above competitive levels in its monopoly markets, using these profits to cross-subsidize below-cost pricing in competitive markets. Persistent or systematic price discrimination is possible only if the dominant firm has a certain level of market power in the markets containing disfavored buyers. Refusal by United to enter into a joint-fare agreement with Frontier places Frontier in the position of being a disfavored purchaser, causing it competitive injury, for in effect, its customers must purchase United's connecting product at a non-discounted price.(see footnote 149) In U.S. v. United Shoe Machinery Co.,(see footnote 150) Judge Wyzanski condemned the defendant for earning a high rate of return in markets where it had no competitors, and a much lower rate of return where competition was greater.(see footnote 151)
Since Continental Airlines abandoned its Denver hub, United Airlines has sharply raised its prices in the monopoly markets created by Continental's departure. By some estimates, prices rose as much as 42%.(see footnote 152) However, United sharply lowered prices in markets the new Frontier Airlines has entered, cross-subsidizing its losses in Frontier's markets with supra-competitive profits earned in its monopoly markets.(see footnote 153)
Monopoly leveraging involves the exploitation of monopoly power in one market to gain an unwarranted competitive advantage in a second market.(see footnote 154) Monopoly leveraging requires proof of three elements: (1) monopoly power in one market; (2) use of that power to foreclose competition or gain a competitive advantage in a distinct market; and (3) injury amounting to a tangible harm to competition.(see footnote 155) United uses the supra-competitive profits earned from monopoly markets to cross-subsidize losses in competitive markets in order to dominate all routes radiating from Denver. United also uses the supra-competitive profits earned from its first class service (with which Frontier does not compete) to cross-subsidize losses sustained in its effort to monopolize the coach market in city-pairs radiating from Denver. By denying jet competitors connecting traffic (with its refusal to enter into joint-fare and code-sharing agreements with Frontier, and biasing its computer reservations system against carriers which do not have a code-sharing relationship with United), United also uses its domination of the connecting market to monopolize the local origin-and-destination market. Further, United's Apollo computer reservations system is used by more Colorado travel agents than any other. Apollo's display bias against non-code-sharing connecting flights (adding the equivalent of 24 hours to their display), coupled with United's refusal to code-share with Frontier, gives Frontier's product offerings inferior shelf space in the vertically integrated retail market which United controls.(see footnote 156) One court summarized the pernicious impacts of CRS display bias:
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Display biasing is unreasonably restrictive of competition in that it restricts competition on the merits in the air transportation business. When consumers attempt to purchase a ticket on the best available flight their final decision is not solely based upon the merits of the particular flight (flight time, price, service, etc.). Rather, biasing artificially inflates the value of the host airline's flights by listing their flights above better flights. The consumer bears the brunt of this practice by getting a less than optimal flight, and the airline with the better flight has lost a sale it should have otherwise made. This type of competitive advantage depends upon the perpetuation of a fraud upon the consumer. It is unreasonable and therefore an unwarranted competitive advantage because it inhibits competition on the merits.(see footnote 157)
REFUSAL TO DEAL WITH A COMPETITOR
Though ordinarily a firm has the discretion to choose those with whom it will do business, a firm with monopoly power cannot predatorily refuse to deal with a competitor in the hope of destroying it or creating a larger market for itself.(see footnote 158) The motive of the dominant firm must be to injure a competitor or substantially drive it from the market, for a refusal to deal raises antitrust concerns only when it is an attempt by a dominant firm to create or maintain a monopoly. A refusal to deal is also an antitrust violation where the firm refusing to deal is a monopolist and the refusal to deal tends to create a monopoly in a second market.(see footnote 159) Frontier believes that United's refusal to enter into joint-fare or code-sharing agreements with it, and United's refusal to sell Frontier access to its Mileage Plus frequent flyer program falls within this doctrine.
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A monopolist must be unable to offer any plausible efficiency justification for its refusal to deal.(see footnote 160) Given that consumers prefer low-priced jet service to high-priced turboprop service, United cannot argue that its customers enjoy better service or lower prices by its refusal to code-share with regional jet carriers. United sells Mileage Plus points to companies as diverse as hotel chains, rental car companies, cruise lines, mortgage companies, florists, telephone companies, and a variety of airlines. It does not sell Mileage Plus points to low-cost/low-fare airlines like Frontier which attempt to compete at its monopoly Fortress Hub.
REFUSAL TO SHARE AN ''ESSENTIAL FACILITY''
Related to the ''refusal to deal'' problem, an essential facility is a productive asset that cannot reasonably and economically be duplicated and to which access is necessary if one wishes to enter the market and compete meaningfully in it.(see footnote 161) A plaintiff must prove that it is economically infeasible to reproduce the facility, and that denial of access imposes a severe handicap on the market entrant. The doctrine is intended to prevent a monopolist in one market from using its market power to inhibit competition in another.(see footnote 162) The essential facilities doctrine emerged in the U.S. Supreme Court decision of United States v. Terminal R.R.,(see footnote 163) where the refusal of a consortium of railroads to afford a competitor access across a bridge into St. Louis was deemed to be predatory conduct attempting to monopolize the trade. Other cases have extended the doctrine to the refusal of a competing power company to ''wheel'' electricity across their lines,(see footnote 164) the refusal of a telephone network to allow a competitor to have access to its local customers,(see footnote 165) and the refusal of ski areas to allow a competitor to market its operations in cooperation with them.(see footnote 166)
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Frontier sought joint-fares and code-sharing with United, but United refused, funneling its passengers onto significantly more expensive and slower ''United Express'' turboprop affiliates.(see footnote 167) Frontier believes that United's vast route network radiating from Denver constitutes an essential facility under antitrust law, one that cannot realistically be duplicated. Frontier further believes that United's refusal to allow Frontier nondiscriminatory access to that network under joint-fare and code-sharing agreements, and United Mileage Plus participation, constitutes a deliberate effort to discourage customers from doing business with Frontier, monopolize the downstream travel market to cities throughout the Rocky Mountain and Great Plains region, and disadvantage consumers with inferior service and higher prices. The Aspen Highlands case suggests a monopolist can be required to cooperate with its competitors in a joint marketing arrangement, like a frequent flyer program such as Mileage Plus, in which United has steadfastly refused to allow Frontier access.(see footnote 168) Mileage Plus is the dominant frequent flyer program in the Denver area, and one to which a disproportionately large number of Denver business travelers belong.
From the narrow perspective of a major carrier's perceived competitive interests, a refusal to enter into a code-share and/or joint-fare relationship with a regional jet carrier can enhance its monopoly position. Any carrier providing jet service presents a greater potential as a future rival in markets served by the major carrier. By refusing to enter into cooperative relationships with such regional jet carriers, the major carrier undermines their economic viability, and even threatens their very existence. By dealing exclusively with regional carriers providing only inferior turboprop service, the major carrier assumes little risk of aiding a potential rival in its major jet service markets.
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Such an exclusionary policy can only be practiced by a major carrier which enjoys considerable monopoly power in the marketplace. While such a practice might appear perfectly rational from the narrow perspective of the economic interest of the monopolist, the same might be said of an monopolist's price-fixing, collusion, and other anti-competitive practices. No less than these practices, however, exclusionary joint-fare and code-sharing practices do irreparable damage to the competitive environment of the airline industry, and deter consumers from receiving the competitive low-priced jet service they prefer.
There is, of course, nothing wrong with a major carrier choosing to code-share or interline with a regional carrier on the basis that such an agreement will improve the efficiency of service. Where the decision to enter into such agreements is on the basis of anti-competitive reasons unrelated to efficiency, however, the law is very clear. As the United States Supreme Court recognized in Aspen Skiing vs. Aspen Highlands,(see footnote 169) that ''if a firm has been 'attempting to exclude rivals on some basis other than efficiency' it is fair to characterize its behavior as predatory.''(see footnote 170)
The law with regard to the ''duty to deal'' with potential competitors has its origins in the ''essential facilities'' or ''bottleneck'' doctrine first set forth in the U.S. Supreme Court case of U.S. v. Terminal Railroad.(see footnote 171) In that case, a railway company combination gained control of all railway connections across the Mississippi river at St. Louis, making it impossible for any railroad company to pass through St. Louis without using the facilities controlled by the railroad combination. This power gave the combination veto power over use of the facility by a competitor. The Court held that the exercise of such power was a violation of the Sherman Act, and ordered a reorganization under which the combination was required to make its facilities available to competitors ''upon such just and reasonable terms and regulations as will . . . place every such company upon as nearly an equal plane . . . .''(see footnote 172)
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This ''duty to deal'' under the antitrust laws was further developed by the U.S. Supreme Court in Otter Tail Power v. U.S.(see footnote 173) In that case, Otter Tail Power company refused to deal with municipalities seeking to establish their own power systems when Otter Tail's retail franchises expired. Specifically, the power company refused to transport wholesale power to the municipal systems.
Otter Tail argued that unless it refused to deal with the municipalities, the municipalities would eventually turn to public power and that Otter Tail would suffer economic injury. In other words, Otter Tail argued that since it was acting in its own economic interest, it had no duty to deal with the municipalities. The Court sharply rejected this argument, citing U.S. v. Arnold, Schwinn Co.(see footnote 174) for the proposition that ''The promotion of self-interest alone does not invoke the rule of reason to immunize the otherwise illegal conduct.''(see footnote 175) The Court observed that the Sherman Act assumes that an enterprise will protect itself by offering superior service, lower costs, and improved efficiency, and not by anticompetitive uses of its dominant economic power.
In the context of exclusionary joint-fare or code-sharing practices, a similar question must be asked as to whether United Airlines' refusal to enter into cooperative agreements with Frontier is for the purpose of improving the quality of service, or for other anti