Case Study American-Airlines-Actions-Raise-Predatory-Pricing-Concerns-8371735
Case Study American-Airlines-Actions-Raise-Predatory-Pricing-Concerns-8371735
Case Study American-Airlines-Actions-Raise-Predatory-Pricing-Concerns-8371735
Concerns
Michael Baye and Patrick Scholten prepared this case to serve as the basis for classroom
discussion rather than to represent economic or legal fact. The case is a condensed and slightly modified
version of the public copy documents involving case No. 99-1180-JTM initially filed on May 13, 1999 in
United States of America v. AMR Corporation, American Airlines, Inc., and AMR Eagle Holding
Corporation.
INTRODUCTION1
Between 1995 and 1997 American Airlines competed against several low-cost carriers
(LCC) on various airline routes centered on the Dallas-Fort Worth Airport. During this period,
these low- cost carriers created a new market dynamic charging markedly lower fares on certain
routes. For a certain period (of differing length in each market) consumers of air travel on these
routes enjoyed lower prices. The number of passengers also substantially increased. American
responded to the low cost carriers by reducing some of its own fares, and increasing the number
of flights serving the routes. In each instance, the low-cost carrier failed to establish itself as a
durable market presence, and eventually moved its operations, or ceased its separate existence
entirely. After the low-cost carrier ceased operations, American generally resumed its prior
marketing strategy, and in certain markets reduced the number of flights and raised its prices,
roughly to levels comparable to those prior to the period of low-fare competition.
American's pricing and capacity decisions on the routes in question could have resulted
in pricing its product below cost, and American might have intended to subsequently recoup
these costs by supra-competitive pricing by monopolizing or attempting to monopolize these
routes. In addition to these routes, American might have monopolized or attempted to
monopolize by means of the "reputation for predation" it possibly gained in its successful
competition against low-cost carriers in the core markets.
American feels that its competition against the low-cost carriers was competition on the
merits.
City Fare $
Amarillo 62
Wichita 112
2
The Herfindahl-Hirschman Index (HHI) measures market concentration levels, and
is calculated as the sum of the squared market share percentages for each market participant.
Albuquerque 97
Omaha 215
Atlanta 117
Indianapolis 225
As the airline with the largest scope of operations at DFW, American has significant
advantages over other competitors or potential competitors in DFW routes in attracting
passengers and charging higher prices. This advantage has variously been called "origin
point presence" advantage, "OPP" advantage, "origin point dominance" or "frequency
dominance" by American, and has been described by American as follows: "a carrier which
achieves substantial advantage over its competition in terms of frequency and scope of
service at any airport, hub or spoke, . . . will invariably obtain a disproportionate share of the
traffic and revenues for the flights originating at that airport."
Frequency dominance or origin point presence advantages are reinforced by marketing
programs including frequent flyer programs and travel agent commission overrides. American’s
investment in establishing its DFW hub involved a large sunk investment, and another airline
with similar cost structure would also have to make large investments to build a similar hub at
DFW.
American generally enjoys higher margins where it does not face low-cost competition.
American’s internal analyses recognize that fares and yields in Southwest and LCC-competitive
markets are significantly lower than fares and yields where American does not compete with
Southwest or other LCCs. Thus, American calculated that its revenue per available seat mile in
DFW-ATL increased by 14% after the 1996 ValuJet crash caused that LCC to exit.
An American memo exists stating that, following Midway Airlines’ departure from the
DFW-MDW route, American should raise prices slowly to avoid "sticker shock," but did not
worry about competitor reactions. In fact, the same document expresses concern about such a
reaction, stating that "connect carriers continue to offer discounted fares, and our experience
during the past year has demonstrated that these carriers possess strong potential to capture share
in markets where large fare differentials exist."
During 1996, flights to and from American’s DFW hub for the previous 12 months made
up 40% to 58% of American's total domestic capacity (ASMs), but accounted for 60% to 86% of
its domestic fully allocated earnings.
As noted earlier, American’s price-average variable cost margins are higher on its flights
to and from DFW than on other flights in its system. The company's internal documents
recognize that this higher market share correlates to higher local yields. Fares on routes where
American competes with other hubbing major airlines are generally higher than on comparable
routes where American competes with LCCs or Southwest.
LCC COSTS
In 1994, American calculated ValuJet’s stage length adjusted cost per ASM to be 4.32
cents, and American’s cost per available seat mile to be 8.54 cents.
American’s Executive Vice President of Marketing and Planning, Michael Gunn,
testified that Southwest’s costs were 30% lower than American’s.
An internal American document discussed the cost advantages of low-cost airlines,
stating that one of the "fundamental problems in the [airline] industry" in 1994 was that
"consumer values (price) and the high cost structures of incumbent airlines have encouraged new
competitors," that in 1993 Southwest’s labor costs/ASM were 45.8% lower than American’s,
During the four quarters preceding Vanguard's April 1995 entry into the DFW - ICT
market (2Q 1994 - 1Q 1995), the total number of local passengers traveling in that market each
quarter ranged from 16,420 to 19,390. The average market fare ranged from $105 to $115 during
that period.
During the period from June 1995 through September 1996, while Vanguard served the
DFW - ICT market but before American’s questionable acts in that market, American's average
During that same period, the total number of local passengers traveling in that market
ranged from 35,140 to 37,460 per quarter. The average market fare ranged from $60 to $68.
During the period from October 1996 through December 1996, when American may have
engaged in predatory acts in the DFW-ICT market, American's average fare, local passengers
carried and total seats, on a monthly basis, were within the following ranges:
During that same October 1996 through December 1996 period, the total number of local
passengers traveling in that market 38,650 for the quarter. The average market fare was $55.
During the twelve - month period beginning six months after Vanguard's exit (July 1997
- June 1998) from the DFW-ICT market, American's average fare, local passengers carried, and
total seats, on a monthly basis, were within the following ranges:
During the same twelve-month period, the total number of local passengers traveling in
that market ranged from 20,840 to 24,590 per quarter. The average market fare ranged from $94
to $99.
During the second twelve-month period beginning six months after Vanguard's exit (July
1998-June 1999) from the DFW-ICT market, American's average fare, local passengers carried,
and total seats, on a monthly basis, were within the following ranges:
During the same twelve-month period, the total number of local passengers traveling in
that market ranged from 19,610 to 23,200 per quarter. The average market fare ranged from
$105 to $120.
During the period from January 1994 to December 1994, before Vanguard entered the
DFW-MCI market, American's average fare, local passengers carried and total seats, on a
monthly basis, were within the following ranges:
During the same period, the total number of local passengers traveling in that market
ranged from 66,190 to 71,860 per quarter. The average market fare ranged from $108 to $115.
During the period from February 1995 through December 1995, while Vanguard served
the DFW-MCI market on a non-stop basis, American's average fare, local passengers carried,
and total seats, on a monthly basis, were within the following ranges:
During the same February 1995 through December 1995 time period, the total number of
local passengers traveling in that market ranged from 94,520 to 103,610 per quarter. The average
market fare ranged from $79 to $88.
During the period from January 1996 to September 1996, when Vanguard did not serve
the DFW-MCI market on a non-stop basis, American's average fare, local passengers carried,
and total seats, on a monthly basis, were within the following ranges:
During that same October 1996 to May 1998 time period, the total number of local
passengers traveling in that market ranged from 104,870 to 128,850 per quarter. The average
market fare ranged from $74 to $96.
After the end of the period when American might have engaged in predation in DFW-
MCI, from June 1998 through September 1999, American's average fare, local passengers
carried, and total seats, on a monthly basis, were within the following ranges:
After the end of the same period, the total number of local passengers traveling in that
market ranged from 110,690 to 126,430 per quarter. The average market fare ranged from $96 to
$113.
During the period from June 1994 to May 1995, the one-year period preceding Western
Pacific's entry into the DFW-COS market, American's average fare, local passengers carried, and
total seats, on a monthly basis, were within the following ranges:
During the period from June 1994 to May 1995 (3Q 1994- 2Q 1995), the one-year period
preceding Western Pacific's entry into the DFW-COS market, the total number of local
passengers traveling in that market ranged from 11,490 to 22,310 per quarter. The average
market fare ranged from $114 to $158.
During the period that Western Pacific served in the DFW-COS market (July 1995
through October 1997 (3Q 1995- 3Q 1997)), the total number of local passengers traveling in
that market ranged from 45,800 to 86,090 per quarter. The average market fare ranged from $75
to $102.
During the period from during the twelve-month period beginning six months after
Western Pacific's exit from the DFW-COS market (April 1998 through March 1999), American's
average fare, local passengers carried, and total seats, on a monthly basis, were within the
following ranges:
During that same period, the total number of local passengers traveling in that market
ranged from 25,550 to 40,120 per quarter. The average market fare ranged from $131 to $139.
During the period from February 1997 through January 1998, while both American and
SunJet served the DFW-LGB market, American's average fare, local passengers carried and total
seats, on a monthly basis, were within the following ranges:
During the same February 1997 through January 1998 period, the total number of local
passengers traveling in that market ranged from 59,210-75,000 per quarter, excluding passengers
carried by SunJet. The average market fare ranged from $94 to $107.
During the twelve-month period beginning six months after SunJet's exit (July 1998
through June 1999), American's average fare, local passengers carried, and total seats, on a
monthly basis, were within the following ranges:
During the same twelve-month period, the total number of local passengers traveling in
that market ranged from 60,200-77,360 per quarter. The average market fare ranged from $141
to $164.
The following table shows the monthly ranges for American's monthly average fare, the
local passengers carried, and the total number of seats allocated to various routes. In addition,
the table shows the total number of passengers in the market (shown per quarter rather than by
month) and the average fare during the period. The first section, dealing with the Dallas -
Wichita route, uses five time periods: the 12 months preceding Vanguard's market entry, the
period after entry but before any possible "predation," the period of the potential predation, and
the two successive 12-month periods following Vanguard's departure from the market. The
second Dallas - Kansas City, uses periods representing the period prior to Vanguard's entry, the
period of Vanguard's non-stop service, the period of Vanguard's connect-only service, the period
of the suspected predation, and the subsequent 16 months. The third section, Dallas - Colorado
Springs, shows three periods: the year prior to Western Pacific's entry in the market, the period
Western Pacific operated in the market, and the twelve month period commencing six months
after Western Pacific's departure from the market. The final section, Dallas - Long Beach, has
two periods: that during which American and SunJet were both in the market, and the twelve-
month period commencing six months after SunJet's exit.
American Market
Average Fare Local Passengers Total Seats Average Fare Passengers/Quarter
DFW - ICT
06/1994 - 05/1995 $ 99 - 108 3932 - 5557 21,314 - 32,109 $ 105-115 16,420 - 19,390
07/1998 - 06/1999 100 - 123 5744 - 8257 25,891 - 33,651 105 - 120 19,610 - 23,200
DFW - MCI
01/1994 - 12/1994 107 - 117 14,831-19,306 61,489 - 69,092 108 - 115 66,190 - 71,860
01/1996 - 09/1996 108 - 147 24,435 - 31,568 74,404 - 92,534 110 - 128 83,740 - 98,900
06/1998 - 09/1999 93 - 126 27,222 - 40,026 72,644 - 100,503 96 - 113 110,690 - 126,430
DFW - COS
07/1995 - 10/1997 73 - 110 9,088 - 24,673 36,385 - 80,304 75 - 102 45,800 - 86,090
04/1998 - 03/1999 120 - 156 7,536 - 12,487 32,607 - 41,334 131 - 139 25,550 - 40,120
DFW - LGB
02/1997 - 01/1998 83 - 118 6,615 - 24,997 21,128 - 34,472 94 - 107 59,210 - 75,000
07/1998 - 06/1999 142 - 177 13,513 - 25,309 21,866 - 33,739 141 - 164 60,200 - 77,3600
COMPETITIVE PRACTICES
REPUTATION ISSUES
American, through its questionable conduct on the routes, has possibly earned a
reputation for predation that deters competition on other DFW routes, allowing it to recoup the
possible predatory investment it made in the Competitive Response Routes at issue by charging
supra-competitive prices on those other DFW routes.
American's potential predatory conduct and reputation could have been a contributing
factor to the abandonment of nonstop service in DFW-ICT and DFW-PHX by Vanguard; the
abandonment of nonstop service in DFW-LGB, DFW-EWR, and DFW-PIE by SunJet [WTS];
the abandonment of expansion plans for DFW-COS service from between June 1995 and
January 1997 by Western Pacific, and that company's ultimate abandonment of nonstop service
in DFW-COS.
The table illustrates two ways to calculate the amount of "predatory loss" American allegedly
incurred in DFW-MCI, DFW-ICT, DFW-COS, and DFW-LGB during the possible periods of
predation.
The first method or test devised to calculate the "predatory loss" column for Table I used
as a benchmark of American's average FAUDNC margin on that route during a period of
"legitimate competitive conditions" prior to the potential periods of predation, which is a natural
base period.
The second method or test that is used to calculate the possible "predatory loss" column
for Table I used as a benchmark American's average FAUDNC margin in "Southwest Markets,"
meaning those routes on which American competes with Southwest. The "predatory loss"
columns in Table I reflect the difference between American's actual revenues during the periods
of alleged predation and the revenues predicted by using the two benchmark FAUDNC margins
devised. The "in market recoupment" columns in Table I reflect the difference between
American's actual revenues after the periods of possible predation and the revenues predicted by
using the two benchmark FAUDNC margins he devised. The "net sacrifice" columns in Table I
are the arithmetic sum of the respective "predatory loss" columns and "in market recoupment"
columns. Where the "in market recoupment" columns of Table I are positive, American might
have already achieved some market recoupment. Where the "net sacrifice" columns of Table I
are positive (such as in Wichita), American has fully recouped on that route according to the
table. Where the "net sacrifice" columns of Table I are negative (such as in Colorado Springs),
American has not recouped in the alleged market according to these calculations.
The only two periods that American might have engaged in supra-competitive pricing on
the DFW-MCI route are January-September 1996 and after May 1998. In the first test of the
January-September 1996 period in DFW-MCI, American earned above-competitive returns of
$135,744, but its alleged predatory loss amounted to $4,811,722, leading to a "net sacrifice" of
CONCLUSIONS
The routes in question, and the associated alleged relevant markets, fall into four
categories. First, there are possibilities of predatory conduct with respect to seven "core" routes
(flights between DFW airport and airports in Kansas City, Wichita, Colorado Springs, Long
Beach, Phoenix, Tampa, and Oakland). In addition to these core routes, American's actions
potentially affected approximately 40 "reputation" routes, in which American might have
monopolized or attempted to monopolize the routes by acquiring a "reputation for predation" in
the core routes. In addition, there are some five routes in which American possibly committed
predatory conduct, but did not monopolize or attempt to monopolize the routes, and five routes
in which American did not monopolize, attempted to monopolize, or engage in predatory
conduct, but in which the effects of the possible predation elsewhere might have been "felt."
In each case, the possibility of American’s actions is substantially similar: that American,
when faced with low cost carrier competition on various routes, might have instituted an
aggressive policy of price matching and capacity increases which might have unfairly "stole"
customers from the low cost carrier, which was eventually forced to cease competition on the
route. After the departure of the low cost carrier, American might have increased its prices and
reduced the number of flights serving the route.
ELEMENTS OF LIABILITY
Potential monopolization against American requires proof: (1) that American has
monopoly power in a properly defined relevant market; and (2) that it willfully acquired or
maintained this power by means of anti-competitive conduct, as distinguished from growth or
development as a consequence of a superior product, business acumen, luck or historical
accident. Potential attempted monopolization requires proof of: (1) a relevant geographic and
product market; (2) American's specific intent to monopolize the market; (3) anti-competitive
conduct by American in furtherance of this attempt; and (4) the dangerous probability that
American will succeed in this attempt.
Business activity is not "anti-competitive" so long as there is "a legitimate business
justification for the conduct." Multistate Legal Studies, 63 F.3d at 1550. Specifically, the Act in
question does not "prohibit the adoption of legal and ordinary marketing methods already used
by others in the market."
The potential anti-competitive conduct in the present action is predatory pricing: that
American, in the face of low fare carrier competition, shifted from its traditional strategy and
adopted competitive tools which combined price reductions and capacity increases, and that the
cost of these tools was greater than the revenue obtained. American possibly endured these
losses only because it knew, once the low fare carriers were driven out of the core markets; it
could reduce service, increase prices, and recoup the losses by supra-competitive pricing.
In reality, American's fare prices and its production level — whether characterized as
'output' or 'productive capacity' are two sides of the same coin. According to American, they
typically preferred to operate by selling (relatively) fewer seats at higher prices. When it was
faced with new entrant, low-cost carrier competitors, American supposedly chose to match the
Predatory Loss Recoupment Net Sacrifice Predatory Loss Recoupment Net Sacrifice