American uses the cartel's clout


THE OTHER DAY, American Airlines announced it was drastically simplifying the crazy quilt of air fares that has frustrated travel agents and infuriated the traveling public.

The bewildering variety of fares was replaced by three basic coach fares, and fares were reduced by as much as 50 percent. Within two days, United matched American's new fare structure, point for point. United's new "everyday fair," remarkably enough, cut unrestricted coach fares by the same 38 percent. And United introduced identical, copycat advance purchase fares, with the identical restrictions. Delta and Northwest quickly fell into line, with full-page ads trumpeting precisely the same fare structure -- and the same fares.

Then bankrupt TWA slashed its fares even more than American had. American promptly announced Monday that it was matching TWA's and USAir's lower fares while not abandoning its simplified fare structure.

What gives here?

The first thing that gives is American Airlines' aggressive chairman, Robert Crandall. Crandall became convinced that the proliferation of fares and the sheer unpredictability of travel costs was scaring away customers. If it costs $1,000 to make a brief business trip from Washington to Chicago, the phone and the fax start looking better and better.

Ironically, ever more intricate pricing was devised by the big airlines to maintain profit margins in a deregulated environment, in which new low-cost carriers could underprice the majors. By using computers to monitor the competition and to vary fares hour by hour to fill up planes and exploit last-minute travelers, the major airlines could drive out competitors, and still make money.

But the major carriers' strategy of complicating fares, clever in the short term, backfired. It did have the effect of reducing competition and creating astronomical regular coach and first-class fares -- but it was scaring away customers.

So Crandall audaciously used American's sheer market power to change the system. And the remaining large carriers quickly fell into line lest their customers flock to American.

What makes a mockery of deregulation, of course, is not that the fare structures on American, United, Delta and Northwest are similar, but that the fares are in most cases identical. Economists have a name for this sort of thing. It is called a cartel. It is just the same thing that OPEC does -- raise and lower prices in tandem to maximize prices and profits.

But what a cartel giveth, it taketh away. According to industry sources, American's Crandall believes that the airline business can ultimately sustain only three viable carriers.

By using American's market power to simplify and reduce fares, he neatly accomplishes two things. First, the lower fares attract more customers, reducing profits in the short run but perhaps increasing profits over time as more people fly. But second, imposing these price cuts serves Crandall's long-term goal of driving weaker competitors out of business or forcing mergers and consolidations. Then prices can be raised again.

A cartel works best with relatively few members in the club. In the palmy days of deregulation, there were lots of new airlines, and genuine bargains. Little by little, the majors used their market power to drive them out. Today, there are just five major airlines not in bankruptcy. Three -- American, United and Delta -- are financially healthy. Two -- USAir and Northwest -- are shaky.

There is exactly one cut-rate independent airline of any size that has survived from the early days of deregulation: Southwest. Its survival hasn't been easy, because the major airlines manipulate fares, lock up airport gates and control the computer reservation systems that travel agents use.

If you ask your travel agent to book the cheapest flight from, say San Diego to Oakland, Calif., he or she is unlikely to mention Southwest, because it isn't in the computer and it is a hassle to book the reservation, not to mention the fact that the travel agent's commission is lower. Given how the system rigs the financial incentives, it takes a very diligent and conscientious travel agent to steer you to Southwest.

I recently flew from San Diego to Oakland on Southwest, a distance of about 500 miles. The unrestricted one-way coach fare was $58, which compares favorably with Greyhound. As it happens, I am writing these words on my laptop computer on a USAir flight between Boston and Washington, about 100 miles shorter than the San Diego-Oakland run. Flying one-way between Boston and Washington in coach cost me $321!

Some free-market enthusiasts may view the new, simplified air fare structure as an exemplary case of the market policing itself and correcting an earlier bout of pricing mistakes.

But this is delusional. The kind of market power and pricing discipline enforced by American is the antithesis of a true free market based on price competition.

If Crandall is right, and efficiency requires a relatively small number of national airlines, there is only one way to make sure that this cartel serves the public interest: It is to regulate it.

Robert Kuttner writes a syndicated column on economic matters.

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