SENT BY: 1-28-93 ; 4:30PM ; Alfll)AYD' Qf GABY J. DORMAN c I, GARY :r. DORMAN, of the O'ly af Lo& Angeles,'ftr1flf!"'SU'lrellf'Olttftrrtmr,--""'......__ one of tbc United State:t of America, MAKE OAlll AND SAY AS FOLLOWS: 1. I am a Senior Vice President of National Economic Research Associates, Inc. (NERA). NBRA has been retained by coUDSel for American Airlines to ana.lyz.e certain of the competition issues arisina in connection with the Application of The Director of lllvestigation and Reseuch. 2. I have prepared the attached document entitled "Rebuttal Testimony of Dr. G&!:)' J. Dorman.It The •opinions expressed therein are true to the best ol. my knowledgew information and belief. My qualifications to give this testimony were described previously in Appendix 1 to "Testimony of Dr. Gary J. Dorman," submitted January 18, 1993. SWORN before me, a Notary Public for the State of California, ia tbt United States of America. on the 28th day of January. 1993 at Loa Anple1. C.alifomia in the United States of America
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1-28-93_ _ ; 4_:30.fM..:, \.I (AI.IJHY lt.ll'(f\L;L..1""'\.,,VL¥1l L..1 I I'"" ·--;--· ·:·-~l!C Im. .:1,in/O!:IJOti.. 415 ufi8 1792,# 3 SENT BY: REBUTl'AL TES'nMO:NY OF DR.. GARY I. DORMAN I. IN'l'.RODUCTION 1. My name is Gary J. Dorman. I am an ecooomist and a Senior Vice President of National F..conomic Research Associate&, Inc. (NERA). My qualifications to present expert testimony in tlrls proceeding have been described in a prior doallllent entitled '7estimony of Dr. Gary J. Dorman/' subnaitted on Janwuy 18, 1993. This rebuttal testimony constitutes a respome to the document entitled "Report of Professor Jerry A. Hausman." dated Januacy 25. 1993. In this rebuttal. I will not attempt to respond to every argument raised by Professor Hausman in his 3S page report~ but will instead focus on a few key issues.
II. RESPONSlt TO THE REPORT OF PROF'ESSOR J. HAUSMAN 2. As stated in my prior testimony. the primary issue in this proceeding is (and ought to be) the poHible conaequences of tbe Director's proposed remedies with re&pect to preserving airlhil competition in CB.ll&da. Professor Hausman. bowever, spends the first 26 paps of hi$ re~rt discussing wnmuter a;acryatign §)'Um (CRS) competition in Canada. The reason for his focus is clear: Profe.uor Hausman has already abandoned hope of presemna meaningful airline competition in canada. He has concluded that )'Canada cannot support two profitable national airlines" [Paragraph 60] and admits that "if CAI [C.anadian Airlines] were to fail. AC [Air Canada] would gain lllOlt of tbe current CAl traffic" [Parqraph .52]. l do not believe that the goal of preserving airline competition in Canada should be abandoned so hastily, bur I will leave the detailed analysis of thU iAue to other eq>erts.
1-28-93 ; 4:3l p \A -..i CA RTHY TETRALLT-iCOMPET IT I ON TK l J?Uf'IAL • 'I'. " u '.'J _; rnC - • ,..., .... c,...>oo- 4l<:i Bl'lb 779?,.# 4 SENT BY: 3. Turni:na to the secondary issue in this procoeding-CRS competition in C&nada--Professor Hausman's analysis suffers from several major defects. First, he clearly rec.ognizos what he has termed the "'predisposition effec~" where an "important component of travel agents' choice of a CRS is which airline their customers most often UM." [Paragraph 17.] Profe.s1cr Hausman uses bis own econometric model of the predisposition effect to project that "if CAi's share of Gemini base shifts to Sabre. Gemini's share of Canadhm CRS boold!ij?s is estimated to decrease from its current S5% to about 31%." [Paragraph 21.] 4. This fisure is thm t@ the share shift estimated by American Airlines itself in the 1991 document cited repeatodly by Professor Hausman ill his testimony. Furthermore_ as the American Airlines document clearly states. that estimated share shift of 8.2 percentqe points 1 'assumes current market conditions prevail (a.weak Gtminj prgduat and a non:q&J'win Qltgpetiq CBS)." ["Appen~ Aurora Valuation Analysis/' page 6, emphasis added.] With the recent replacement of the inferior Reservec and Pepsus products with the competitive "Apollo by Gemini" CRS. that assumption is. no lonier valid and the resulting estimate of the share shift would need to be reduced. Indeed, the second scenario analyzed in that document. where "the Gemini product is improved and i& agressively marketed;" results in a "potential market share risk"' to SABRE of 12.0 percen.taae points. S. Moreover, Professor Hausman does not apply symmetrically the result.~ of his econpmetric model of the predispositl.on eft'ect. Even after a tramfer of Canadian Airlines ho.stina from Gemini to SABRE, the Gemini CRS \\"Ill still be associated with Air Canada. a larger carrier than Canadian Airlines, With the recent achievement of
SENT BY:
-3· comparable functionali~v between Gemini and SABRE, it is SABRE which will be at a competitive disad\l&Dtage relative w Gomini. Even if one adds topther the traffic of Canadian Airlines with that of American .o\irlines' operation& in Canada. SABRE is still backed by a smaller aidlne presence than Gemini, which is associated with all of the following airline&: Air Canada. United, US.Air, British Airways. Swissair. KLM and Alitalia. 6. In short. the fundamental flaw of Profea∨ Hausman's analysis is that he considers only those present Gemini accmmts which SABRE may pin by reuon of its perceived sponsol'5hip by Canadian Airlines. However, be ignores entirely those current SABRE accounts which may be pined by Gemini·-wbich bu only had a competitive CRS since July 1992-because of Gemini's perceived sponsorship by Air C'.anada and the other carriers affiliated with the Apollo system. He makes this error even though ht. concedes {Paragraph 45] that the predisposition. effect can work i:ti favor of Gemini. Ind•ed, if Canadian Airlinea ceases operations and most of its traffic shifts to Air Canada (as admitted by Professor Hausman in Paragraph 45), or if Canadian Airlines were to survive and remaht affiliated with Gemini. how could SABRE hope to compete with Gemini in Canada givan comparable functionality and Gemini's overwbe.lmina airline presence'.> 7. A second major defect in Professor Hausman'& analysis relates to the issue of eronomies of scale. His conclusions rely in part on U.S. CRS cost data obtaitted from the U.S. O.panment of Transportation (DOT) {Paragraph 15]. These data. are not comparable across CRS vendors. as the. DOT reeopzed rsmay of Airline O)txJl!utQr Bam;vation Sy1tcms, May 1988. pages 49-SO]: Similar firms opera.ting within the same industry have the dia~retion to adopt diUerent but equally acce.pta.blt accounting practices. and these differences can eontrlbuto to variation in accounting profits and rates of return reported by firms that are nte1r/a
1-28-93; 4:31Pttl; SENT BY: -4-
actually eai-ning identical economic returua. The definition 8lld measurement of revenues and expemes Hported by the different airline '1endon refleet ·their exerdsc of this ~etlon, and require their reported data to be adjusted in various ways to develop consistent 111easurc1 oC the retUJ'Jll earned on their CR5 activities. a process subject to potential errors of mi&clusificati.on. Finally. the Department's Information t>kcme required the vendors to allocate certain cost& (Pdl u those for central computer operations) between airline and CRS opcratiom. a procedure that is &omewhat arbitrary. Therefore, inter-firm cotnpa:risom of CRS costs per bookina bued on the DOT data are not a reliable buis for mea.iruring economies of scale in this industry. 8. Furtbormore, the DOt data on annual costs for individual CRS vendors for a single year (1986) are not appropriate for determining the relationship between the size of a CRS and ite cost per hookina. 'Ib:i1 i5 because the cost data used by Professor Hausman reflect the total cash expendituros made by each vendor in each year. irrespective of whether they are for current-year operating expenses or for lona·lived capital investments [DOT Study, pages S0·.54]. No effort wu made by Professor Hausman to amortize the initial cash expenditures for central computer facilities, communications equipment, subscriber t,errninab and software development o¥er the useful lives of these assets. 9. Uslq Professor Hau&man's methodoloaY. in the early years of a CRS when cash investments are large and the number of bookings is small. the a.verqe cost per booking will appear to be very high. Conversely, in the later years when most of the cash investments have already 'been made and the munbu of booldnp is large. the average cost per booking will appear to be very low. The comequence of this faulty methodology is a. set of data which is biaued towards a steep drop in cost per bookina as the number of bookings increases. Such data are completely inappropriate for the purpose of attempting to measure CRS economies of scale.
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10. Bven if one acoepts Professor Hausmaa's moasuroment of CRS economies of scale, sudl economies as are· currently achieved by Gemini arise mainly throup its use of the Apollo computer facility in Denver where the Gemmi CRS proc:essing is done. Professor Hausman forecasts that if Canadian Airlines hosting is moved to SABRE. this would result in a 24 percentage point shift from Gemini to SABRE and 8.4 million fewer segments booked annually on Gemini [Paragraph 26]. When analyzillg the effect of any such assumed shift on t1M achievement of CRS economies of scale. it is necessary to compare thoso 8.4 million bootinp with the total bookinp currently beina processed at the Apollo computer facilit)r in Denver, which excted 100 million per year. Sucb a shift is unlikely to affect significantly tbe lJllit costs of providing Apollo CRS services. Therefore. in the event of the failure of the Gemini partnership, C.Ovia's role as a competitive constraint on SABRE in Canada is not throatencd by the transfer of Canadian Airlines hosting to SABRE. for all~ reasons given in Paralfaphs 10.12 of my prior testimony, 11. Finally, Profe&&Or Hausman's analy$is of CRS economies of scale, if correct. has a dfsturbina implicauon. He states that size differences and the accompanyina oeonomies of scale give Sabre a considerable cost advantage among CRS vendors. Thus. Worldlpan and System One would be unlikely entrants into Canada, especially given the much higher telecommunications COits in Canada than in ~ U.S. If tbc Director succeeds in his 1oaJ of the hosting contract tormiuauon and Gemini do~ not continue operation. it is not clear that Covia would offer CRS service in C8nada given ib coat diladvantqe to Sabre ari&ing from its approximate 50% smaller size and the demomtraied lack of contract enforcement in CanlidL (Paragraph 37.] The clear implication of this reasoniuj is that the CRS business in C.anada is a natural monopoly because of tbe size of the market and the cost advantage of a large firm.
1 -. -?. a-0 a 3_ _ •· 4: 32f~-·· . · ; • M . c . C ARTHY TETRAULT....COMPET IT I ON TRIBUNAL; r;.11111 SENT BY: ~ ~l~"~~~~~d~ 416 aes 17a2:# 8 12. Professor Hausman 1 s analysis seems to have left us with inevitable airline .md CRS monopolies iD Canada. Under his approach, the only issue remaining is the identity of the monopoUst. In the airline market. he warns that "{i]f the Director is successful, a.nd CAI survives~ I foresee that AC will soon also face extreme financial difficulties." [Parawa:ph 4U.J Obviously, Air Canada desires to be the survivor. since 11 if CAI were to fail. AC would pin most of the current CAI traffic" [Paraaraph 52]. In the CRS market, he forecasts a SABRE share of 70 percent [Paragr~ph 71·-an "outcoDle where Sabre is a near-monopoly CRS operatins in Canada or is by far the dominant CRS"' (Paragraph 54]. This forecast is suspect given that (1) SABRE bes never achieved even half the market when it was competiq qai:nst the inferior predecesson to Apollo by Gemllli, and (2) American Airlines' own forecast shows its share levelina off at 47 percent through 1998 ["Appendix, A.nrora Valuation Analysis," Appendix BJ.
Ill. CONCLUSIONS 13. Professor Hausman's focus on the CRS market is misplac:ed. The primary concern should be the prueivation of meaninaful airline competition mC anada. Moreover, for the reason& given in my prior testimony, the shift of Canadian Airlines bostina to SABRE does not threaten to create a CRS monopoly in Canada. Professor Hausmanis analysis of CRS competition is 8awed, and does not constitute an adequate basis to reject the Director's propos«I remedies. Meet importantly, it would likely be an irremediable miitake to permit the eradicadon of existing airline competition on the basis of au opinion that the canadian market has room for only one national carrier.