an airline operating two Lockheed Electras (L-188) and transporting 293,000 annual passengers in 1967 to the operation of seven Boeing 737-115 passenger jets and one Electra serving 1.4 million customers in 1974. The corporate mission of the company is to provide low-cost commuter-type air service in markets that do not have required service or receive poor and inadequate service from interstate airlines. Of the 19 markets presently served by Air California, 12 received first time service from Air California, 2 received better service, and 5 received competitive service. The State of California is to be admired for its foresight in recognizing the need for intrastate air transportation and enacting legislation which established an orderly control mechanism for route authorities, tariffs, and financial guidelines. California, if it were a nation, would indeed be the eighth largest economic producer (gross national/state product) in the world, so it naturally follows that communication and transportation are vital and dramatically necessary in an ever-changing way. The Public Utilities Commission has been responsive in the recognition of new service route needs, and has been able to meet such needs through the availability of two rather large, viable, and competent transportation companies, Air California and PSA. The existence and growth of our companies is adequate and strong testimony as to the need for services of the type offered and the good judgment of our regulators. There is no question in my mind that services of the type we provide which are quickly responsive to new market needs and priced in innovative packages which develop markets with maximum speed would not be possible in the framework of present interstate certification processes. Ours is an operation in which fares are priced at minimum levels which can be realistically supported by expected load factors. We, like all other air carriers, are currently caught in a pinch because of fuel prices. Although the Commission has been attentive to the fuel price increase, the additional 19 percent in our fares has somewhat depressed traffic. In comparison to other airlines, intrastate and interstate, our fares are in some instances lower and in some instances slightly higher. Our fares are lower than Hughes Airwest, however slightly higher than Continental, Western and PSA in our Ontario to Sacramento service. In order to encourage discretionary travel, Air California offers and is highly supportive of reduced rate incentives. We offer a discounted family plan, military fare, group rates, and a standby E-z fare (20 percent reduction on certain selected low volume flights). Our operating costs are somewhat lower than the interstate carriers since we are relatively a new carrier and our seniority rates are not as mature as others. The price of our supplies, including fuel, spare parts, miscellaneous equipment, office supplies, etc., are probably comparable to those of other air carriers. We don't look upon ourselves as a cutrate airline for, in fact, we charge fares that permit a fair level of profitability potential and offer services which are comparable to those of any air carrier operating short segment flights similar to ours. We require a relatively high load factor for breakeven and we maintain these load factors by effective scheduling of individual flights on daily schedules which match peak demand. That is, we schedule more trips on days which provide higher traffic potential (Fridays, holidays, etc.), and contract schedules on days of expected minimum activity, i.e., Saturdays, day after holiday, etc. We are able to control capacity through the use of our modern, computerized reservation system which utilizes the data bank of Continental Air Lines. Our type of operation, which is based upon high frequency on short flight segments, requires close adherence to published flight schedules. The maximum possible completion of our scheduled trips on time is a constant concern. Our completion factor for the year 1974 was outstanding-99.8 percent with 89.2 percent of the flights operating on time (within 15 minutes). Although our intrastate customers enjoy a high level of service proficiency, we are not able to offer interline ticketing or interline baggage exchange. This deficiency is brought about by the possibility of our being considered an interstate carrier if such service was offered. On two occasions we have requested Civil Aeronautics Board issuance of an exemption to permit interlining of baggage and tickets with stated restrictions which would negate the possibility of straight-through, direct interstate commerce. We understand the technical regulatory problems involved in the consideration of this matter; however, we believe that the traveling public would be best served through the adoption of a plan which would offer our services for trips which were not, in fact, interstate in nature. Transportation services, in order to be effective and of value, must meet the needs of the people they serve. These needs are not static, but rather ever-chang ing. We believe the ingenuity and flexibility brought to the air transportation industry by carriers such as Air California should be recognized as beneficial and that the continued expansion of their services should be encouraged. We are proud to be a member of an industry which provides services which are so vital to our national economy and well-being. We thank you again for the opportunity to appear before you and would be pleased to answer any questions which would be of benefit in your consideration of these matters. Senator KENNEDY. The next testimony will be from Dr. William A. Jordan, professor of managerial economics at York University, Toronto, Canada; and Dr. John R. Summerfield, president of Summerfield Associates, a transportation research and consulting firm. During the past 27 years, Dr. Jordan has worked for Scandinavian Airlines System, Air France, Seaboard World Airlines, and Western Airlines. Dr. Jordan has consulted on airline and airport matters. He has taught graduate courses in economics and government regulation at Columbia, Stanford, Northwestern, U.S. International, and York University, and he is a colonel in the Air Force Reserve. Dr. Jordan is well known for his publications on airline regulation and capacity agreements. Dr. Summerfield has directed transportation research at the RAND Corp. and has served as corporate economist and director of economic studies at Douglas Aircraft Co. and as vice president of economic planning at Western Airlines and Pan American World Airways. Dr. Jordan, do you want to start, please? STATEMENTS OF DR. WILLIAM A. JORDAN, PROFESSOR OF MANAGERIAL ECONOMICS, YORK UNIVERSITY AND DR. JOHN R. SUMMERFIELD, PRESIDENT, SUMMERFIELD ASSOCIATES Dr. JORDAN. Thank you. My presentation today is based on research for the past 10 years on the effects of CAB regulation. Rather than attempt a theoretical study, I decided the best way to do this would be to compare the actual performance of CAB-regulated airlines with the benchmark of the actual performance of those airlines not regulated by the CAB. The nonregulated airlines are primarily the intrastate airlines, but not entirely. This study covers the post-World War II period with emphasis on the years since 1949. CONTROL OF INDUSTRY ENTRY IS NECESSARY FOR REGULATION One conclusion of this study is that a necessary condition for effective regulation is the control of entry. It is necessary to control entry to prevent rival airlines from entering should regulation cause fares to rise above average costs, and it is necessary to prevent entry in case costs themselves rise above the minimum average achievable. The CAB has effectively closed entry into U.S. interstate airline operations. There have been 16 to 10 trunk carriers, decreasing in numbers from 1938 to the present time, with Pan Am being another large carrier, but primarily international. There have been 21 to 8 local service carriers from 1946 to 1950 to the present time with Air New England being the latest addition after a 25-year hiatus in the authorization of such carriers. In 1973, the total operating revenues of all U.S. airlines operating large aircraft were approximately $13 billion. Of this $13 billion, the 10 trunks plus Pan American counted for 84.2 percent, and each of these trunk carriers served between 37 and 111 cities with 60 to 390 aircraft each. Local service carrier share was 8.2 percent of the $13 billion, and they served 50 to 95 cities per carrier with 33 to 133 aircraft. So these two CAB-regulated airline groups together have accounted for 92.4 percent of the $13 billion or a total of roughly $12 billion of this $13 billion. All other airlines in the United States accounted for the remaining 7.6 percent or roughly $1 billion. DISECONOMIES OF SCALE: 100 TO 200 AIRLINES WITHOUT REGULATION The conclusions of my study indicate that without CAB regulation there would be between 100 to 200 or more airlines in the United States operating large aircraft in scheduled service, and figure No. 1, which is the one in the corner there, summarizes this. Twenty CABregulated trunk and local service carriers plus Pan Am as opposed to 200 or more nonregulated airlines without the CAB. Senator KENNEDY. How can you make a statement like that when we have just heard from two operators, one of whom felt that unless you were very sure that you would be able to build up 65-percent passenger capacity, that you may very well go out of business? Here we have 20 with regulation. You talk about 100 to 200. How do you draw that conclusion? Would it not oversaturate the market and cause financial turmoil and disaster among carriers? Dr. JORDAN. We should recognize that the nonregulated airlines have all been smaller lines. Senator KENNEDY. Does that mean you go on a small line from Boston to Washington? Dr. JORDAN. Yes, it would operate from 3 to 4 to 6 planes as opposed to 40 to 60 to 400 airplanes. The point is there is enough traffic to support small airlines with three or four aircraft and make them viable. They will be able to achieve all the possible efficiencies with that small operation, and such small airlines have been viable in the California and Texas situation without regulation. What I am saying is that without regulation which causes airlines to be large, you would have a large number of small airlines, each one specializing in a certain kind of operation. Senator KENNEDY. Why does regulation require that the airlines be large? Dr. JORDAN. Because, given entry control, the trunks have been limited to those certified in 1938 and the local service carriers limited to those certificated between 1946 and 1950, and these are the only airlines that have been allowed to provide interstate service. As the citypairs have expanded and total traffic has expanded, these airlines have been required to expand. Also, when an airline makes a major mistake, it is forced to merge like the Capital-United merger of some years back so with no entry the size of the remaining airlines increases. Closed entry is the cause of large airlines. Senator KENNEDY. If you had a greater number of airlines actually required to go into a merger situation, as you pointed out, why does that not run contrary to your thesis that you would have 100 to 200, if the experience has been in recent times that the total numbers have actually reduced? Why do you not believe if you start out with 100, that it will finally contract down to the 20 or so even without the regulation? Dr. JORDAN. Because without regulation we find that airlines can be efficient, low-cost carriers with small numbers of aircraft, and therefore, as airlines become larger they become less efficient, and we will lose business to the small airlines that will enter. I should mention that one very striking comparison-we have had merger acquisitions in CAB regulation. There has not been a single merger application in a nonregulated environment. Senator KENNEDY. Is it more efficient to have a smaller number of planes and more airlines, or a larger number of planes and fewer airlines? It seems to me, for example, in the terms of trucks supplying the planes with gasoline or handling baggage that you would have regulated lines. Let us take, for example, the case of the trucks supplying planes with gasoline or handling baggage transfer. On the one hand, you would have the larger regulated airlines using one gasoline truck to refuel planes all day, while, on the other, you would have the smaller airlines using one gasoline truck to refuel four or five planes. Dr. JORDAN. In response to that question, the gasoline truck is usually owned by the fuel company. It supplies airlines and it does not have to supply one airline. Senator KENNEDY. Is that true of all these other services? REGULATED FARES ARE 40-70 PERCENT HIGHER THAN UNREGULATED Senator KENNEDY. Let's continue with your other testimony. Given closed entry, we find what are some results of CAB regulation. One clear result has been higher fares. I have shown in figure 2, a comparison of fares with regulation as opposed to fares without regulation. Those in red are with regulation. I have broken them down into short-haul, which I have defined as 0 to 250 miles, more or less; medium-haul from 251 to 1,000 miles; and long-haul over 1,000 miles. I have shown the Boston-New York, Boston-Washington, and BostonLos Angeles fares as examples for these mileage categories. In the case of a short-haul, the California analysis implies that the fares with regulation are between 40-70 percent higher than without regulation, and this is the basis for the difference between $25.93, which is the actual regulated fare between Boston and New York, and the $15 fare without regulation. In terms of medium-haul, we find that the fare differences are around 75 to 100 percent, which is a difference of $41.67 with regulation, versus $21 without regulation for the Boston-Washington fare. Finally, for the long-haul, we find fares roughly 100 percent larger with regulation, which gives you the $187.04, the actual fare today, as opposed to without regulation, approximately $95. Now, these large differences are in city fares that have relatively high traffic density, being defined as over 100,000 passengers per year. The same analysis applies for small city-pairs with the fare differences not as large, but with the nonregulated fares still lower than regulated fares. This analysis is based upon California, but supported by similar analyses in the Texas case, in the military airlift case where we had regulation by the CAB, imposed in 1960, and it is supported by a comparison with regulated fares in Canada, between Montreal and Toronto. We find with regulation in Canada, their fares are high, roughly the same as regulated fares in the United States. So, without regulation fares are lower. With regulation, fares are higher. Senator KENNEDY. Why? REGULATION INCREASES COSTS- -SERVICE COMPETITION Dr. JORDAN. Well, that is the next question. If prices are so high why are there not large profits, for example. Well, it appears that regulation also serves to increase costs of operation. Fares go up, costs also go up. This is a major area of work. I have identified three important sources of these differences in cost. One source is decreased aircraft utilization. The second source is lack of specialization among the regulated airlines. The third source is the purchase of more and more inputs at higher prices, that is labor and aircraft, for example. First, the matter about aircraft utilization. CAB regulation for the last 36 years has been asymmetric, it has been complete in entry and exit, it has been very effective in price, but it has been ineffective and almost nonexistent in the matter of service quality. Furthermore, the CAB has failed to allocate specific market shares to each airline. Instead, it has certified two or more airlines in many city-pairs whereupon it has said all right, fellows, your prices are fixed but you are in this city-pair, go ahead and get what you can get. The airlines' response has been well, we are controlled pricewise but not service qualitywise, let's have superior service quality. The way to do that is to operate brandnew airplanes at high-schedule frequencies. They have done this. Furthermore, they put fewer seats in their aircraft, and even given fewer seats, they have operated enough frequencies to give them lower numbers of passengers per flight, low-load factors. Now, I have on figure No. 3, which I will refer to very shortly, an explanation of what this means in terms of cost. Looking only at aircraft costs, just the aircraft from the viewpoint of the airline costs, if we increased the load factor from the current 56-percent level, which is what it was last year, 1974, to 70 percent, a 25-percent increase, and by the way, the 70 percent load factor is the lowest load factor that existed between 1955 and 1964 in California. Quite feasibly, it has occurred regularly without regulation. If we have this kind of load factor in all U.S. operations we would decrease the fleet size by 20 percent, 25 percent increase in load factor, 20 percent decrease in passenger flights. Such a decrease in the fleet would reduce the value of the aircraft fiect from the present $12.25 billion, undepreciated value, for the trunk airlines, to about $9.8 billion. A second factor would be if we increased the average life of each aircraft by 25 percent, going from say 14 years, which is an average allowance for present CAB airlines, to 171⁄2 years, you would de |