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An Airline Merger that Might Not Get Off the Ground

Irwin M. Stelzer

The antitrust lawyers I have served as a consultant often have the same complaint: Their clients don’t know when to shut up. This was certainly true of the executives of US Airways and American Airlines as they touted the virtues of their proposed $11 billion merger. US Airways president Scott Kirby reportedly said consolidation allows airlines to raise fees and charge for baggage, and the company’s CEO, Doug Parker spoke of the virtues of “rationalization,” which antitrust enforcers have always taken to mean higher prices and consumer harm. Now that the Justice Department has decided to sue to stop the merger, the airlines’ lawyers say these comments are taken out of context.

Forgotten by most observers is that American was practically forced into this merger by its much smaller prospective partner. US Airways, which in 2005 acquired America West without objection from the Justice Department, found American, which had previously acquired TWA, unreceptive to its overtures. The larger carrier painted a picture of its glorious future as a stand-alone airline once it emerged from bankruptcy. But US Air lobbied the unions and American’s creditors, painting an even more glorious picture of the virtues of a combined operation that would have 6,700 daily flights to 336 locations in 56 countries, making it by some measures the biggest airline in the world. Earnings would be stabilized. The airlines’ over 100,000 employees would have greater job security and higher wages, a plus for the trade unions. American’s creditors would be better off. Profits would rise. Passengers would get an improved network with more options and better connections. And US Air would drop out of the Star Alliance and join American in British Airway’s One World group, strengthening the attractiveness of BA’s frequent-flier program.

Unfortunately for the prospective partners, they have two hurdles to jump. The first is the series of consolidations that preceded their proposed merger. While the Antitrust Division of the Department of Justice played Rip Van Winkle to the airline industry’s consolidation movement, carrier after carrier disappeared. The US Air-American merger would result in an industry dominated by four airlines—the merged American/US Air, United/Continental, Delta/Northwest, and Southwest/AirTran would have 85 percent of domestic seats, according to researchers at Innovata LLC. Aroused from its slumber, Justice is emulating Robert Durán, the boxer who famously turned to the referee during his battle with Sugar Ray Leonard, and cried No Más. In this case, no more consolidation, at last doing what those of us who were involved in airline deregulation thought it would do: preserve competition so that regulation would be unnecessary. That was the hope of Alfred Kahn, the so-called father of deregulation, when he turned off the lights at the Civil Aeronautics Board and left it to the market to protect consumers and drive the airlines to improve service and efficiency.

For a while it looked as if Kahn had won his bet: Consumers for whom air travel had been out of reach found they could afford to vacation in Florida, or visit grandma in Los Angeles. Then the mergers started, creating the second hurdle for American and US Air: Facts. Scott McCartney of the Wall Street Journal reports “some big-city routes saw price increases of 40% to 50% or more after mergers reduced competition.” Fares on the Chicago-Houston route are up 57 percent from levels that prevailed before United and Continental merged, and United’s domestic fares are up 16 percent, says McCartney. More facts: The prospective partners, says the Justice Department complaint, compete directly on more than 1,000 routes and between them control 69 percent of the slots and 63 percent of the nonstop routes out of Washington’s Reagan National Airport. And the merged carrier would have less reason to maintain its low-fare Advantage Fares program that Delta finds itself forced to meet.

Previous mergers not only have been followed by fare increases, but the elimination or scaling back of hubs, depriving many travelers of convenient, nearby points at which to start their trips. The Government Accounting Office predicts that a merged company would de-emphasize US Air’s Charlotte hub in favor of American’s Miami hub in order to eliminate duplicate service to some 56 cities. Worse still from the point of passengers, these mergers never go smoothly. After three years of trying to get its operations in order, Southwest and AirTrans are experiencing delays, booking errors, and difficulty in combining their frequent-flier programs. United and Continental have had even greater difficulties combining operations: Late flights, lost reservations, disgruntled employees who often view passengers as interruptions in their ability to complete their crossword puzzles, and the lowest customer satisfaction rating in the domestic airline industry—at 62, a full 17 points below even the U.S. Postal Service, no paragon of efficiency.

None of this should be taken as the only possible interpretation of the facts that will be presented to U.S. District Judge Colleen Kollar-Kotelly, who is no newcomer to antitrust cases: She spent years overseeing the Justice Department’s settlement with Microsoft. US Air and American have retained some of the most experienced antitrust counsel in America to present their side of the story. The merger will create a stronger competitor for Delta, something American standing alone cannot do. Low-cost carriers will provide sufficient competition to prevent the merged company from raising fares and reducing service. The stronger company will be placing orders for hundreds of new aircraft, introducing Wi-Fi service, securing the high-paying jobs of thousands of employees and, as United CEO Jeff Smisek put it in an interview with Bloomberg Businessweek about his merger, making “the money we need to invest in the products our customers want.”

That story will be played against two bits of background music. The first is the industry’s history of multiple and for some carriers serial bankruptcies. According to the old saw, if you want to become a millionaire, first become a billionaire and then buy an airline. Defense lawyers will be warning that American, standing alone, will emerge from bankruptcy in a weakened condition, to which the antitrust team will undoubtedly respond that the past need not be prologue, that the conditions that forced previous bankruptcies have been corrected by cost cutting and better management.

The second bit of background music that the judge will hear is the moaning of customers dissatisfied with the myriad charges they face when changing flights ($200 on each of the major domestic carriers, proof that it is easy for few sellers to agree on prices without meeting in a hotel room), or checking baggage. Economists might like the idea of having each passenger pay only for the service he uses, but ordinary people, unread in theoretical economics but unnerved by surprise charges, disagree. The anti-merger witnesses will try to make the case that the $6 billion annually that the industry is exacting in these unpopular charges will rise as tacit collusion by the big four eliminates or reduces whatever competition remains in the industry.

A deal can be struck—forfeit some slots at Reagan, perhaps—but my guess is that the biggest investment in the industry right now is the Antitrust Division’s investment in this case, and it is not about to write it off with a settlement that leaves consumers as seriously disadvantaged as the Division’s lawyers say they will be.

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