I know, I know. I’m not on vacation anymore, but when industry veteran Hubert Horan sent me this rebuttal to Evan Sparks’s piece, “Why International Alliances Are Good for You,” I just had to post it. What do you think?
I was in charge of international network planning and scheduling at NWA in the early/mid 90s, and developed the first (NWA-KLM) alliance network in 1993. Within 18 months we expanded hub-to-hub flying from 2 to 9 daily flights, establishing the network model subsequently copied by Delta-Swissair (in 95) and United-Lufthansa (in 97). I later spent four years at Swissair/Sabena, so I have worked these alliances from both sides of the Atlantic. I’ve not only built up alliances that actually worked from a customer/financial standpoint, but I’ve helped shut down alliances (America West-Continental, the European Qualiflyer alliance) that didn’t. In recent years I’ve published a variety of articles on alliances, the dynamics of international competition, the EU-US treaty negotiations, and related topics. Thus when I say that the arguments in the 13 April post “International Alliances Are Good For You” demonstrate a profound ignorance of international airline competition and the economics of airline alliances, there is a substantial body of analysis and experience behind my claims.
The current applications for alliance antitrust immunity will completely end meaningful competition on the North Atlantic. 23 airlines that used to compete independently have applied to the US and EU governments to consolidate into three Collusive Alliances. There are active press reports that two others may join in the near future (see list below). The three Collusive Alliances will control 97% of all North Atlantic traffic. The three groups would function as a North Atlantic Cartel with the Lufthansa and Air France groups dominating Continental European traffic (75-80% of the total North Atlantic) while the British Airways-led group would dominate the US-UK market (the other 20-25%). None of the members of this cozy Cartel would have any incentive to compete aggressively with the others.
The central issue here is whether you think this radical North Atlantic consolidation is “Good For You”, as the author of the 13 April post believes, or would cause lasting damage to consumers and industry efficiency. A few factual points are critical to understanding the economic issues.
- These Collusive Alliances, which explicitly eliminate competition, function totally differently from the longstanding “Branded Alliances” (Star, Skyteam, Oneworld) which are enhanced frequent flyer programs, and are not anti-competitive. United can collude on prices and schedules with Lufthansa and other European “Star” members, but faces aggressive competition from ANA, Thai, Singapore, and other “Star” members. Reciprocal frequent flyer “alliances” date to the early 80s, long before the Collusive Alliances began. Oneworld has functioned fine for ten years without any antitrust immunity arrangements; if its members were not granted immunity to collude on North Atlantic pricing, Oneworld would continue to function in its present form.
- The North Atlantic, like other Intercontinental markets, has huge barriers to competitive entry. It is absolutely impossible to compete on the North Atlantic without a large scale hub operation on at least one side of the ocean. This is a pure “network airline” market; no LCC or niche competitor has ever achieved more than a miniscule share of the North Atlantic. Many of the most important airports (JFK, EWR, LHR, CDG, FRA, ORD) are highly slot constrained. Even though there has been active entry and dynamic growth in most of global aviation since deregulation, there has been almost no net entry into the Intercontinental sector in the last 25 years. There is no plausible evidence to support the claim that any anti-competitive behavior by the Alliance Cartel would be quickly disciplined by new competitors entering the market.
- The three original Collusive Alliances (NWA-KLM, Delta-Swissair, Lufthansa-United) benefited consumers in the early mid-90s by providing improved schedules and lower prices to one previously underserved piece of the market, the so-called “double connect” markets. These St. Louis-Berlin or Jacksonville-Munich type city-pairs, where no one offered “online” service, actually accounted for about 25% of the North Atlantic in 1990. You could fly interline, but fares were high. The original alliances provided good schedules in these markets and the full range of discounts found elsewhere. But by 1997, this market gap had been fully closed. After 1997, the Collusive Alliances didn’t offer consumers any new services or prices that hadn’t been available before.
- As late as 2003, the North Atlantic had healthy competition and was strongly profitable. The three largest competitors served about 55% of the market; no one had anything close to the “market power” that would permit the type of oligopoly behavior that could harm consumers. The three Collusive Alliances (focused on connect markets) combined had about 45% of total traffic; they competed with each other and with the non-alliance carriers that focused on larger nonstop markets (BA, Virgin Atlantic, AA, US Airways, Continental).
- Prices paid by North Atlantic consumers have been climbing rapidly (chart below). In the 1990s, transatlantic average fare trends closely tracked US domestic trends. But this changed after 2000; as North Atlantic concentration levels (top 3 share) rose from 47% to 67% in 2007, average North Atlantic fares rose 40% more than US domestic fares. The threat of consumer price gouging will surely increase further as concentration grows from 67% to 97%.
- Each of the 23 (soon to be 26) previously independent airlines went to the US and EU governments with a petition to either merge, or for antitrust immunity to actively collude on prices, schedules, service and everything else (which is exactly the same as a merger). The big Legacy carriers have invested millions in lobbying and public relation efforts advocating “industry consolidation”. The move to radical consolidation had nothing to do with consumers, efficiency, or “market forces”. The shift from a market where the top 3 competitors had a 55% share, to a world where they have a 97% share, resulted from government officials agreeing with the requests from these airlines to eliminate competition.
Why are the current antitrust immunity applications and the larger trend towards radical North Atlantic consolidation Bad for Consumers and Industry Efficiency?
- Because none of the consolidation since 2003 generated any new consumer benefits or offsetting productivity gains that could have possibly justified the reduced competition.
- Because extreme concentration in markets with high entry barriers always creates huge risks, and there is zero probability of new competition that would ever threaten the hegemony of the 3-alliance Cartel–Southwest or Easyjet will never invest the tens of billions that would be needed to mount a serious competitive challenge.
- Because once it is in place, it will be much more profitable for the 3-alliance Cartel to steadily raise prices while cutting capacity and service—classic oligopoly behavior—undermining the growth that airports and local economies depend on, and undermining the pressure for innovation that is critical to long-run industry efficiency
- Because airlines will use the totally artificial profits from the protected North Atlantic Cartel to distort competition in the US domestic market—for example Delta can use these artificial profits to subsidize competition against more efficient shorthaul carriers such as Airtran and Southwest.
- Because having a radical shift towards concentration totally driven by government action—explicitly favoring the interests of the big Legacy airlines over the interests of consumers, communities and non-Legacy airlines—makes a travesty of the basic principles of deregulated competition and Open Skies.
How can the author of the April 13th post, and the Legacy Airline PR people claim that merging 26 independent North Atlantic airlines into a 3-alliance Cartel is Good for Consumers?
- Try to confuse people by conflating the frequent flyer benefits of Branded Alliances with the anti-competitive impacts of mergers and Collusive Alliances
- Use false and deliberately misleading evidence, i.e., claim that an academic analysis demonstrating that consumers benefited when the original alliances were first introduced in the mid 90s under vibrant competitive conditions proves that consumers will achieve new incremental benefits if these alliances are merged together and competition is totally eliminated in 2009
- Ignore historical evidence (recent pricing data), or simply fabricate false claims, i.e., that reduced competition is a necessary response to the recession, ignoring the fact that all of these mergers and alliances were planned years ago when the market was strongly profitable, and ignoring the fact that no one is demanding radical consolidation of the much more competitive domestic market
- Consider every transaction in isolation, without ever considering competitive responses, or ever examining the overall evidence of accelerating North Atlantic consolidation. The reviews of the Air France-KLM and Delta-NWA applications ignored the inevitable follow-on applications from Continental, BA-AA and others
- Make sure there is no regulatory scrutiny by objective outsiders of any merger/antitrust immunity claims; the only public evidence of the DOJ review of the Delta-Northwest merger is a one page press release touting the lower prices and expanded service that the reduced competition would allegedly create
As witnessed with the financial industry, the fight for airline consolidation has been led by people who claim to be true believers in “free markets” but are actually fighting to get governments to intervene in favor of badly managed (but politically powerful) big companies. The “free market” consolidation argument is really a demand to gut remaining antitrust and regulatory protections for market competition so that those big companies can merge into “too big to fail” global airlines. The “free market” case isn’t based on any data or analysis that can be objectively verified, and insists that anyone who disagrees must be a self-serving politician, if not an evil socialist. People who care about the future of commercial aviation shouldn’t ever tolerate this kind of nonsense.
Hubert Horan is a Phoenix-based aviation consultant with 25 years of industry experience. His website is horanaviation.com
Note 1—the 23 previously independent competitors that have merged, or have formally applied to merge into the three Collusive Alliance groups: United, Continental, Lufthansa, Air Canada, Austrian, Swiss, SAS, TAP, Turkish, LOT, bmi, Brussels into the Lufthansa-led group; Delta, NWA, Air France, KLM, Alitalia, Czech into the Air France-led group and BA, AA-TWA, Iberia, Finnair into the British Airways-led group; Aer Lingus, Virgin Atlantic, and US Airways are also widely reported to be pursuing membership but have not yet formally applied for antitrust immunity. The largest carriers outside the Collusive Alliances would be Aeroflot (0.5% of transatlantic capacity in 2007) Aerosvit and flyglobespan (0.2% of capacity each).