A Compelling Argument Against Airline Mergers

When it comes to mergers in the airline industry, I’ve generally been mildly in favor. I’m not exactly a fan boy, jumping up and down with excitement, but I hadn’t really seen enough negatives to make a compelling counter-argument. Now, I can say that I’ve seen one that’s definitely thought-provoking at the very least.

Last year, Hubert Horan wrote a guest post here on why consolidation over the North Atlantic was bad. Now he’s extended that thought process to oppose the United/Continental merger. In fact, he testified in front of Congress this week and he was kind enough to send me a transcript of what he said.

In short, he argues that these mergers will cause great harm to travelers. I’ve heard that argument before, but it’s never really struck a chord with me until now. His argument breaks down into four pieces.

1) Consumer Welfare Losses From Anti-Competitive Pricing Power Already $5+ Billion and Rising

Hubert argues that since airlines have been granted antitrust immunity over the Atlantic, fares have risen dramatically. This chart says it all:

North Atlantic Fares

In 2004, the number of competitors on the North Atlantic decreased, and that led to higher fares. More than just higher fares, it led the Atlantic fares to decouple from the domestic fares that they used to track with. This seems crazy because there was also a dramatic increase in capacity, but it happened and the lower number of competitors are the best way to explain that.

He’s also clear to point out that it’s not the alliances that cause problems but rather the antitrust immunity that allows airlines to coordinate schedules and fares. They were still competitive in regular alliances, but once they started receiving antitrust immunity, competition went down.

2) United/Continental is Part of a Well-Planned, Ongoing Process to Consolidate Virtually All Legacy Network Airlines Into Just Three Competitors That Will Control 80% of US Airline Traffic

Knowing what we know from #1, this shouldn’t make a difference, right? I mean, Continental and United already have antitrust immunity for international flying, so a merger shouldn’t change much. I needed the link between that and domestic flying to understand where the harm would come from. Now I think I understand the argument.

Over the last few years, we’ve seen legacy airlines rush to send their fleets into the international market. Domestically, big markets are covered by the low cost carriers so competition is high, and smaller markets are, well, small. So the big profit potential is internationally for the legacy guys. The problem is that as these airlines grow internationally, they end up squeezing out other competitors from succeeding over the ocean. That in turn makes the domestic network less valuable and that leads us to . . .

3) Domestic Consumers Are Threatened by Weakened, Distorted Competition that Low Cost Carriers Will Not Address; United/Continental Directly Threatens the Independent Survival of US Airways

So here’s where we get into the meat of the argument. Domestically, the low cost carriers are most efficient, and then we see US Airways. (You might remember that they have a cost advantage to make up for their revenue disadvantage, and that means they produce seats more efficiently.) The other legacy carriers continue to grow and dominate the international arena, so they can use those profits to subsidize their domestic operations, but US Airways, despite its greater efficiency, will get squeezed.

US Airways is likely to see reduced feed from partner airlines in this new world. A great deal of US Airways Atlantic traffic comes from Star Alliance partners. Those partners will now be more likely to send traffic via their own joint venture partners, Continental and United because it’s better for them. If Continental and United merge, they can coordinate domestic schedules to make connecting even more efficient within the airline. This leaves US Airways out in the cold and reduces the value of its domestic operation as well.

And that’s why we see US Airways saying that it will merge with someone. It sees the writing on the wall down the road. So that gets us to three legacy competitors.

The low cost carriers will continue to provide great competition on the biggest routes, as they do today, but they have yet to figure out how to compete in smaller cities and internationally. As the legacy carriers bump up their international profits, they can subsidize their domestic operations and be more aggressive with low cost carriers.

Meanwhile, in smaller markets, with less competition, airlines will be less concerned about maintaining service and can cut back to profitable levels. Nobody will step in to fill that void in smaller markets.

But should anyone? I mean, isn’t the point to make airlines healthier? So unprofitable capacity should go away. But . . .

4) Mergers Such as UA/CO and DL/NW Cannot Be Justified on Efficiency/Synergy Grounds and Are Strictly Motivated by the Potential for Increased Anti-Competitive Market Power

In other words, mergers don’t provide increased cost efficiencies or enough “synergies” to make up for the “enormous acquisition and implementation risks.”

Hubert looked at the mergers since deregulation and found only four that were successful. US Airways/America West was because it happened as part of a bankruptcy proceeding which allowed for real gains. The rest happened years ago and were either because two airlines consolidated a hub into one to gain efficiency (TWA and Ozark) or it was a very small, easy integration (Southwest and Morris).

I think this is my favorite quote.

The industry does have financial problems, but those problems will not be solved by suspending the antitrust laws so that mediocre airlines clinging to obsolete business strategies can exercise artificial market power at the expense of consumers and more efficiently run airlines.

Ziiiiiiiiiinnnnnnnngggggggg!

You can read Hubert’s full testimony here and his reponse to Vaughn Cordle’s pro-merger arguments here. I’d recommend digging in, because it’s a good argument.

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55 Comments on "A Compelling Argument Against Airline Mergers"

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FlyLBB
Guest
Brett, first off disclaimer…i’m not a fan of the consolidation that happening. That said, I see some flaws in Hubert’s logic and will offer a different interpretation of what’s happening. Quite simply, the Transatlantic market has done a better of resegmenting its traffic base and in adapting pricing structures to fit it. 1) Hubert’s data doesn’t show us the prior-1993 period. It would be interesting to know the effects of deregulation all up…so a 1960-ish – now look would be more revealing. 2) From 1994-2000, domestic fares grew faster than Transatlantic. On the lower end of the fare structure, $99… Read more »
frank
Guest

In 2004, the number of competitors on the North Atlantic decreased, and that led to higher fares.
=====================================================

At the same time, you had your FUEL COSTS go up/double: From the mid-1980s to September 2003, the inflation-adjusted price of a barrel of crude oil on NYMEX was generally under $25/barrel. During 2003, the price rose above $30, reached $60 by August 11, 2005
http://en.wikipedia.org/wiki/2000s_energy_crisis

longtimeobserver
Member

Of course this means carriers plying the Atlantic had far greater pricing power (to push through fuel surcharges) in transAtlantic markets than they did on domestic operations. Suggesting the competitive structure on the Atlantic including ATI and scheduling/pricing coordination did have a supportive effect on pricing.

FlyLBB
Guest

I’m not sure i buy the number of competitors arguments (since the number of domestic competitors has decreased as well)….pricing power can exist in just about any type of market environment…OPEC and the price of oil’s history is an example of how an oligarchy and a cartel can both have or not have pricing power.

Jason H
Guest

I’m interested to know how the 2 west coast legacy carriers that everyone forgets about fit into this? How does Hawaiian and Alaska/Horizon work in this argument? Both are profitable, both fly international routes, and both compete with the large legacy carriers without the cover of an alliance membership. Alaska/Horizon fly into a lot of small markets that no one else would touch (Walla Walla, WA for example) and they have shown they will step into routes that others abandon (SEA-STL).

FlyLBB
Guest

These carriers behave like all others. For a carrier like Alaska, routes are cross subsidized…ones with higher margins (Alaska, Montana) offset one’s with lower margins (California). For a carrier like Hawaiian, it’s both cross seasonal and cross margin.

Alaska can step into STL due to the network effect…and plus frankly, they need to stick their excess capacity somewhere other than their existing network. AA’s had to pull down of STLSEA for the reverse reason…..and anyway, the AA/AS partnership makes the handover acceptable to the Frequent Flyer base…neither group of FFQ’er (AS or AA) get screwed over.

Jason H
Guest
I realize they are cross subsidized and subsidized by airports, communities, and the EAS funds, but that doesn’t change the fact that they are both willing to step into routes that LCCs won’t (to point 3 of Cranky’s post); heck they are stepping in where WN is stepping out (SEA-STL again). As for the STL route, I’m not convinced that it is an excess capacity move. They are retiring 3 -400s and 2 -700s and only bringing in 4 -800s, so their available seats is shrinking (not by a lot, but still shrinking) and Horizon is sub-leasing some of their… Read more »
FlyLBB
Guest
To run the plane in the middle of the day to STL means there was not an better opportunity to fly it in the existing network….so that says to me they have too much capacity and the stage-length adjusted financial performance to is much worse. A good financial move, probably, but not because there was a better alternative. To be clear, also, WN serves SEA-STL, just not nonstop. I took the market comment to mean overall size of the O&D not the nonstop market. WN has retrenched during the past ten years in smaller markets (Spokane, Amarillo, Lubbock, Midland…and even… Read more »
FlyLBB
Guest

ugh…typo/grammar fart there in the first paragraph. Basically, to pick a new route means the alternatives to run it in the internal network were worse.

Jason H
Guest
Perhaps you are right, but this is exactly where lumping air carriers into three groups (legacy, LCC, and regional) doesn’t make sense. AS is making a decision; relatively quickly at that, to serve the STL market using their current resources. They probably could use that 737 on a (quasi-)international route to/from Canada, but instead stepped into a new market. I really can’t remember the last time I saw that behavior from another legacy carrier that wasn’t trying to score political points. Additionally, it appears from some tweets by Horizon today that AS might be planning to replace some CRJ700s with… Read more »
Carl
Member

I think Horizon has made its life difficult by having no smaller planes to provide the connecting functions a regional is supposed to provide. Not too many routes can support a 76-seat propeller plane. And I think it is questionable on whether passengers will stay on prop for more than 90 minutes if there are any good alternatives, including connections, especially if the prop is only once or twice a day.

Andrew
Guest

Call me skeptical… but do you know who is currently paying this guy?
He spent his entire career promoting/developing airline mergers and consolidation (http://www.horanaviation.com/Bio_Experience.html) but suddenly now that he is a paid consultant, he’s advocating against them.
For the right payday, someone else could create equally compelling bullet points and charts in favor of this merger.

Carl
Member
The argument that the three consolidated network carriers will control 80% of the U.S. domestic market is obviously incorrect. The #1 U.S. domestic carrier is Southwest, and the LCCs all together are approaching 50% of the domestic market. There is LCC competition on over 80% of the mainline routes. With the rise of the LCCs, there is no longer the need for 5 legacy network carriers. The UA-CO consolidation is exactly what is needed for the changing business models, and it is the presence of the LCCs that will keep pricing for consumers. As long as entry into new markets… Read more »
David SF eastbay
Member

If people are worried about the lack of competition and fares going high, they the government should never have allowed alliances to form in the first place.

As someone I know always says, ‘what goes around, comes around’. We will see history repeat itself one day. DL, AA, and a UA/CO combo will one day turn into the PanAm, Braniff, and TWA in aviation history and be gone and the big boys over the Pacific, Atlantic, and to Latin America will be Southwest, AirTran, and Spirit.

Just because you ‘rule’ the internation market today, doesn’t mean you will rule it tomorrow.

Nick Barnard
Member

DL, AA, UA, and CO all bought their international routes from PanAm, Braniff, and TWA. I honestly doubt any of the current carriers would repeat the mistake of selling off their really lucrative routes.

Ed Casper
Guest
I have to question Mr. Horan’s “facts.” And therefore, his conclusions. In footnote #5 on page 5 Horan states that US Airways and America West were BOTH in Chapter 11 during their merger. Based on everything I’ve read and seen (I live in PHX so get plenty of HP / US news) This is false. America West was NOT in Chapter 11. US Airways was and may have faced liquidation. I also question his conclusion that it’s likely both carriers would have faced liquidation (although he may have information I have no access to). The only thing I’ve ever seen… Read more »
scott.wintner
Member

OK Cranky, I’m confused. It seems that Mr. Horan’s arguments all boil down to “consolidation means prices go up”. No argument here… but isn’t that the whole point?

You have been outspoken despite how unpopular your view (much to your credit, I believe) that prices NEED to go up in order for the industry to be sustainable. Has that view changed?

jaybru
Member
For the average customer, it’s tough figuring out what does and does not make sense regarding mergers, consolidations, etc. But, the granting of anti-trust immunity, whether related to pricing, routes, capacities, whatever, seldom seems to me to be in my best interests. I know, the proponents say, more and better choices. But, I find too often they really mean: “At last, we no longer have to compete.” The result, fewer choices, higher prices. Alliances, fine. Just like having preferred providers, or people we would prefer to deal with. OK. but when you allow the alliance to have anti-trust immunity, all… Read more »
Trent880
Guest

“Obsolete business strategies”…such as what? And what would be the alternative? The reality is if the US wants the network currently offered by its air carriers, fares need to rise, regardless of how they rise. Period.

Carl
Member
The business strategy of the network carriers is that every flight is a connection to a hub. Pretty much every domestic UA flight is to/from ORD, IAD, DEN, SFO or LAX. Pretty much every domestic CO fligth is to/from IAD, EWR or CLE. Pretty much every domestic AA flight is to/from LGA/JFK, DFW, ORD, MIA or LAX. Pretty much every domestic DL flight is to/from LGA/JFK, ATL, DTW, MSP, MEM or SLC, and what remains of CVG. The way they serve all other markets is via connections at their hubs. That’s higher cost than LCC direct flights on routes that… Read more »
Carl
Member

CO IAH, not IAD
US getting rid of anything that is not PHX, CLT, PHL or DCA (still has LGA but wants to rid itself)

Trent880
Guest

The problem is that whereas the point to point model is the most cost effective way to get people from A to B, it also has an extremely finite application and is often the least practical. If the industry was all point to point, a good half of all cities would have zero air service–at least. The hub and spoke model is alive and well, and the most efficient way to get people from anywhere to anywhere. It may be higher cost but it also is much higher yielding on average.

Carl
Member

The old airline business model was to charge high fares for (the convenience of) non-stop flights and lower fares for connecting itineraries. This allowed the LCCs to undercut the legacies. Now they have to charge what the LCCs do for non-stops, and that probably means a premium for connecting itineraries that don’t have enough traffic to warrant non-stop service

Trent880
Guest
LCC’s can undercut legacies because their costs are lower. Legacy carriers, however, can manage the lower yield traffic off the plane when there is a hub on one or both ends, something that is impossible in all but the largest, highest yield point to point markets. Hence most of the rest of point-to-point markets are dominated by the lowest cost carrier, not because LCCs are geniuses and have found an untapped goldmine, but because they’re the only ones that can make them work, until someone else comes along with lower costs. Inevitably the B6s, NKs, FLs, and even WNs of… Read more »
Carl
Member
Two interesting comments: 1. SW operations in Denver and MDW sure look a lot like a hub, don’t they? It does seem that this becomes a natural evolution for the airlines as they mature. 2. Most LCCs start with young, junior employees. But as time goes on, their costs rise and start to approach the network carriers. The only ones that has bucked that trend, to a degree, is SW. Maybe one reason is that they for years kept their model simple and avoided all frills, but even they seem to be slowly getting more like the others, though they… Read more »
Sally65
Guest

Bottom line, no matter how it happens, if airfares rise significantly, less people will fly. That is what WN and other low cost carriers have brought to the marketplace. Don’t know the answer but with the volatility of fuel prices, the continuing recession, domestically business travel has decreased and in the leisure market, unless there are cheap seats, vacationers typically won’t fly. Drive up ticket prices signficantly, there will be more empty seats.

Kate
Guest

Some truth to that already. We’re driving this year instead of flying for our vacation. It was too expensive for airfare + rental car + hotel, so we are driving + hotel and saving a ton of money, plus seeing the country on back roads.

Don Nadeau
Guest

” . . . Are Strictly Motivated by the Potential for Increased Anti-Competitive Market Power” and by the incredible fees merchant banks and legal firms receive as a result of promoting them.

Tory
Member

Alternate hypothesis: fuel prices rose for everybody, both domestic and international. But SWA had substantial fuel hedges domestically, and became the low price setter others had to match (leading to big domestic losses). But since SWA doesn’t fly internationally, prices could rise there.

As far as LCCs not serving smaller cities, wouldn’t AirTran be a counter-example?

vin2basketball
Member
Brett, to sort of play devil’s advocate here. Looking at US airlines only, for the period 1995-2008, the network carriers in total grew ASMs .033%. During that time LCCs grew total ASMs by something like 380%. So LCCs by 2015-2020 will control 40-50% of the market based on current trends. The other point I wish to make, is yes, small markets will lose some competitors, but I don’t think airlines will raise fares in those markets too much. Here’s my reasoning. Small markets are vital in providing feed to the larger hubs. If they raise fares too high, then they… Read more »
DC
Guest
Cranky – Excellent post. There’’s a lot going on here that you could dissect in subsequent posts if you wanted. I’m a little late to the party but wanted to offer a few points. I don’t expect one to agree with all of my positions, but I know I’m not alone and we spend money. 1. AIrline service is not a pure free market. If it were, WN would be all over DCA already. There are many constraints that the airlines cannot do much about, at least not on at a speed to respond to fluctuations in the market: slots… Read more »
DC
Guest
Thanks for the considered response. I like the perimeter rules because I believe BUF would disappear (along with BTV, ROC, along with many cities in the Carolinas and Tennessee among others) without them. Biggest benefit applies to statistics. I’m talking about people and what the local population wants. I reject the most benefit to the most people. Why? Because people don’t mind driving to IAD for hourly service to LAX, SFO or wherever else over 4 hours. And people from Los Angeles moved here knowing they probably couldn’t go home for the weekend. But that is not the case for… Read more »
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[…] post on Hubert Horan’s anti-merger stance generated a ton of discussion here, and that was great. While some agreed, others didn’t. […]

Mike Ferguson
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I know it’s late and might not get a response, but does anyone know anything of the re-emergence of the skywest-expressjet merger rumor?

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