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:

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.