Breaking Down the DOJ’s Weak Objections to the American/US Airways Merger

I didn’t get into specifics in my post about the US Department of Justice (DOJ) filing suit to block the American/US Airways merger yesterday, but today it’s time to dig in.

In the 56-page complaint filed by DOJ, there is an attempt to show that this merger will violate antitrust law. Let’s go through each point one at a time. You can follow along starting on page 14.

Many Relevant Markets Are Highly Concentrated and the Planned Merger Would Significantly Increase that Concentration
DOJ uses the Herfindahl-Hirschman Index (HHI), a measure of market concentration. There are over 1,000 markets where the HHI exceeds 2,500 points (considered highly concentrated) and the merger increases it by 200 points (considered a significant change in concentration). DOJ says that this makes the merger illegal, but in reality, DOJ guidelines say that it’s only “used in conjunction with other evidence of competitive effects.”

HHI takes the market share of each competing airline, squares it, and then adds them together. So if there’s only one airline in the market, it’s 100*100 = 10,000. That’s a monopoly market. If there are four airlines each with 25 percent of the market, that’s 25*25 = 625*4 = 2,500. You get the idea.

So there are 1,000 different markets that are deemed non-competitive using those guidelines. That’s a big scary number. But look at the list of markets in Appendix A. I can’t go through them all, but most of these are pretty small markets. Norfolk – San Juan, Des Moines to Palm Springs, Little Rock to Rochester, etc.

Let’s dig into that last little market. In 2012, there were about 4 people a day going each way between Little Rock and Rochester. Here’s the market share for full year 2012 based on DOT data (via masFlight):

2012 Little Rock Rochester Market Share

As you can see, Delta is the big boy in the market today. After the merger, let’s assume that everything freezes completely, as you have to do when you use HHI. In theory, that means Delta and American become almost equal. Nobody has more than 50 percent of the market, and there are still three competitors fighting for those 4 people every day. Is this a less competitive market after the merger? Well, yeah. The HHI will increase from 2,701 to 3,500 as one airline disappears. But is it non-competitive? No way.

More importantly, let’s take a trip back in time to 2007. In early 2008, Delta and Northwest announced they were going to merge. So what did this market look like in full year 2007?

2007 Little Rock Rochester Market Share

Well, well. Look at that. When DOJ was reviewing the Delta/Northwest merger, this market had an HHI of 3,347, a good 600+ points higher than today. And when Delta merged with Northwest, it increased it to 4,485, a much bigger increase than what we see with American/US Airways. But back then, DOJ didn’t see this as being important. Now, all of a sudden, it matters?

We should also look at what happened after Delta and Northwest merged. Well, United/Continental came into the market and US Airways grew its share. Oh, and the average fare went down. Now can I say this happened in every market? No, but I can tell you that all these previous mergers had plenty of markets that had high HHIs and DOJ never saw that as an issue previously. Nothing should have happened to change that belief.

This Merger Would Increase the Likelihood of Coordinated Behavior Among the Remaining Network Airlines Causing Higher Fares, Higher Fees, and More Limited Service
This is a four-part complaint, so I’ll just go through them below. But the overall complaint is that it’s easier for fewer competitors to coordinate pricing. There are examples given about how airlines have signaled each other previously, but there is no evidence given that it will somehow become easier after a merger than it is today.

1) The Merger Would Likely Result in the Elimination of US Airways’ Advantage Fares
Go figure. DOJ apparently sees US Airways as a low fare savior. In some markets, US Airways currently files prices below the other airlines for last minute walk-up fares. If the merger goes through, DOJ says those will go away. The justification they use here is laughable. I’m guessing they found an intern to literally just take screenshots from the ITA Software flight search matrix to show a lower fare on a certain day. As anyone who understands this industry knows, fares change all the time. You can’t just take a snapshot of a single day and use that as evidence.

One of the couple markets they highlight is Miami – Cincinnati. Let’s use 2012 DOT data to get real results. Wanna guess who actually has the highest fares in that market?

Cincinnati-Miami Average Fare

You got it. US Airways, apparently the DOJ’s champion of low fares thanks to a screenshot on one day, had the highest average fare in the market in 2012. How can that be? Well, it’s likely because while US Airways does have some lower walk-up fares, they aren’t going to be available on every flight, every day. In addition, I assume US Airways is holding back on the cheap lower fare seats that can be booked in advance. The result is lower fares for business travelers, higher fares for people booking in advance, and overall, a higher fare in the market. Does that mean that DOJ values lower fares for business travelers more than lower fares for those buying further in advance? Or does it mean that DOJ just hastily put this together without actually looking at data?

This market is also a great argument for how the American team is doing something wrong. If you fly nonstop in the market, you should be able to get a higher fare than everyone else. So how is US Airways getting a higher fare with connecting service? But I digress…

2) The Merger Would Likely Lead to Increased Industry-Wide “Capacity Discipline,” Resulting in Higher Fares and Less Service
3) The Planned Merger Would Likely Block American’s Standalone Expansion Plans, Thwarting Likely Capacity Increases

Soon after going into bankruptcy, American put out a plan highlighting that it would be adding a lot of capacity in the coming years. That statement scared everyone from other airlines to Wall Street. Why? Because for years, airlines competed by putting too much capacity in the market. They would fight each other for market share and everyone would lose money. Consolidation has changed things. Now there are generally fewer, smarter management teams in place, and they realize that the key to actually posting a respectable profit is to keep your capacity in check. American’s current team is the only one who didn’t seem to realize that.

So DOJ likes the plan because it floods more capacity into the market, and that’s all that matters. Would it result in lower fares? Sure, at least until the airline loses too much money and retrenches. But DOJ takes American’s plans at face value, assuming that this is a solid strategy that will actually happen. The only way this happens is if American’s current management team somehow remains intact post-bankruptcy. That is far from a foregone conclusion since anyone will be able to file a plan of reorganization if the merger gets called off. And the money men are absolutely going to be looking for a plan that gets them a better return. I wouldn’t expect to see this kind of growth actually materialize. If it did, it wouldn’t last.

4) The Merger Would Likely Result in Higher Fees
I’m not sure how the potential for fees to be higher is grounds to block a merger, but apparently it’s worth an argument from DOJ. And it’s not a very solid argument. What evidence does DOJ give that fees will rise after this merger? Well, here’s one quote:

A December 2012 discussion between US Airways executives included the observation that after the merger, “even as the world’s largest airline we’d want to consider raising some of the baggage fees a few dollars in some of the leisure markets.”

Uh, ok. I’m guessing these kind of emails cross everyone’s desk at every airline all the time. Of course they want to consider it. It doesn’t mean they’ll do it, and it also doesn’t mean the other competitors will go along. DOJ says that since the new American would be the world’s largest airlines, the other airlines would just roll over and do what they say. Riiight.

The one actual piece of proof is that US Airways thinks that “fee harmonization” would result in $280 million in additional revenue each year. That means that when they standardize across the two airlines, some fees will go up and some will come down. In the end, they expect to be $280 million in the black on that. That’s in a company that generates $38 billion in revenue every year.

The Merger Would Eliminate Head-to-Head Competition in Hundreds of Relevant Markets and Entrench US Airways’ Dominance at Reagan National Airport
Yes, there are a handful of nonstop routes that would see a real, actual decrease in competitiveness, but the inclusion of connecting markets is a new trick up DOJ’s sleeve. The biggest weapons airlines have in controlling a market is their schedule. If you fly nonstop and nobody else does, then you can do a lot with pricing. So being concerned about those dozen or so overlapping nonstop markets is fine. But on Hunstville to Indianapolis (yes, that’s one of the markets on the list), going from 4 to 3 airlines isn’t going to give anyone meaningful extra power.

I think the bigger issue here is surrounding Washington/National. DOJ doesn’t like that the new American would have so many slots at National, and I think pretty much everyone expected some sort of concession to have to be given. But the impact is still completely overblown.

The merger would only increase US Airways’ incentives to hoard its slots. Today, US Airways provides nonstop service to 71 airports from Reagan National, and it faces no nonstop competitors on 55 of those routes.

What this fails to mention is that nobody wants to provide competition on these routes. You think anyone else is going to fly up against US Airways to Tallahassee? Or Jacksonville, North Carolina? You could put out a million slots, and you still wouldn’t find competition on most of these routes. But if taking some slots away from the combined airlines makes DOJ feel like it’s doing something, then that’s fine. Those will be used on bigger routes, some of which may already have competition today. But DOJ’s complaint has really blown up way beyond just National. They’ve marginalized that as an issue even if it may be the only legitimate one.

In the end, DOJ ties a little bow on it all by saying that nobody can compete with the big three airlines after this merger is completed:

The remaining airlines in the United States, including Southwest and JetBlue, have networks and business models that are significantly different from the legacy airlines. In particular, most do not have hub-and-spoke networks.

I find it pretty amusing that Southwest isn’t considered a legitimate competitor even though it’s the largest domestic US airline. It doesn’t serve small cities but it is definitely a big competitor that connects people through its focus cities (some might call them hubs). And there are plenty of smaller competitors providing service that is clearly appealing to someone. In fact, those smaller competitors are where the real growth lies in this industry.

But when it comes to big corporate contracts, where a lot of the money is, it’s true that the biggest airlines will have a huge advantage. Only problem with that? Today American and US Airways alone aren’t truly effective competitors with Delta and United for that business. You put them together, and you have a third real competitor.

DOJ certainly disagrees with me, but so far, it hasn’t presented any credible evidence to support its case. And the burden of proof in this lawsuit lies with DOJ.

Get Posts via Email When They Go Live or in a Weekly Digest

There are 140 comments Comments


Your email address will not be published. Required fields are marked *

Please enter an e-mail address