Can you believe it’s been more than 7 months since I last wrote about the Alaska/Virgin America merger? Way back at the end of April, I published my interview with EVP and Chief Commercial Officer Andrew Harrison, but since then… nothing. The reason for that, of course, is that nothing had happened, at least not publicly, because the Department of Justice (DOJ) took a very close and lengthy look at the merger. After months of negotiations, there is finally a settlement.
The issue? It’s really all about the government’s favorite whipping boy as of late, American. I understand what DOJ is thinking, but unsurprisingly, I don’t draw the same conclusions. Fortunately for the airline, I (and more importantly, Alaska) consider this to be a relatively minor issue, and the merger is going to close very soon.
Traditionally, the feds look at market concentration and use that as the basis for determining if a merger is anti-competitive or not. In this case, it was hard to see how there would be any problems. After all, Alaska and Virgin America together form the fifth largest airline; one that can become far more competitive with the Big Four, especially in the state of California, than they could on their own. And as for overlap, there was almost none. The most obvious routes like San Francisco to Seattle are already pretty competitive, and sure enough, DOJ didn’t seem to have any issues with that. No, instead, it took issue with two things, one that is smart, the other, not so much.
Smart: The assets Virgin America acquired in the American/US Airways merger
When American and US Airways merged, the feds made them divest a few things to gain approval. Of those, Virgin America picked up some slots at both Washington/National and New York/LaGuardia. Further, it snagged a couple gates at Dallas/Love Field. DOJ doesn’t take issue with the new Alaska having those assets. It does, however, want to prevent Alaska from selling or leasing them to another airline without approval. I find that to be completely fair. Now, if Alaska wants to get rid of those assets, it needs to run the transaction through DOJ. It is also expressly prohibited from transferring them to American. Ok, I get it. Then there’s the bigger issue, which makes less sense to me.
Not So Smart: The codeshare with American
While Alaska and Virgin America alone don’t present any sort of antitrust concerns, DOJ was really bothered by Alaska’s codeshare with American. The American codeshare has long been in place, and it has been strengthened lately. But Alaska’s revenue benefit has actually dropped from $225m in 2014 to only $190m in 2016. This is Alaska’s largest codeshare (the ever-shrinking Delta relationship still contributes $65m), but it’s really pretty small at about 2.5 percent of Alaska and Virgin America’s combined total revenues.
The codeshare makes a lot of sense for Alaska, because it has enabled the airline to have a larger footprint than its route network allows. It can fly people to Waco or Norfolk or Harrisburg through this codeshare. That’s fine, but what really gives Alaska the heft for its more frequent fliers are the reciprocal elite benefits. An Alaska Mileage Plan elite member can book and fly American knowing that he or she will get perks similar to (if not as good as) what will be given on an Alaska flight. That’s what really gives Alaska the presence it needs with its most important fliers.
DOJ, in its infinite wisdom, looked at this and decided not to touch the frequent flier program at all. Nor will it touch interlining. Instead it zeroed in on codesharing as the problem. But it’s not all codesharing that’s an issue. The codeshare that gets Alaska into Waco, Norfolk, and Harrisburg isn’t bad. Or in image form:
The problem lies in other markets that DOJ thinks make the two airlines less likely to be competitive with each other. DOJ is wrong, but that’s the way it is. Essentially, DOJ is saying this.
Alaska, if you bring people into American’s hubs, you can then codeshare with American to take those people beyond the hub into another city and vice versa. Anything else, you’re on your own.
That means Alaska can fly someone on its own code from Seattle to, say, Baton Rouge. But it has to carry the passenger from Seattle to Dallas/Ft Worth on its own. So what’s the bad codeshare?
- Alaska can no longer codeshare on flights American operates into Alaska hubs. (eg Miami-Seattle)
- American can no longer codeshare on flights Alaska operates into American hubs. (eg Washington/National-Seattle)
- American and Alaska can no longer codeshare in markets where they both fly nonstop. (eg LA-Seattle)
There’s also a specific carve-out around LA, where Alaska can’t codeshare on American flights from LA to other American hubs. Presumably DOJ thinks that this will spur Alaska to start its own flights in those markets, but it’s unlikely.
All of this added together tallies only 45 markets where the codes have to come off, but there is collateral damage. For example, since American can’t codeshare on the National-Seattle flight, that means it won’t be able to connect someone in from Norfolk (the example Alaska used). So the impact is more than 45 markets. In the end, it’s worth about a third of the total American codeshare revenue for American. That sounds like a lot, but it’s under 1 percent of total Alaska revenue.
What will this accomplish? Well, in DOJ’s rambling press release, the problem is that “the codeshare agreement, which currently allows Alaska to market American flights on over 250 routes, creates incentives for Alaska to compete less aggressively on routes both carriers serve and to forgo launching new service in competition with American. As a result of these incentives, the complaint alleges that Alaska and American often behave more like partners than competitors.”
That’s laughable. In particular, consider this. From Seattle, Alaska has started service to every one of American’s hubs save Charlotte. It also moved its Miami flight to Ft Lauderdale awhile back, so technically it no longer serves that airport, but clearly Alaska finds it worthwhile to serve American’s hubs. In fact, it’s the partnership that makes some of these flourish. I don’t know that we’d see Philly still in the network were it not for the American partnership. I also doubt we’d see up to four flights a day in Seattle-DFW as we see now.
Where I get thrown for a loop is this idea that codesharing is anti-competitive, or that it somehow encourages airlines to reduce competition. Joint ventures with antitrust immunity? Oh yeah. But codeshares don’t allow any kind of coordination. I haven’t seen any indication, especially in this case, that the codeshare has made Alaska shy away from going right up against American. (And we certainly know that hasn’t happened with Delta either.) There is consumer benefit, and that’s why these guys do it.
Fortunately, I don’t see this as a huge deal. Alaska doesn’t seem overly concerned either since it expects to recapture all but $15m to $20m of the lost revenue by selling to its own passengers instead of American’s. (They may not pay as much, but there are people to fill many of those seats.) With that, the net impact is fairly minor. I certainly questioned whether Virgin America was worth the initial purchase price. But I don’t see these givebacks being anything to cause additional concern.
I can only wonder what took DOJ so long to figure this out. Let me guess, this was “novel and complex” or something along those lines? Either way, with this hurdle cleared, Alaska wasted no time in settling that garbage private lawsuit from the firm that sues every airline for everything. Now there’s nothing stopping the merger from happening. We just need to wait for the date, and I can only imagine it’s going to come very soon.
[Further reading: Alaska’s presentation on the settlement]
