Aviation Law Prof Blog

European Commission OKs Lufthansa/Austrian Deal

The European Commission issued a statement yesterday indicating that it was prepared to approve the proposed Lufthansa/Austrian Airlines merger:

After talks earlier today about the results of this week's market test, Lufthansa has put forward further improved remedies to address the competition concerns raised in this case. Following this, Commissioner Kroes has instructed her services to draft a conditional clearance decision. The draft decision will be submitted to the Advisory Committee of the Member States and a final proposal will be presented, for adoption, to the College of Commissioners as soon as possible.

See Press Release, Europa, Commissioner Neelie Kroes Reacts to Improved Remedies in Lufthansa/Austrian Airlines Merger Case, MEMO/09/358 (July 31, 2009) (available here).

Further information on Lufthansa's revised bid is available in a Financial Times story which appeared earlier this week.  See Nikki Tait & James Wilson, Lufthansa Confident Over New Proposals in Austrian Airlines Takeover, Fin. Times, July 29, 2009 (available here).

Guest Post: Hubert Horan on Airline Consolidation

Hubert Horan is an independant aviation analyst with 25 years of experience.  He has published extensively on airline competition issues and has first-hand experience working with over a dozen major airline mergers, alliances, and restructuring.  Further information on Mr. Horan, including articles and public statements, may be found on his website, Hubert Horan Aviation. 

 

Thanks to Prof. Brian Havel for the invitation to post an introduction to the “anti-airline consolidation” viewpoint. The issues here are immediately relevant to the current antitrust immunity applications (CO/Star, AA/BA), the next phase of US-EU Open Skies negotiations, and the dispute between the DOT and DOJ that emerged in the CO/Star case. I am not a lawyer, but have been an airline manager/consultant for a quarter century. At Northwest, I was responsible for the original development of the NW-KL alliance network that served as the template for all of the subsequent North Atlantic alliances, and later managed one from the other side of the Atlantic (Swissair-Delta). I’ve also helped shut down major alliances that didn’t make any economic sense (CO-America West, the intra-European Qualifyer group) and have been involved in a wide variety of merger cases. I have published a number of articles on international airline competition, and testified before Congress on the Delta-Northwest merger. One can obviously not prove or refute major claims in a blog setting, but I’ll try to throw out a number of points that I think would need to be fleshed out in a more serious analysis, and addressed by advocates of increased consolidation.

 

A couple critical background points:

 

1. “Branded” alliances <> “Collusive” alliances: The Branded global alliances (Star, Oneworld, Skyteam) must not be confused with the immunized North Atlantic alliances that can collude on prices and capacity, although most press reports do. The “Branded” alliances are just a modern twist on decades-old industry practices (codesharing, favorable interlining, frequent flyer cooperation) and pose no serious competitive risks. The Collusive Alliances reduces the number of competitors, cannot function without antitrust immunity and need to demonstrate public benefits justifying the risks to consumers.

 

2. The original 1990s Collusive Alliances exploited a specific market opportunity. In 1990, there was a sizeable North Atlantic market niche (about 30% of the total market) primarily “double-connect” markets—city pairs like St.Louis-Stuttgart or Milwaukee-Munich that didn’t have single carrier 1-stop service via any of the competing hubs. Passengers were limited to interline services at high fares. It made no economic sense for individual airlines to build hubs on both sides of the ocean, and all such attempts (TWA at Paris, Iberia at Miami) failed badly. The original KL/NW and SR/DL alliances introduced well-timed on-line equivalent connections via efficient hubs, and offered the full range of discount fares offered in traditional markets, and consumers responded strongly to the new/improved service. The Collusive Alliances had a clear competitive advantage in this market segment just as the traditional carriers had competitive advantage in large nonstop and one-stop markets.

 

3. Collusive Alliances have never existed outside the North Atlantic: There have been three Collusive Alliances—KLM/Northwest (1993) the Swissair/Delta  based group (1995, shifted to Air France/Delta in 2000) and the Lufthansa/United based group (1997). The KL/NW and AF/DL alliances merged; the DOT is now evaluating a proposed new American/British Airways based group. Airlines have never attempted to apply this alliance model to the transpacific or anywhere else in the world, because this type of market opportunity doesn’t exist (or is trivial compared to the cost of the alliance).

 

4. Competitively, Intercontinental airline markets are very, very different from domestic/regional markets. Longhaul markets have fundamentally different economics than shorthaul markets, driven by scale requirements (the need for huge connecting hubs, global marketing capabilities, expensive long-range aircraft) and complex airpolitical requirements and constraints. It is much easier to start a narrowbody airline, easier to adopt to changing conditions, and easier to redeploy assets if things don’t work out. Intercontinental airlines require very large hubs (HKG, FRA, EWR, SIN, DXB, ATL) while domestic/regional airlines are much more point-to-point oriented. You cannot apply the competitive logic/standards of narrowbody markets (domestic US, intra-EU) to intercontinental markets. All of the dynamic (if not cutthroat) competition associated with modern aviation is limited to domestic/regional markets. Intercontinental markets are totally stagnant, with no (net) new entry in decades, despite the huge growth in global trade and travel.

 

Turning to some specific airline competition/antitrust arguments:

5. The antitrust issue is consolidation, not “alliances”. The question is not whether Collusive Alliances are good or bad for consumers, but whether applications that reduce competition are good or bad for consumers. Airline consolidation applications happen to have been almost exclusively limited to North Atlantic competitors, and involved expansions of (or mergers between) Collusive Alliances.

 

6. The current ATI applications will establish a three-airline cartel on the North Atlantic. The current applications will consolidate 23 previously independent airlines into three groups with over 90% of the North Atlantic, a market with roughly 55 million annual passengers. The LH and AF groups already dominate the Continental Europe market (75%), while the new BA group would dominate the UK market (25%). This would quickly become 26 into 3 as the next three largest carriers (USAirways, which codeshares with the LH group but does not have ATI, Virgin and Aer Lingus) would not survive independently. Each has already indicated an interest in joining, and the DOT’s logic in approving CO/Star strongly suggests it would approve these as well. This would give the 3 groups 98% of the total market.

 

 

 

7. There is almost no possibility that future entry could discipline near-term competitive abuses. Only one new entrant in the last 25 years ever achieved a 2% or greater share on the North Atlantic (USAirways). Airport constraints at many important markets (New York, London, Paris, Chicago) create significant entry barriers. No “LCC”-type airline has ever succeeded in longhaul markets, and no US/EU LCC appears to have any interest in the North Atlantic. Startup would require billions in capital, and the willingness to risk predatory-style pricing reactions by the large incumbents. If DL/NW abuses its post-merger position in the local Detroit-Atlanta market, competitors could shift aircraft into that market overnight. If the LH group pursues oligopoly pricing and capacity cuts on the complex web of US-German routes in a 98% concentration environment, no comparable market correction would occur.

 

8. Neither DOT or DOJ has ever examined the competitive risks of extreme concentration. As noted above, the original 90s Collusive Alliances were pro-competitive, and certain consolidation steps may have been totally benign, but no one has objectively analyzed the public benefits/consumer risks of the aggressive recent trend to high concentration. The Delta/Northwest and CO/Star applications explicitly ignored the possibility of competitive response, despite years of industry agitation for consolidation, and BA/AA’s acknowledgement that their application was a necessary competitive response to the DL/AF and CO/LH ATI expansions. Would competition between the three alliances with 98% of the market serve consumers just as effectively as the 11 large competitors in 2001 when top-3 concentration was 58%? Neither DOT or DOJ have ever seen the need to look at the issue. There is no objective, verifiable analysis of this question on the public record. None of the recent cases define specific standards that had been met by the current transaction but might not be met by one of the likely subsequent transactions.

 

9. All of the North Atlantic consolidation of the last five years was anti-competitive. Any public benefits that would justify expanded ATI must be linked to sizeable, demonstrable cost synergies or competitive market advantages. This evidence does not exist. The market opportunity seized by the original alliances has been fully served since the late 90s. Current claims are largely based on the assertion that gains witnessed in the mid-90s will be replicated by every future alliance, regardless of market conditions. The only purpose of the recent/current transactions was to reduce competition.  None of the consolidation of recent years was due to “market forces” (airlines with lower costs and superior service driving inefficient ones out of business)—it was entirely due to government actions authorizing reduced competition among incumbent carriers. 

 

Brief answers to some common, related questions:

 

10. What is behind the DOT-DOJ Star Alliance dispute? The DOJ argued that ATI approvals required clear evidence of public benefits; the DOT argued that their policy-based assertions of benefits justified approval. The DOJ cited over 15 specific cases where the DOT’s preliminary approval had been based on unsubstantiated assertions, or evidence of benefits that were not specifically tied to the CO/Star application, or benefits that could have been achieved without antitrust immunity. The DOT’s final approval did not directly address any of the DOJ’s claims of evidentiary deficiency, but focused on the benefits of DOT’s overall airline competition policies, and the DOT’s authority in this area. I would summarize the DOT’s recent airline competition policy as “rubber stamp whatever proposal the airlines bring us as long as there isn’t serious industry opposition”. 

 

11. Isn’t consolidation a necessary reaction to current industry conditions? Yes, the airline industry has lots of problems but the real-world evidence directly contradicts this claim. All of the recent consolidation applications have been limited to the North Atlantic, which over the past decade was one of the most profitable sectors in global aviation, and already enjoyed major barriers to the cutthroat competition witnessed elsewhere. All of the consolidation proposals were being actively developed years ago when profits were booming. Absolutely none of the public demands for “industry consolidation” have been coming from the more competitive domestic/regional markets where profitability has been most elusive.

 

12. Doesn’t the US-EU Open Skies treaty require approval of these ATI applications? That’s certainly what the applicants are claiming, but if it did the State Department would have said so, and that would have saved DOT and DOJ the need to undertake detailed reviews. I didn’t see anything in the treaty limiting the application of US antitrust laws and precedent, and I think the claim that it did would stir up vigorous opposition on Capitol Hill. The whole point of America’s long campaign for Open Skies was to let the market pick winners. The DOT and the alliance carriers are arguing that government policy ought to determine the level of competition on the North Atlantic. 

 

13. Won’t these alliances help break down “nationality” based barriers to competition? In their current form, no.  Every one of these applications works strictly within the decades-old system where airline operations are strictly tied to nationality, unlike hypothetical mergers such as BA-Qantas, which would have divorced UK airpolitical rights from UK ownership and control. To break down nationality barriers, the industry needs to develop new systems for safety, financial, labor, and various other legal and regulatory regimes that can be enforced globally, and won’t be readily subject to regulatory arbitrage. A very worthy objective, but the current CO/Star and BA/AA applications accomplish nothing in this regard.

 

 

 

Guest Blog Posts

The Aviation Law Prof Blog welcomes guest posts from academics, attorneys, analysts, industry participants, and interested students of aviation law and policy on any topic related to the subjects considered on this blog.  Guest posts may respond to content featured on the blog or explore entirely new issues.  Those interested in contributing a guest post should submit the proposed text to either Brian Havel or Gabriel Sanchez.  All submissions are subject to (light) editing and should not have appeared on another web-log or in print. 

Hubs Versus Airport Dominance

Professors Volodymyr Bilotkach & Vivek Pai of UC Irvine's Department of Economics have an informative working paper on airport dominance up on SSRN.  See Hubs Versus Airport Dominance (Working Paper, Feb. 25, 2009) (available here).  From the abstract:

This study separates what is known in the literature as the airport dominance effect (dominant airline's ability to charge higher fares for trips to/from the airport at which it has the dominant position) into what can be interpreted as quality and market power based components, using price data for trips to/from/through five US airports, each serving as a hub for two US carriers. We find market power based component of the dominance premium is smaller than the quality based one. We also determine that dominant carriers exercise their market power on an average customer rather than a price insensitive business traveler. This is in contrast to what previous studies suggested.

Immunized Alliances and the Market

Readers of the blog interested in the economic analysis of immunized airline alliances and their impact on the aviation market would do well to read W. Tom Whalen's A Panel Data Analysis of Code-Sharing, Antitrust Immunity, and Open Skies Treaties in International Aviation Markets, 30 Rev. Indus. Org. 39 (2007).  As the abstract reads:

This paper estimates the effects of code-sharing, antitrust immunity, and Open Skies treaties on prices, output, and capacity using an eleven-year panel of U.S.-Europe data. Code-sharing and immunized alliances are found to have significantly lower prices than does traditional interline (multi-carrier) service, but the effects are smaller in magnitude than those found in previous results that rely on cross-sectional data. Statistical tests that prices for immunized alliance service are equal to online (single carrier) service often cannot be rejected, providing additional evidence that immunity grants allow immunized carriers to internalize a double marginalization problem. Estimated output effects, consistent with the price effects, show that alliances are associated with large increases in passenger volumes. Lastly, estimates suggest that capacity expansions associated with “Open Skies” treaties are due entirely to expansion by immunized carriers on routes between their hubs.

A list of further readings on alliances and antitrust immunity is available in an earlier post here.

Congressmen for Open Skies

Though there is a great deal of anti-airline alliance invective coming out of the Halls of Congress at the moment, it should not be taken as a sign the U.S.'s legislators are of one mind on the nation's air transport policy.  According to a news report issued by the National Industrial Transportation League--a longstanding representative body for the freight transportation sector--members of the U.S. Senate Commerce, Science and Transportation Committee

urged Transportation Secretary Ray LaHood in a letter to have his department “exercise its long-held statutory authority and expertise to determine if applications for airline antitrust immunity are in the public interest.”

The letter, released by the senators, said: “We are writing regarding the long-standing authority of the Department of Transportation (DOT) to approve or disapprove applications for antitrust immunity between U.S. and foreign air carriers. This fundamental component of the department’s jurisdiction has helped to promote competition in the airline industry by opening up restricted markets and encouraging healthy competition among international alliances.”

A full copy of the piece is available online here.

Oberstar's Specious Assertions

As mentioned in one of yesterday's blog posts, see post here, Rep. James Oberstar, Chairman of the House Transportation Committee, is back pressing his case against antitrust immunity for international airline alliances.  The crux of his argument, which he made clear in a letter earlier this month to, see Letter from Rep. James Oberstar to Christine A. Varney, Asst. Attorney General (July 8, 2009) (available here), is that

[i]f the [Star and oneworld alliance] applications are approved [by the Department of Transportation], the United States-European market will essentially be locked down by the top three alliances [including SkyTeam], which will have a market share of over 95 percent.  There will be no incentives for these alliances to compete with each other, and major entry barriers at the most important airports would make it extremely difficult for non-alliance carriers to seriously challenge the alliances.

Taking the second point first, no one seriously doubts that there is a capacity crunch at a select number of airports in the U.S. and many more within the European Union.  There is also reason to believe that measures taken on both sides of the Atlantic to alleviate these constraints are in need of some (perhaps serious) overhaul.  What Rep. Oberstar appears to ignore in his statement is where a "serious challenge" could or should come from.  As has been well documented in the literature, airline consumers value the network benefits that major airlines provide (whether through their own hub-n-spoke networks or the combined networks with their alliance partners).  See, e.g., Michael E. Levine, Commentary, Airline Alliances and Systems Competition, 45 Hous. L. Rev. 333 (2008).  New entrants may not be able to provide comparable networks, but they may, for example, be able to provide low-cost service on certain high-volume routes to customers uninterested in taking advantage of an incumbent's network.  To do so efficiently oftentimes means using secondary airports, similar to Southwest's operations in the U.S. domestic market or Ryanair's for its intra-European services.  Available slots at major airports, particularly in the EU, do not come cheap.  For transatlantic service, this model may never capture more than a small share of the overall traffic volume; the network benefits are too enticing (as are the combined customer loyalty programs that accompany them).  But they do provide an alternative for those consumers looking for point-to-point service between major city pairs at the lowest price available.

As for Rep. Oberstar's second point, it is almost counterintuitive to hold that the three major alliances "will have no incentives" to compete with each other.  As a recent paper by Yale Law Professor George L. Priest discusses, see Rethinking Antitrust Law in an Age of Network Industries (Yale Law & Economics Research Paper No. 352, 2007) (available here), an "airline will attempt to define its network so that it generates enough aggregate travel over the long term to support the entire system," id.at 13.  "Thus," according to Priest, "it must determine to which cities to extend spokes and the number and size of flights along those spokes that will support traffic" along with "determin[ing] how to allocate general network costs in the pricing of specific routes in a way that maintains the most effective network."  Id.  This is true of alliances as well.  In order to sustain and expand their networks, airline alliances must coordinate services and establish prices which will keep as much traffic as possible coming in.  The more traffic an alliance has, the more services to in-demand destinations it can provide consumers and hence the greater share of revenues its members can capture.  There is no logical basis for Oberstar's assertion that the three alliances will calcify their services or refuse to vie for new customers from each other's networks.

Privatization, Regulation and Airport Pricing

Thanks goes out to the Antitrust & Competition Law Blog, a fellow member of the Law Professors Blog Network, for calling attention to Xavier Fageda & German Bel's Privatization, Regulation and Airport Pricing: An Empirical Analysis for Europe (EUI Working Paper RSCAS 2009/27, June 2009) (available here).  From the abstract:

This paper examines factors determining prices that airports charge to airlines. Using data for 100 large airports in Europe, we find that they charge higher prices when they move more passengers. Additionally, competition from other transport modes and other nearby airports imposes some discipline on the pricing behavior of airports. Low-cost carriers and airlines with a high market share seem to have a stronger countervailing power. Finally, we find that private airports not regulated charge higher prices than public or regulated airports. From our analysis, we can infer that market power of each airport is dependent upon its specific characteristics.

More on Alliances and Antitrust

The Wall Street Journal's Law Blog has a new commentary up on the New York Times article referenced earlier this week, see previous post here, concerning the Department of Justice's new stance on robust antitrust enforcement and the political resistance it is receiving.  See Ashby Jones's Post to the WSJ Law Blog, Varney Getting Pushback on Aggressive Antitrust Agenda (July 27, 2009) (available here).  The Journal is also reporting that House Transportation Committee Chairman James Oberstar is "stepp[ing] up efforts to limit airlines' ability to join alliances that cooperate on schedulingand revenue sharing, urging the White House to review antitrust policies."  Josh Mitchell, Lawmaker Seeks Air-Alliance Curbs, Wall St. J., July 28, 2009 (available here).  As the articles goes on to state:

Rep. James Oberstar (D., Minn.) sent a letter Monday to Lawrence Summers, director of the National Economic Council, expressing "deep concern over the decline of airline competition in international markets." He said three global alliances -- Star, Sky Team and oneworld -- now control more than 87% of traffic between the U.S. and Europe, hurting consumers.

Mr. Oberstar urged a "sunset" on exemptions to antitrust laws that have allowed U.S. airlines to join the alliances.

Rep. Oberstar's sunset proposal has been discussed previously on the blog.  See earlier posts here, here, and here.  It's not surprising that following the recent decision of the Department of Transportation to grant (almost full) antitrust immunity to Continental's application to join the Star Alliance he would choose to again raise his concerns with the Administration.  He has not been shy about characterizing the alliances as examples of collusive arrangements which harm consumers.  See, e.g., Letter from Rep. James Oberstar to Christine A. Varney, Asst. Attorney General (July 8, 2009) (available here).  Yet for all his high-octane numbers intended to demonstrate unprecedented and anticompetitive market dominance by Star, oneworld, and SkyTeam (e.g., that they account for 80% of the world's airline capacity, 78% of world revenue passenger kilometers, and 87% control of U.S./European air traffic), see id. at 2, he has not provided empirical data demonstrating actual consumer harm from these arrangements.  Oberstar is also committed to maintaining the U.S.'s outmoded foreign ownership and control rules for airlines, thus preventing the consummation of transnational mergers.  What alternative, then, is left to the airlines as they seek to remain viable in a tough operating environment by offering transnational network benefits and enhanced loyalty programs to consumers?  That, too, appears absent from the Congressman's assessment of the current international aviation marketplace.

The EAS Program: History, Criticism, and Defense

Over the weekend, a link was produced to a new study by the U.S. Government Accountability Office on the Department of Transportation's Essential Air Services (EAS) Program.  See earlier post here.  For those interested in the history of this program, including criticisms and defenses, the following law journal articles may be of interest:

• Christopher L. Manos, Note, Airline Deregulation and Service to Small Communities, 57 N.D. L. Rev. 607 (1981);

• Arnold I. Havens & David A. Heymsfeld, Small Community Air Services Under the Airline Deregulation Act of 1978, 46 J. Air. L. & Com. 641 (1981);

• James S. Meyer, Comment, Section 419 of the Airline Deregulation Act: What Has Been the Effect on Air Service to Small Communities, 47 J. Air L. & Com. 151 (1982);
• Alfed E. Kahn, Airline Deregulation--A Mixed Bag, But a Clear Success Nevertheless, 16 Transp. L.J. 229 (1987);
• Melvin A. Brenner, Rejoinder to Comments by Alfred Kahn, 16 Transp. L.J. 253 (1987);
• Paul Stephen Dempsey, Airline Deregulation and Laissez-Faire Mythology: Economic Theory in Turbulence, 56 J. Air L. & Com. 305 (1990); &
• Amy K. Bock, Comment, How to Restore the Airline Industry to Its Full Upright Position, 59 J. Air L. & Com. 663 (1994).

Loyalty Programs in Tough Economic Times

A new article up online today discusses the role of airline customer loyalty programs in generate revenues during the current worldwide economic downturn.  See Ian Wylie, Flying Far and Wide on the Back of Airline Loyalty, Fin. Times, July 27, 2009 (available here).  As the piece notes:

[I]n this recession, the real value to airlines of loyalty programmes lies in their ability to generate cash rather than loyalty. "Frequent flyer programmes no longer serve to drive brand loyalty alone, but rather to deliver extra cash, mostly through the sale of miles to card-issuing banks," says Jay Sorensen, a former Midwest Airlines executive and now president of IdeaWorks, a consulting company.

At Delta alone, Mr Robertson says the SkyMiles and WorldPerks programmes are expected to generate more than $2bn (€1.4bn, £1.2bn) in revenue in 2009. United and Continental each raised cash last year from the advance sales of miles to their card partner, JPMorgan Chase.

"Tough economic times have encouraged airlines to rely upon this kind of short-term gratification," says Mr Sorensen, who reckons that when investor confidence returns some of the biggest airlines will try selling off their programmes.

More on the Shift in Antitrust Views

A new opinion piece from Business Travel News discusses the recently completed proceeding for Continental Airlines to join the Star Alliance and what it has to tell about the apparent shift in antitrust views which has taken place within the Department of Justice recently.  See Jay Boehmer, Star Approval Illustrates Shift in D.C. Antitrust Views, Bus. Travel News, July 27, 2009 (available here).

N.Y. Times on Antitrust Enforcement and the Airlines

There is a fascinating story on the front page of today's New York Times discussing the new enforcement aims of the Department of Justice's Antitrust Division and the resistance it is meeting from within the Obama Administration.  See Stephen Labaton, Antitrust Chief Hits Resistance in Crackdown, N.Y. Times, July 26, 2009 (available here).  Both railroad giants and airlines have signaled out by the DOJ as part of its desired crackdown.

The story contains a succinct briefing on the recent controversy caused by the DOJ's involvement in Continental's application to the Department of Transportation for antitrust immunity to join the Star Alliance and notes that the interagency strife caused by the proceeding prompted Obama's economic advisor, Lawrence Summers, to mediate the dispute.  Also intriguing is the article's mention that the House Judiciary Committee is preparing to hold a hearing on the application in the near future.  The outcome of that hearing could indicate the extent to which the DOJ will continue its involvement in airline alliance applications.