Tuesday, August 13, 2013

DOJ Complaint Focuses on Broader Effects of Industry Consolidation as Opposed to Head-to-Head Competition

Terry Maxon and Airline Biz Blog reports that on a conference call with reporters this morning, Assistant Attorney General Bill Baer made clear that this morning's suit wasn't just a tough negotiating tactic by the DOJ in the hopes of extracting concessions out of American Airlines and US Airways. Many observers predicted the merger plan would be approved because of limited overlap between the two carriers' networks on nonstop routes. The merged entity's dominant position at Reagan National Airport in Washington D.C. was a widely anticipated obstacle, but one easy enough to overcome by surrendering slots to other airlines. However, in a key quote, Baer says, “We have many concerns, and they’re not limited to Reagan National.” This is also evident from reading the DOJ complaint.

While the DOJ notes the increased concentration that would result from the merger both at Reagan National and on 1,665 city pairs listed in an annex at the end of the complaint, much of the complaint focuses its attention on the anti-competitive effects of industry-wide consolidation. For example, as noted in an earlier post, the complaint devotes extended discussion to US Airways' Advantage Fares program which uses connecting service to undercut the fares offered by American, United and Delta on certain non-stop routes. US Airways is the only carrier to do this, as the other three legacy carriers don't want to provoke each other into retaliating on their own nonstop routes. Because US Airways' hub configuration gives it the least profitable nonstop routes, it is the only carrier economically positioned to pursue this strategy, something it would no longer be inclined to do after the merger. There are no possible concessions that could satisfy the DOJ's concerns on this front. Instead, the DOJ appears to be arguing that US Airways plays a unique and important role in the market, and any conceivable merger with American would eliminate that role and therefore have anti-competitive effects.

Beyond the Advantage Fares program, the DOJ appears to be unhappy with how the aviation industry operates in general, accusing the major carriers of coordination on everything from fares to services and ancillary fees. The DOJ views industry consolidation as a major driver of this coordination. I thought the following was a key paragraph from the complaint: 

Coordination becomes easier as the number of major airlines dwindles and their business models converge. If not stopped, the merger would likely substantially enhance the ability of the industry to coordinate on fares, ancillary fees, and service reductions by creating, in the words of US Airways executives, a “Level Big 3”of network carriers, each with similar sizes, costs, and structures.

Similarly, the DOJ seems to take the position that capacity reduction has gone far enough, and further reduction will harm passengers:

Legacy airlines have taken advantage of increasing consolidation to exercise “capacity discipline.” “Capacity discipline” has meant restraining growth or reducing established service. The planned merger would be a further step in that industry-wide effort. In theory, reducing unused capacity can be an efficient decision that allows a firm to reduce its costs, ultimately leading to lower consumer prices. In the airline industry, however, recent experience has shown that capacity discipline has resulted in fewer flights and higher fares.

Therein lies the DOJ's answer to critics who contend that the route-overlap and overall anti-competitive effects of an American-US Airways merger are much smaller than in prior combinations the DOJ has approved over the past decade, such as United-Continental and Delta-Northwest. The DOJ would appear to agree and to conclude that the anti-competitive consequences of prior mergers are evidence for why it should not approve this one. While some would argue that it is unfair to keep American Airlines and US Airways smaller and less stable than their recently merged competitors, to the DOJ this is a feature not a bug. The DOJ has high praise for American's expansionary stand-alone post-bankruptcy plans and believes consumers would benefit from a marketplace where American and US are forced to pursue growth strategies and increase, rather than reduce, overall capacity in the U.S. market.

Whether the DOJ's broad industry overview approach as opposed to a more city-pair focused analysis will hold up in court is yet to be determined. The DOJ fails to present much in the way of empirical evidence to show that the coordination among legacy carriers about which it is so worried will be made significantly worse as a result of this merger. Regardless, it can be safely assumed that this is not merely a negotiating ploy. The DOJ appears to be genuinely determined to halt an almost decade-long trend toward consolidation in the U.S. airline industry.

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