Friday, August 16, 2013
To close the week, here is a compilation of various commentary and news updates on the DOJ's surprising decision to challenge the American Airlines/US Airways merger:
- A highly critical take on the DOJ's decision.
- And a more positive view.
- Former American Airlines CEO Robert Crandall isn't a fan of the move
- Loose lips sink planes? The DOJ complaint makes extensive use of quotes from US Airways executives.
- A good recap of negotiations leading up to the DOJ announcement.
- Texas Attorney General Greg Abbott explains why Texas joined the DOJ suit.
- Some are skeptical about the prospects for a settlement.
- Lawyers from the two carriers discuss plans to fight the suit.
- Meanwhile, the judge overseeing American's bankruptcy process postponed his decision on the carrier's reorganization plan with the merger up in the air.
- A judge has been assigned to the antitrust case.
- Staffing decisions related to the merger are being put on hold, at least temporarily.
- Airline stocks prices fell.
- Finally, this story suggests that American and US are largely the victims of bad timing. I think there's some truth to that. The industry is more consolidated now than when earlier mergers were approved. It is also more profitable. On the government side, the DOJ has had time to witness the consequences and feel some regret over the approval of earlier mergers and to gain comfort with enforcing the new Horizontal Merger Guidelines. Related, though unmentioned in the article, the DOJ's argument about coordination of baggage fees wasn't available for some of the earlier mergers.
It's been a busy news week, so I thought it best to break up the end-of-week aviation link omnibus into two posts. Here's a collection of aviation pieces that may have been missed amidst the merger madness. We'll have a collection of reactions to the DOJ decision posted later this afternoon.
- Matt Yglesias takes on cabotage restrictions. For a longer analysis, we recommend Robert Hardaway's Of Cabbages and Cabotage.
- Justin Fox questions the success of U.S. airline deregulation.
- Is high speed rail hurting Chinese airlines? A good companion piece to last week's story on Chinese flight delays.
- Ryanair has dismissed the pilot who publicly criticized the carrier's safety practices.
- More Dreamliner technical glitches.
- Investigation ongoing into cause of UPS cargo plane crash that killed both pilots earlier this week.
Thursday, August 15, 2013
As I have observed in multiple posts the past two days, the potential elimination of US Airways' Advantage Fares program appears to be an important component of the DOJ's opposition to the American Airlines/US Airways merger. Although the complaint doesn't use the actual term "maverick," it is clear from the analysis that the DOJ views US Airways operations under that program as playing the role of a "maverick" firm.
Under the 2010 Guidelines, one piece of evidence that the DOJ can use to determine that a merger will have anti-competitive effects is if the merger eliminates a maverick firm:
The Agencies consider whether a merger may lessen competition by eliminating a “maverick” firm, i.e., a firm that plays a disruptive role in the market to the benefit of customers. For example, if one of the merging firms has a strong incumbency position and the other merging firm threatens to disrupt market conditions with a new technology or business model, their merger can involve the loss of actual or potential competition. Likewise, one of the merging firms may have the incentive to take the lead in price cutting or other competitive conduct or to resist increases in industry prices. A firm that may discipline prices based on its ability and incentive to expand production rapidly using available capacity also can be a maverick, as can a firm that has often resisted otherwise prevailing industry norms to cooperate on price setting or other terms of competition.(2010 Horizontal Merger Guidelines 2.1.5).
The maverick firm concept has been a part of antitrust law for a while (see this 2002 article by Jonathan Baker for a great discussion of the concept and application to scenarios involving the airline industry). But it has received increased attention under the Obama administration, appearing in DOJ complaints against recent high profile merger attempts such as AT&T/T-Mobile and H&R Block/TaxACT (this 2013 note from Taylor Owings provides a good overview of recent cases).
So what makes US Airways a maverick firm? As I wrote Tuesday, and as the section V.C.1. of the complaint explains, under the Advantage Fares program US Airways offers one-stop flights on certain routes that significantly undercut the fares offered by dominant non-stop carrier on those routes. According to the complaint, the other major network carriers don't use connecting flights to undercut prices on their competitors' non-stop monopolies out of fear of retaliation on their own non-stop routes. It is only the less profitable structure of US Airways' own non-stop routes that gives US Airways the incentive to compete in this way. This lines up with two of the potential maverick firm characteristics described above: US "[has] the incentive to take the lead in price cutting or other competitive conduct or to resist increases in industry prices," and "has often resisted otherwise prevailing industry norms to cooperate on price setting or other terms of competition."
So will the court buy this maverick firm argument? An examination of the court's opinion in H&R Block suggest that it might. That court was highly dismissive of the importance of labeling one of the firms involved as a "maverick," at one point accusing the government of playing "semantic gotcha." This may be one reason why the DOJ declined to use the term in this complaint, instead describing the Advantage Fares program as "highly disruptive to the industry's overall coordinated pricing dynamic." However, the court in H&R Block was persuaded by the underlying theory -- that TaxACT played a special market role that constrained prices and its elimination would therefore be anti-competitive. So there is no reason to assume the court will reject the theory outright. Additionally, the DOJ presents fairly persuasive evidence that the Advantage Fares program will be discontinued should the merger go forward, addressing the frequent counterargument from merging firms that the competitive "maverick" behavior will continue post-merger. To defeat the DOJ's argument, attorneys for American Airlines and US Airways are likely to contest whether US Airways, through its Advantage Fares program, actually plays a price-constraining role within the domestic air service market, a claim some have already disputed.
Wednesday, August 14, 2013
While I laid out the DOJ's rationale for opposing the proposed AA-US merger in mostly layman's terms in yesterday's post, I thought it appropriate to come back and explain the legal theory underpinning the DOJ's argument. The place to look to better understand the basis for this move is section 7 of the 2010 Horizontal Merger Guidelines, under the heading "coordinated effects." According to the Guidelines:
A merger may diminish competition by enabling or encouraging post-merger coordinated interaction among firms in the relevant market that harms customers. Coordinated interaction involves conduct by multiple firms that is profitable for each of them only as a result of the accommodating reactions of the others. (Horizontal Merger Guidelines 7)
The bulk of the DOJ complaint is dedicated to a discussion of coordinated interaction between U.S. legacy airlines. The possibilities for increased post-merger coordination are laid out in section V subsection C of the complaint, which represents approximately 15 pages of the 34-page complaint and is the heart of the complaint's analysis of potential anti-competitive effects. The arguments about industry-wide capacity discipline leading to higher fares, increased baggage fees and abandoned hubs are all addressed as potential coordinated effects. It is the DOJ's contention that each of these actions would be unprofitable if undertaken by an airline individually, but that all of the major carriers will profit if they adopt these measures simultaneously. The DOJ's concern for the future of US Airways' Advantage Fares program is also related to this coordinated effects analysis, something I'll examine further in a future post. It may seem that the DOJ has assigned itself the daunting task of proving each of those consequences are likelier to take place post-merger, and as a result of coordinated as opposed to distinct business strategies, but the Guidelines are fairly lax with regard to the need to justify coordinated effects arguments:
There are, however, numerous forms of coordination, and the risk that a merger will induce adverse coordinated effects may not be susceptible to quantification or detailed proof. Therefore, the Agencies evaluate the risk of coordinated effects using measures of market concentration (see Section 5) in conjunction with an assessment of whether a market is vulnerable to coordinated conduct....Pursuant to the Clayton Act’s incipiency standard, the Agencies may challenge mergers that in their judgment pose a real danger of harm through coordinated effects, even without specific evidence showing precisely how the coordination likely would take place. (Horizontal Merger Guidelines 7.1)
This permissive evidentiary standard will likely prove important if the DOJ lawsuit proceeds to trial and is successful in blocking the merger (note that the Guidelines aren't binding on courts, although courts often rely on them). The DOJ appears on sound footing in describing the airline industry as structurally vulnerable to coordination, describing it as dominated by a few large players, consisting of small transactions with transparent pricing. The DOJ also provides evidence (especially from US Airways) of previous examples of coordination, and attempted coordination as well as business planning around the anticipated reactions of competitors.
Demonstrating that a market is vulnerable to coordination is only one of three criteria the Guidelines consider necessary for making a coordinated effects case, DOJ also needs to show that the merger would significantly increase concentration and lead to a moderately or highly concentrated market. The DOJ attempts to do this through its annex of city-pairs that will experience a significant increase in concentration as well as its reference to consolidation in the U.S. airline industry overall. The DOJ must also have "a credible basis on which to conclude that the merger may enhance that vulnerability." Again, note the low threshold required under that phrasing. As I quoted yesterday, the DOJ believes removing one more major airline, regardless of the routes involved, is enough to make coordination easier and thus the merger worth blocking.
This is not to say that a court will be persuaded by the DOJ's coordinated effects argument, or that it won't demand greater empirical justification for the DOJ's claims than the Horizontal Merger Guidelines require. But for anyone who is surprised by the lack of rigorous city-pair analysis in the DOJ's suit, the arguments the DOJ makes are in keeping with an emphasis on structural factors and coordinated effects arguments in prior cases brought by the DOJ under the Obama administration.
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.
The U.S. Department of Justice announced this morning that it will attempt to prohibit the US Airways-American Airlines merger because it believes the deal violates U.S. antitrust law. The move comes as a surprise, if not shock, to many industry observers who believed the proposed merger was on solid footing. We'll have more commentary on the decision later in the day. The DOJ's press release is available here. Key excerpts are below:
According to the department’s complaint, the vast majority of domestic airline routes are already highly concentrated. The merger would create the largest airline in the world and result in four airlines controlling more than 80 percent of the United States commercial air travel market.
The merger would also entrench the merged airline as the dominant carrier at Washington Reagan National Airport, with control of 69 percent of the take-off and landing slots. The merged airline would have a monopoly on 63 percent of the nonstop routes served out of Reagan National airport. As a result, Washington, D.C., area passengers would likely see higher prices and fewer choices if the merger is allowed, the department said in its complaint. Blocking the merger will preserve current competition and service, including flights that US Airways currently offers from Washington’s Reagan National Airport.
The DOJ appears particularly concerned about the probable elimination of US Airways' Advantage Fares program as a constraint on the fares offered by other legacy carriers:
Today, US Airways competes vigorously for price-conscious travelers by offering discounts of up to 40 percent for connecting flights on other airlines’ nonstop routes under its Advantage Fares program. The other legacy airlines – American, Delta and United – routinely match the nonstop fares where they offer connecting service in order to avoid inciting costly fare wars. The Advantage Fares strategy has been successful for US Airways because its network is different from the networks of the larger carriers. If the proposed merger is completed, the combined airline’s network will look more like the existing American, Delta and United networks, and as a result, the Advantage Fares program will likely be eliminated, resulting in higher prices and less services for consumers.
Monday, August 12, 2013