For the last decade, the government has given the green light to a series of airline mergers for one basic reason: the industry had fallen into a pattern of ruinous competition. So many airlines were competing for passengers and market share that none of the old-line carriers could make any money. The only realistic choice for such “legacy” carriers was either to merge or go through another bankruptcy reorganization.
This week, in moving to block what was thought to be the final merger among the old-line carriers, between American and US Airways, the Justice Department argued that the era of ruinous airline competition had ended—and with it, the public’s tolerance for further industry consolidation.
Make no mistake—ruinous competition was as good for consumers as it was bad for airline shareholders, creditors and employees, as anybody who ever snagged a round-trip, cross-country plane ticket for $200 can attest. But by 2009, there were signs that the industry had begun to stabilize. Fares and fees started to rise, the number of flights—the industry capacity—started to fall. Most of the legacy carriers had managed to cut their labor costs to the point that they were roughly equivalent to those of the “low cost” carriers such as Southwest and Jet Blue. A rare period of industry profitability ensued.
For American and US Airways, the challenge now will be to convince a federal judge in Washington that, without their merger, the industry as a whole—and American and US Airways in particular—will be back in the soup the next time the economy turns down again or fuel prices spike. Without that, the court will have no choice but to rule in favor of the government, which in its 56-page suit presents strong evidence that a consolidation has already created an airline oligopoly that allows major competitors to routinely collude on pricing and policies.
One pillar of the government’s case concerns US Airways’ current Advantage Fare program, in which it has defected from the industry practice and prices one-stop trips at a 40 percent discount from the non-stop flights offered by competitors. In a truly competitive market, of course, all carriers would do that, reflecting the significant value passengers assign to non-stop service. But the other airlines have a tacit agreement not to “undercut” each other’s non-stop fares. US Airways has refused to play along. The government cites e-mails and analyses from American and US Airways executives suggesting Advantage Fares will go the way of free baggage check once the merger is complete.
The government suit also shines a spotlight on another cute industry practice that goes by the name of “cross-market initiative.” An example: Back in 2009, US Airways lowered fares and relaxed restrictions on flights from Detroit, then a Delta/Northwest stronghold, to Philadelphia. Delta responded by lowering its fares on US Airways' lucrative Boston-Washington route. US Airways' pricing team got the message loud and clear and concluded it had far more to lose by going ahead with the Philly-Detroit move and walked it back.
Among the more embarrassing documents unearthed by the government was a string of e-mails among US Airways executives from 2010 complaining about a new “triple miles” promotion launched by Delta as it sought to move into new markets and bring some mothballed planes back into service. US Airways chief executive Douglas Parker complains that the aggressive move would hurt the profits not just at Delta but at all the other airlines that would be forced to match it. Then he suggests bringing pressure on Delta by contacting industry analysts to have them criticize the move. To reinforce the point, Parker even sent the e-mail string to Delta’s chief executive, who quickly remonstrated Parker for his ham-handed attempt at price fixing and forwarded the whole thing to his general counsel.
From their internal memos, it is clear US Airways executives saw the merger as the best way to stop American from expanding its service after emerging from bankruptcy reorganization. Rather than add capacity, their plan, according to documents cited by the government, is to cut capacity in the merged airline by 10 percent, just as other airlines had done following their mergers. It was no doubt the prospect of such cuts—and the fare increases that would follow—that prompted the attorneys general of Arizona, Tennessee, Florida, Pennsylvania and Texas to join in seeking to block the merger.
US Airways also figured the merger would generate $280 million in additional annual revenue from “fee harmonization,” meaning that American customers would now be subjected to US Airways' higher baggage fees and $40 “redemption” fee every time they went to use their frequent flier miles. In recounting all this, Justice Department lawyers took delight in quoting an e-mail from a senior US Airways executive bellyaching about the “exorbitant” fee that the New York Stock Exchange would charge the company to change its stock symbol after the merger.
The government calculates that one-quarter of the consumer harm from this merger would be felt by passengers in the Washington region that use Reagan National Airport, where US Airways and American now hold 69 percent of the limited number of takeoff and landing slots. The government calculates that, post-merger, there would be only 21 non-stop routes out of National where there would be any competition. The impact of the merger at National would be so dramatic that even Ken Cuccinelli, Virginia’s pro-business attorney general, felt compelled to join the Obama Justice Department in its suit.
Like many observers, I expected that the companies would have offered to surrender or sell all of American’s slots at National to win government approval of the merger (at the going rate of $2 million a pop)—and that the government would insist that they be sold to airlines such as JetBlue, whose recent entry into the Washington-Boston market forced a US Airways to accept a $700 reduction in the last-minute fare. But, curiously, the companies never offered a National fix and Bill Baer, head of the antitrust division, never asked for one, concluding the merger had too many other problems.
In his court filing and subsequent comments , Baer effectively conceded that the government had made a mistake in approving the earlier mergers, which had made it easier for the legacy carriers to carve up the market and collude on reducing capacity and raising prices. And while it may seem unfair that American and US Airways be punished for being the last two legacy carriers to merge, Baer is quick to point out that there has long been a “last mover disadvantage” in merger law, where the focus is on fairness to consumers, not producers.
The Justice Department’s decision to go to court to block further consolidation of the airline industry, along similar tough stances against Budweiser’s hookup with Corona and AT&T’s purchase of T-Mobil, signal a new era in antitrust enforcement. It’s no longer enough for companies and their lawyers merely to show that their mergers will result in cost savings and economy-enhancing efficiencies, under a presumption that a competitive marketplace will pass the benefits on to consumers. Given the level of consolidation that has already been allowed in most markets, companies are now on notice that they now have the burden of proving that post-merger efficiencies are likely to translate into lower prices, more choice and better service.