Let’s take a closer look at the complaint filed this week by the Department of Justice and the attorneys general of four states, two Commonwealths and the District of Columbia to block US Airway’s takeover of American Airlines on the grounds that the transaction would substantially lessen competition. As previously reported, the suit was a bit of a surprise. I, and seemingly nearly everyone else, expected that the deal would ultimately be cleared once the parties agreed to divest routes and gate slots in overlapping city pairs. Maybe the details of the complaint will offer some clues about why that didn’t happen (yet) and allow for some insight into the case’s likelihood of success.
Right off the bat, the complaint sets the proposed merger on a background of recent perceived reduced competition in the airline industry, noting in the introduction that recent years have lead to coordinated fare increases, new and higher fees and reduced service. In other words, is there even adequate competition in the industry before this deal?
The complaint alleges both unilateral and coordinated effects. It alleges more than 1,000 routes for which the parties offer overlapping services, on which consumers would lose the benefits of competition (unilateral effects) and a reduction in the number of “legacy” carriers from four to three that would make it easier for those that remain to coordinate, rather than compete, on price and service.
Note that “legacy” business. It excludes one of the largest airlines in the country and other start ups and discount carriers that the parties are sure to argue are absolutely fundamental to competition in the industry. The complaint dismisses those other carriers as “unlikely to significantly disrupt” coordination because of their less extensive domestic and international route networks.
Where might DOJ have gotten that idea that airline consolidation might lead to higher prices? Well, how about directly from the CEO and President of US Air? The complaint quotes them as directly crediting consolidation for successful fare increases and implementation of ancillary fees.
The complaint also paints US Air as a “pricing maverick” that is treated differently by its rival legacy airlines. As evidence, the complaint points to US Air’s “Advantage Fares” that offer lower prices on US Air for connecting flights that compete against another legacy carrier’s nonstop price. An novel notion, no, that it should cost less if you have to stop than if you can fly direct? It wouldn’t seem like it, but the complaint alleges that the other legacy carriers do not offer discounts like this and instead “respect” the price set by the non-stop carrier on a given route. In other words, if only one carrier offers nonstop service between city A and city B, it gets to the set the price and the other carriers will not try to lure customers to their connecting service by offering a lower price.
Unless, according to the complaint, the non-stop provider is US Air. Allegedly in retaliation for US Air’s Advantage Fares, other legacy carriers will discount their connecting routes against US Air’s nonstop service. So, eliminate US Air as a separate player with less attractive hubs, and you lose a competitor that disrupts coordination.
But, you may ask, isn’t US Air the acquiring party here, and isn’t its management going to run the combined company? And if that’s the case, wouldn’t US Air continue its pricing policy with the merged firm? And isn’t it pure speculation by DOJ that US Air would abandon Advantage Fares?
The answers, of course, are yes, maybe not, and not really. According to the complaint Advantage Fares are the result of US Air having hubs in less economically attractive airports. Presumably that means that fewer people are looking to fly to Charlotte, Philadelphia, Phoenix and National than are trying to fly, for example, to JFK, Chicago, and maybe even Dallas and Miami. So US Air needs to do something to get customers who are flying to New York to chose it over an airline that offers a New York hub and thus a direct flight to New York.
But after the merger, that will no longer be the case. US Air will have a New York hub, just like the other legacy airlines.
Moreover, the cost of US Air’s low price policy will also be greater once the merger is completed. Remember how the other legacy carriers “respect” each other’s nonstop pricing but not US Air’s (allegedly)? Once it’s the biggest airline in the world, it’s going to have a lot more nonstop routes along which it will face pricing competition if it continues to discount, thus giving it an increased economic incentive not to.
Overall, I’d say the complaint has a decent argument for why the deal can reasonably be assumed to mean the end of Advantage Fares.
But what about American’s bankruptcy? Is there a failing firm defense?
Not so fast, says the complaint, which alleges that American had an standalone plan to emerge from bankruptcy and grow, even going so far as to recently make the largest order of new aircraft in industry history. Those plans for growth, which US Air called “industry destabilizing” could be abandoned in favor of tacit coordination if the transaction goes through.
When I heard that the complaint would be filed, I wondered whether the development meant a breakdown in divestiture negotiations or actual DOJ concerns that could not be satisfied via divestiture. The full complaint really does suggest that latter. The focus is mostly on system-wide competition (and gates and slots at National). The complaint does declare the combination to be “presumed, as a matter of law, to be anticompetitive” for a long list of particularly concentrated city pairs, but otherwise is relatively sparse on unilateral effects allegations.
And that assertion, too, strikes me as a little strange. As far as I know, the only source for any presumptions based HHI measures of concentration come from the Horizontal Merger Guidelines, which, while highly persuasive to courts, most certainly are not law.
You may have noticed that I keep saying that the parties haven’t agreed to a divestiture “yet.” As with any case, the pressure to settle ramps up as the prospect of actually having to litigate looms closer. It certainly wouldn’t be the first time an antitrust agency reached a settlement with merger parties after the complaint was filed.
In that vein, the news today was that the lawyers for the airlines have declared, “We’re litigating, period.” While they’ve certainly got the type of team you’d want if you are going litigate, the quote brings to mind the expression of confidence from management that usually immediately proceeds the firing of a coach. We’ll have to wait and see.