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Why the DOJ’s arguments against the American/US Airways merger are DOA – Part I

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Why the DOJ’s arguments against the American/US Airways merger are DOA – Part I

Why the DOJ’s arguments against the American/US Airways merger are DOA – Part I
August 22
06:15 2013

MIAMI — The following is an in-depth dissection and refutation of the US Department of Justice’s (DOJ’s) lawsuit. The italicized text is quotes from the DOJ’s lawsuit and the normal text is my response. Responses are organized topically and not in the order that they appear in the actual lawsuit.

In Part 1 of this analysis, we tackle the DOJ’s arguments on Advantage Fares, Reagan Airport, and others. Part 2 will run early next week.

Washington Reagan


Passengers to and from the Washington, D.C. area are likely to be particularly hurt. To serve Ronald Reagan Washington National Airport (“Reagan National”), a carrier must have “slots,” which are government-issued rights to take off and land. US Airways currently holds 55% of the slots at Reagan National and the merger would increase the percentage of slots held by the combined firm to 69%. The combined airline would have a monopoly on 63% of the nonstop routes served out of the airport. Competition at Reagan National cannot flourish where one airline increasingly controls an essential ingredient to competition. Without slots, other airlines cannot enter or expand the number of flights that they offer on other routes. As a result, Washington, D.C. area passengers would likely see higher prices and fewer choices if the merger were approved.

This is somewhat true but not entirely valid. First, it’s probably important to note that the combined American will only hold a 49% market share at Reagan National – US Airways today only holds 35% despite holding 55% of the slots – many of its flights are to smaller cities in the US on smaller turboprops and regional jets. These flights are made possible precisely because US Airways has such a large slot holding at Reagan – the US Airways operation there is a secondary connecting complex thanks to the frequency enabled by the slot holdings. Two points should be made. One, because US Airways and American overlap on several routes out of Reagan, post-merger, US Airways will be able to reduce some redundant capacity to existing American Airlines destinations. This will allow US Airways to expand its hub operations at Reagan, adding new small city destinations in the eastern half of the United States. The adverse impact of increased concentration at Reagan will be partially offset by the new access gained from small cities to Washington Reagan and the economic benefits thereafter. Second, that 49% number is important. Currently in the US, there are four major slot restricted airports; New York JFK and La Guardia, Newark, and Washington Reagan (Chicago O’Hare used to be slot controlled, and the DOT has considered adding slot restrictions at San Francisco International in recent years). At two of the other three airports (excluding Reagan), individual airlines have a market share that is greater than that 49% number (Delta at La Guardia and United at Newark). Both of those market conditions were given explicit approval by the DOJ itself. Why should Reagan be treated differently?

In the market for slots at Reagan National, the merger would result in a highly concentrated market, with a post-merger HHI of 4,959. The merger would also significantly increase concentration by 1,493 points. As a result, the merger should be presumed, as a matter of law, to be anticompetitive.

Out of curiosity, I wonder what the HHI is in the market for slots at La Guardia and Newark. Both have to be higher than the 4,959 figure quoted by the DOJ here. Still, this is the one DOJ argument that has some teeth; Reagan is a very lucrative market and fares are certainly rising. So adding competition at Reagan is a valid concern for the DOJ, and if it wants to remedy this, the fix is really quite simple. Require the merged carrier to divest some of its slot holdings at Reagan. The combined carrier will operate 294 peak day departures to 80 unique nonstop destinations at Reagan (based on Summer 2013 data). A simple, and elegant solution is to force the carrier to divest 10% of those slots (or 29 of them) to be distributed at the DOJ’s convenience. At the same time, order to ensure that small city access to Reagan is protected, the DOJ can require that as a condition of the merger, US Airways be required to serve at least 75 nonstop destinations from Reagan at any given moment. The DOJ has the power to do this tomorrow if it wants – and easily solve the one serious anti-competitive threat of the merger (or at least soften).

This merger would thwart any prospect for future entry or expansion at Reagan National. US Airways, which already has 55% of the airport’s slots, does not sell or lease them because any slot that goes to another airline will almost certainly be used to compete with US Airways. The merger would only increase US Airways’ incentives to hoard its slots. Today, US Airways provides nonstop service to 71 airports from Reagan National, and it faces no nonstop competitors on 55 of those routes. After this merger, the number of US Airways routes with no nonstop competition would increase to 59, leaving, at best, only 21 routes at the entire airport with more than one nonstop competitor. Unsurprisingly, Reagan National is US Airways’ second most-profitable airport.

US Airways doesn’t have competition on 55 of its routes because it is the only carrier that can profitably serve these routes, thanks to the connecting complex enabled by its 55% slot share. What other airline wants to serve Fayetteville, North Carolina, Manchester, New Hampshire, or Columbia, South Carolina from Reagan? Only a carrier with a true hub at the airport can sustain service to such small cities, which requires frequencies; ergo slot share.

JetBlue’s entry on four routes, particularly Reagan National to Boston, has generated stiff price competition. Fares on the route have dropped dramatically. US Airways estimated that after JetBlue’s entry, the last-minute fare for travel between Reagan National and Boston dropped by over $700. The combined firm will have the right to terminate the JetBlue leases and thereby eliminate, or at least diminish, JetBlue as a competitor on some or all of these routes.

The DOJ can solve this by requiring the merged carrier to continue leasing these slots to JetBlue for a specified period, or even by requiring the carrier to sell the slots to JetBlue at a pre-determined price. These solutions are all within the DOJ’s power.

Consumer preferences also play a role in airline pricing and are relevant for the purpose of analyzing the likely effects of the proposed merger. Some passengers prefer nonstop service because it saves travel time; some passengers prefer buying tickets at the last minute; others prefer service at a particular airport within a metropolitan area. For example, most business customers traveling to and from downtown Washington prefer service at Reagan National over other airports in the Washington, D.C. metropolitan area. Through a variety of fare restrictions and rules, airlines can profitably raise prices for some of these passengers without raising prices for others. Thus, the competitive effects of the proposed merger may vary among passengers depending on their preferences for particular types of service or particular airports.

It’s very good that the DOJ acknowledges this, and I’ll expand a bit. Basically, business travelers do certainly prefer Reagan over Dulles and Baltimore-Washington because Reagan is much closer to DC proper. But leisure travelers (those visiting family and relatives [VFR] as well as tourists) largely see the three airports as equal; that is they don’t mind whether their flight is out of Reagan, Dulles, or Baltimore Washington – as long as it is the lowest fare. Now keep in mind that the vast majority of Washington D.C area passengers are leisure travelers – more than 65%.

Advantage Fares


 

US Airways intends to do just that. If this merger were approved, US Airways would no longer need to offer low-fare options for certain travelers. For example, US Airways employs “Advantage Fares,” an aggressive discounting strategy aimed at undercutting the other legacy airlines’ nonstop fares with cheaper connecting service. US Airways’ hubs are in cities that generate less lucrative nonstop traffic than the other legacy airlines’ hubs. To compensate, US Airways uses its Advantage Fares to attract additional passengers on flights connecting through its hubs…..The other legacy airlines take a different approach. If, for example, United offers nonstop service on a route, and Delta and American offer connecting service on that same route, Delta and American typically charge the same price for their connecting service as United charges for its nonstop service. As American executives observed, the legacy airlines “generally respect the pricing of the non-stop carrier [on a given route],” even though it means offering connecting service at the same price as nonstop service. But American, Delta, and United frequently do charge lower prices for their connecting service on routes where US Airways offers nonstop service. They do so to respond to US Airways’ use of Advantage Fares on other routes……If the merger were approved, US Airways’ economic rationale for offering Advantage Fares would likely go away. The merged airline’s cost of sticking with US Airways’ one-stop, low-price strategy would increase. Delta and United would likely undercut the merged firm on a larger number of nonstop routes. At the same time, the revenues generated from Advantage Fares would shrink as American’s current nonstop routes would cease to be targets for Advantage Fares. The bottom line is that the merged airline would likely abandon Advantage Fares, eliminating significant competition and causing consumers to pay hundreds of millions of dollars more.

The DOJ misunderstands the rationale behind, and more importantly the enabler of US Airways’ Advantage Fares program. The rationale behind Advantage Fares is twofold. One part is, as the DOJ correctly pointed out, that US Airways does have hubs that are relatively weak in terms of volumetric (daily passengers worth of) O&D, though they are strong O&D bases (from a yield perspective)in their own right. But the second part is US Airways offers the Advantage Fares because it can; it has lower unit costs (cost per available seat mile – or CASM) than its legacy carrier peers. This is what truly enables US Airways to offer these Advantage Fares as a way of filling seats that would otherwise fly out empty – it is also reflective of a philosophy that empty seats equal lost revenue, something unique to US Airways amongst legacy carriers. Now all details surrounding the US Airways – American merger indicate that CASM at the new American will certainly rise from current US Airways levels, but critically will still be lower than those of Delta and United. According to an investor presentation made by American, it projects that after all of its bankruptcy contracts are written in place, it will have non-fuel CASM of 8.4 cents, significantly below that of United and even with that of Delta.

Now even if costs on the pre-merger US Airways network rise to match those of American, there is an additional $280 million in net cost synergies for the merged carrier, or more than 1% of combined operating expenses, dropping CASM ex-fuel for the merged carrier to 8.3 cents, nearly a cent and a half cheaper than CASM ex fuel at United and cheaper than that at Delta (only set to rise thanks to Delta’s more generous labor contracts and older fleet).

Moreover, with the labor contracts and capital expenditures/fleet plans that Delta and United have put in place, CASM at all 3 carrier’s looks like it will move in lockstep upwards, maintaining the same CASM delta between the new American and Delta/United. While American’s aggressive capital expenditure program to renew its fleet affects net profitability, the financial effect is primarily on the non-operational ledger. And airlines make pricing decisions based on operating costs, not total costs. And, US Airways’ lower costs are not just an accident of history, but a direct result of the management style and philosophy of current US Airways and future American CEO Doug Parker. It’s not a stretch to imagine that he will bring that to American, thereby resulting in lower costs for the new American. Now what this cost gap means is that the new American will still be able to profitably offer discounts in the vein of Advantage Fares throughout the combined network, though the scale/scope may be lessened – to say 10% (just a hypothetical example, the number could be larger or smaller). While the loss of up to 40% discounts on parts of US Airways’ network may cause consumers a great degree of harm, the resultant 10% discounts applied across the new American’s much larger network should provide a large consumer benefit that cancels out the harm from the loss of Advantage Fares – and the DOJ has no proof that a merged American would not pursue this.

American Airlines. (Credits: Vinay Bahskara)

American Airlines. (Credits: Vinay Bahskara)

Now later on in the lawsuit, the DOJ tries to piece together a bunch of quotes from US Airways and American executives and claim that that is concrete evidence that post-merger American will eliminate Advantage Fares outright. The following three passages are written to that effect:

US Airways’ President acknowledged in September 2010 that its Advantage Fare strategy “would be different if we had a different route network . . . .” Currently, US Airways’ network structure precludes Delta and United from preventing US Airways’ aggressive “one-stop pricing.” Because US Airways’ hubs have relatively less nonstop traffic, the other legacy airlines cannot respond sufficiently to make Advantage Fares unprofitable. But by increasing the size and scope of US Airways’ network, the merger makes it likely that US Airways will have to discontinue its Advantage Fares.

American’s executives agree. American believes that Advantage Fares will be eliminated because of the merger. Internal analysis at American in October 2012 concluded that “[t]he [Advantage Fares] program would have to be eliminated in a merger with American, as American’s large non-stop markets would now be susceptible to reactionary pricing from Delta and United.” Another American executive observed that same month: “The industry will force alignment to a single approach—one that aligns with the large legacy carriers as it is revenue maximizing.”

US Airways believes that it currently gains “most of its advantage fare value from AA,” meaning that Advantage Fares provide substantial value for US Airways on routes where American is the legacy airline offering nonstop service. Post-merger, continuing Advantage Fares would mean that US Airways was taking that value away from itself by undercutting its own nonstop prices. Plainly, this would make no sense. Thus, for US Airways post-merger, the benefits of Advantage Fares would go down, and its costs would go up.

Tackling the first passage, Kirby explicitly says that the Advantage Fares strategy will be “different” post-merger. He never says that the strategy will have to be cancelled outright; rather that US Airways revenue management model will have to shift as it network increases in strength and scope. Turning to the second passage; it’s wise to note that the analysis of American executives is less relevant because the post-merger network planning and revenue management team will be primarily composed of existing US Airways team members. Moreover, even if American’s large nonstop markets are susceptible to reactionary pricing, its cost advantage versus its legacy peers will allow American to withstand that reactionary pricing to more limited post-merger discounts. Although US Airways gains most of its Advantage Fare value from American today, that doesn’t mean that it will be the same post merger. The new American will compete head to head on a lot more markets with Delta and United than US Airways did alone; so it can probably drive more value by undercutting those two airlines than it did pre-merger. Moreover, even if the benefits go down and costs go up, an Advantage Fares style program would still make sense for American so long as it was profitable – in a business with margins as low as those in the airline industry, airlines will look to seize any and all profit opportunities.

Millions of consumers have benefitted. Advantage Fares offer consumers, especially those who purchase tickets at the last minute, meaningfully lower fares. The screenshot below from ITA Software, Airfare Matrix (“ITA”), taken on August 12, 2013, for travel departing on August 13 and returning August 14 from Miami to Cincinnati, shows the benefits of US Airways’ Advantage Fare program to passengers. American is the only airline on this route to offer nonstop service, charging $740. Delta and United do not meaningfully compete. Both charge more for their connecting service than American charges for nonstop service. Thus, on this particular route, a passenger who chose Delta or United would pay more for an inferior product. In contrast, US Airways’ fares today are significantly lower than American’s fares, and offer consumers a real choice. Those consumers who are more price conscious receive the benefit of a substantially lower-fare option. In this case, a customer who purchased a US Airways one-stop ticket would save $269 compared to American’s nonstop service.

DOJ's ITA Fare Matrix Screenshot for Cincinatti-Miami: one of several screenshots used by the DOJ in its analysis in lieu of actual DOT fare data.

DOJ’s ITA Fare Matrix Screenshot for Cincinatti-Miami: one of several screenshots used by the DOJ in its analysis in lieu of actual DOT fare data.

I’m not sure why the DOJ needs to use ITA Fare Matrix snapshots in its analysis when it has a treasure trove of DOT air fare data to use. And as Cranky Flier so deftly pointed out, the DOJ should be judging the average fare paid by consumers in a market, and the merger’s effect on that (despite Advantage Fares ironically enough, US Airways actually has the highest average fare of any carrier on Cincinnati-Miami). And all 3 of these screenshots fail to convince me that Advantage Fares will be eliminated outright. Let’s say (in a worst case scenario) that the combined carrier’s costs are 10% higher than those of US Airways (halving the cost gap) – it might still make sense for the new American to offer $134 in savings through an Advantage Fares style program – we just don’t know, but the DOJ seems to believe that it is a certainty that the pricing model will be disbanded entirely. Keep in mind also that there is a growing threat from ULCCs, especially Spirit. And in an interview with us a few weeks ago, Spirit CEO Ben Baldanza pointed out that legacy airlines tend to sell a very limited set of inventory at prices matching Spirit long before the travel date. As Spirit grows in stature and market penetration, some of the capacity that is eliminated from Advantage Fares would have to be shifted over to combat Spirit; Advantage Fares is still eliminated, but the low fare supply of tickets is still present for consumers.

By ending Advantage Fares, the merger would eliminate lower fares for millions of consumers. Last year, more than 2.5 million round-trip passengers—including more than 250,000 passengers from the greater Washington, D.C. area; another 250,000 passengers in the Dallas-Fort Worth area; half a million passengers in the greater New York City area; and 175,000 passengers from Detroit—bought an Advantage Fare ticket. Hundreds of thousands of other passengers flying nonstop on US Airways, particularly from their hubs in Phoenix, Charlotte, and Philadelphia, benefited from responsive fares offered by the legacy airlines.

Let’s give the DOJ the benefit of the doubt and assume that a nice round 1 million passengers benefit in connecting markets from Advantage Fares. Look at the total number of beneficiaries; 3.5 million. That’s equivalent to roughly 0.6% of the US air travel market – 0.6%. For an issue that nearly 15% of the lawsuit text (excluding the list of 1000 city pairs) is devoted to, it doesn’t even affect that many passengers overall.

The US Airline industry is already an oligopoly


 

The merger between US Airways and American would likely substantially lessen competition, and tend to create a monopoly, in violation of Section 7 of the Clayton Act, 15 U.S.C. § 18. Therefore, this merger should be permanently enjoined.

I really hope that the DOJ means oligopoly here; because otherwise it might be wise for them to halt proceedings until such time as they acquire a suitable dictionary. All joking aside, (and warning this is a tangent), this is an important points. Folks, the oligopoly is already here in the US airline industry, and is here to stay, regardless of whether American and US Airways are allowed to merge or not. Look, I don’t have a problem necessarily with the argument the DOJ is making about mergers driving up fares (though they miss the secondary counter-argument that mergers expand consumer choice by making new routes viable through increased fares). But I keep coming back to where in the world was this analysis five years ago during Delta-Northwest and in the intervening years mergers since? To all of sudden start claiming that mergers have all of these deplorable consequences when they didn’t five years ago is akin to Chicken Little claiming that the sky is falling. Buddy, the sky has already fallen. Economics 101 textbooks are actually split on what metric to use to decide on whether an oligopoly exists or not – many use four-firm concentration ratio (the percentage of a market controlled by the four largest firms in that market) while others use five-firm concentration ratio. And the five-firm concentration ratio in already above 80% at this very moment – and it won’t change much at all once the merger goes through. The US airline industry is already an oligopoly.

Coordinated Industry Behavior


There is also past express coordinated behavior in the industry. For example, all airlines have complete, accurate, and real-time access to every detail of every airline’s published fare structure on every route through the airline-owned Airline Tariff Publishing Company (“ATPCO”). US Airways’ management has called ATPCO “a dedicated price-telegraph network for the industry.” The airlines use ATPCO to monitor and analyze each other’s fares and fare changes and implement strategies designed to coordinate pricing. Airlines have previously used ATPCO to engage in coordinated behavior. In 1992, the United States filed a lawsuit to stop several airlines, including both defendants, from using their ATPCO filings as a signaling device to facilitate agreements on fares. That lawsuit resulted in a consent decree, now expired.

Even if access to ATPCO were restricted, it’s not as if it would be impossible for airlines to get this data. In today’s world, with technology advancing at the rate that it has, it would not be difficult for airlines to cobble together a program that grabs real time fare and supply data from the global distribution system (GDS). Moreover, it’s not as if there aren’t other industries that have this kind of pricing information about competitors. AT&T for example, knows exactly where T-Mobile and Verizon are pricing the Samsung Galaxy S4 in different markets in real time, and sets its prices accordingly.

US Airways also has communicated directly with a competitor when it was upset by that competitor’s efforts to compete more aggressively. In 2010, one of US Airways’ larger rivals extended a “triple miles” promotion that set off a market share battle among legacy carriers. The rival airline was also expanding into new markets and was rumored to be returning planes to its fleet that had been mothballed during the recession. US Airways’ CEO complained about these aggressive maneuvers, stating to his senior executives that such actions were “hurting [the rival airline’s] profitability – and unfortunately everyone else’s.” US Airways’ senior management debated over email about how best to get the rival airline’s attention and bring it back in line with the rest of the industry. In that email thread, US Airways’ CEO urged the other executives to “portray[ ] these guys as idiots to Wall Street and anyone else who’ll listen.” Ultimately, to make sure the message was received, US Airways’ CEO forwarded the email chain—and its candid discussion about how aggressive competition would be bad for the industry—directly to the CEO of the rival airline. (The rival’s CEO immediately responded that it was an inappropriate communication that he was referring to his general counsel.)

This is certainly damaging and looks very bad for Doug Parker. That being said, I fail to see what implications it has for an antitrust case against the merger. If Doug Parker is guilty of inappropriate communication with another airline’s executives, then by all means pursue legal action against that (and do the same if the behavior continues post-merger). US Airways has a right to complain internally about rival business actions, and I fail to see where this would make a merger violate antitrust actions. It feels like the DOJ just threw this into the lawsuit to make Doug Parker and US Airways look bad and win public opinion points, rather than for any actual antitrust purpose.

Competing Airlines


This merger will leave three very similar legacy airlines—Delta, United, and the new American—that past experience shows increasingly prefer tacit coordination over full-throated competition. By further reducing the number of legacy airlines and aligning the economic incentives of those that remain, the merger of US Airways and American would make it easier for the remaining airlines to cooperate, rather than compete, on price and service. That enhanced cooperation is unlikely to be significantly disrupted by Southwest and JetBlue, which, while offering important competition on the routes they fly, have less extensive domestic and international route networks than the legacy airlines..

The last part about Southwest and JetBlue is increasingly becoming false. As both carriers dealt with a rising cost base due to increasing labor costs over the past decade, each carrier evolved its business model from a pure low cost carrier (LCC) to more of a network carrier with a hub-and-spoke domestic network in the vein of Delta, United, and the new American. JetBlue operates major connecting complexes at New York JFK and Boston, and smaller ones at Orlando, Fort Lauderdale, and Long Beach. Southwest has evolved even further, while it still has not opted for a banked operations patterns at its main hubs, close to 40% of its passengers are now connecting ones, and its largest hub at Chicago Midway, with more than 230 daily departures, actually has more than 50% of its passengers connecting today. And its operations at Denver, Baltimore-Washington, and Phoenix, amongst others, are all above 40% connecting passengers. Moreover, as JetBlue’s recent entrance into the premium transcontinental markets between New York JFK and Los Angeles/San Francisco as well as Southwest’s more dated entrance into major markets like New York La Guardia, Newark, Boston, and Philadelphia show, JetBlue and Southwest are increasingly attacking legacy carrier strongholds domestically. Internationally, their scope is more limited. However, both JetBlue and Southwest are strong competitors to the legacy carriers in leisure markets in Central America and the Caribbean, and JetBlue has strong operations to South America with a major growth plan for South America out of Fort Lauderdale. Especially in the context of a US Airways – American merger, where capacity on Latin American routes is likely to decline and fares are set to rise, JetBlue will have a strong opportunity to undercut American on South American routes. JetBlue CEO David Barger has openly discussed bringing 787s to JetBlue in the past, an idea that has gained credence with JetBlue’s new premium and non-premium product(s) on the A321s. Because their networks are increasingly overlapping with those of the legacy carriers, Southwest and JetBlue will play a larger role.

A Southwest 737-700 arriving at Hobby Airport, one of the carrier's largest hubs. Southwest Airlines is the world's largest operator of the Boeing 737-700, with 384 in service at press time. (Credits: via Commons)

A Southwest 737-700 arriving at Hobby Airport, one of the carrier’s largest hubs. Southwest Airlines is the world’s largest operator of the Boeing 737-700, with 384 in service at press time. (Credits: via Commons)

Computer rendition of Airbus A321-200. (Credits: Airbus S.A.S.)

Computer rendition of Airbus A321-200. (Credits: Airbus S.A.S.)

Southwest, the only major, non-network airline, and other smaller carriers have networks and business models that differ significantly from the legacy airlines. Traditionally, Southwest and other smaller carriers have been less likely to participate in coordinated pricing or service reductions. For example, Southwest does not charge customers for a first checked bag or ticket change fees. Yet that has not deterred the legacy carriers from continuing, and even increasing, those fees. In November 2011, a senior US Airways executive explained to her boss the reason: “Our employees know full well that the real competition for us is [American], [Delta], and [United]. Yes we compete with Southwest and JetBlue, but the product is different and the customer base is also different.”

Has the DOJ’s airline monitoring division has been hibernating for the past six years? Because that’s perhaps the only way they could have missed the rapid convergence of Southwest’s fares, costs, and business models towards those of the legacy carriers. Southwest is now a revenue-focused airline and they carry plenty of business traffic (the core customer base for the legacies), especially in second tier markets like St. Louis, Nashville, Baltimore-Washington, and the like. And Southwest has done nothing if not raise fares substantially in its stronghold markets over the past 6-7 years. The Federal Government’s own data shows that since 2000, air fares adjusted for inflation have increased at just 16 of the 100 largest US airports (what was that about the explosive growth in the cost of air travel again?). Of those 16 airports, Southwest is the market share leader in 14, including 3 of Southwest’s largest hubs (Dallas Love had the biggest fare increases, Houston Hobby was 4th, and Chicago Midway 11th – Salt Lake City, a Delta hub, and Boise, with a large Alaska Airlines operation, were the only airports on the list where Southwest wasn’t the market leader). And the same applies for JetBlue.

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.

A Spirit A319 in the present-day branding adopted when they became a ULCC leisure oriented carrier. This A319 is seen at LAX where Spirit has entered the legacy airline fray with non-stop flights to Las Vegas, Chicago O'Hare, and Ft. Lauderdale. (Credits: Aero Icarus)

A Spirit A319 in the present-day branding adopted when they became a ULCC leisure oriented carrier. This A319 is seen at LAX where Spirit has entered the legacy airline fray with non-stop flights to Las Vegas, Chicago O’Hare, and Ft. Lauderdale. (Credits: Aero Icarus)

But this also makes it easier for a nimble low cost carrier (perhaps a ULCC like Spirit, Allegiant, or now Frontier) to come in underneath and disrupt this convergence. Readers are surely familiar with the physics principle that for every action, there is an equal and opposite reaction. A similar principle works here. For every fare increase by a Big 3 carrier (the action) there will be a ULCC player expanding its offering to take advantage of an increasing fare gap (the reaction). This has been seen throughout every previous wave of consolidation in the US airline industry, and now that Spirit has figured out how to make the ULCC model work from major airports, it will likely become increasingly true in coming years.

New entry, or expansion by existing competitors, is unlikely to prevent or remedy the merger’s likely anticompetitive effects. New entrants into a particular market face significant barriers to success, including difficulty in obtaining access to slots and gate facilities; the effects of corporate discount programs offered by dominant incumbents; loyalty to existing frequent flyer programs; an unknown brand; and the risk of aggressive responses to new entry by the dominant incumbent carrier. In addition, entry is highly unlikely on routes where the origin or destination airport is another airline’s hub, because the new entrant would face substantial challenges attracting sufficient local passengers to support service.

This is simply not true. Look at the list of new routes created by Spirit Airlines alone in 2011 and 2012. In most of these markets, especially out of Dallas Fort Worth and O’Hare, Spirit was a new entrant and it has been wildly successful in these markets. The one countervailing factor that the DOJ misses is that increased concentration and rising fares on a route only make it easier for a new entrant with 20% lower costs (in the US market Spirit, Allegiant, Frontier, and any other start-up ULCC) to gain a foothold.

 

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About Author

Vinay Bhaskara

Vinay Bhaskara

Senior Business Analyst, Big Airline Enthusiast, Avid Airport Connoisseur, Frequent Flyer, Globetrotter. I Miss Northwest Airlines Every Day. vinay@airwaysmag.com @TheABVinay

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