The Disadvantages of US Airline Merger
The big 6 airlines have reached a state of oligopoly; any further mergers are likely to have an extremely negative impact on the airline industry and the air travelers. Fortunately the US Airways/ Delta hostile merger bid was foiled by Delta’s management. We have to remember the situation before the Airlines Deregulation Act when any attempt to introduce cheaper air routes was actively discouraged by CAB. If the Delta/US airways merger had succeeded, the defensive merger of other airlines groups would possibly have created a cartel.
The three giants would have controlled majority of air traffic through their monopolistic hubs to remove all competition. Creating ‘giant three’ would make it more and more difficult for new entrants to capture any part of the market as the big three can control the market, make inter airline transfer more difficult and effectively stifle the new competition. [Cooper, 2001] in his report to the House of Representative painted a good picture of allowing further consolidation of the ‘big 6’. Cooper argued that the big 6 already had a huge advantage of operating through the hubs.
The monopolistic level of control (>70%) on the hubs is preventing the new entrants from entering competition. Those advocating further consolidation are trying to control the industry to an extent where further competition by new entrants will become too difficult if not impossible as the capital required to compete with the giants will be prohibitive. [Cooper, 2001] argues that when the number of competitors companies fall into single digits the public policy concerns become important. Hirschman-Herfindahl Index (HHI)
During the Reagan period, the Department of Justice (DOJ) prepared the merger guidelines. The DOJ used a Hirschman-Herfindahl Index (HHI) of 1000 as an indication of a moderately concentrated market [DOJ, 2007]. HHI of 1000-1800 was considered moderately concentrated and HHI of above 1800 was considered highly concentrated. According to the DOJ guidelines a market of six equally sized firms has a HHI of 1667 which falls under the moderately concentrated. Reducing the number of airlines by further consolidation will take the HHI into highly concentrated or oligopoly range.
Cooper argued that on regional basis many areas had already had a HHI of well over 2000 and in the big 6 situation the national level of HHI was 1400. Further consolidation to ‘giant three’ will take the HHI to 2200 on a national scale (highly concentrated) showing that the consolidated industry will be bad for competition and discourage new entrants. Thus it is clear that any further merger will be against the previously recognized guidelines of encouraging competition. The US Airways bid to acquire Delta was therefore against the interest of the industry and the consumers.
As seen above the consumers already suffer the effects of monopolistic level of control by the big 6, any further consolidation will give the airlines a carte blanche and only the consumer will suffer. The airlines controlling the hubs exploit their control by restricting competition, manipulating computerized reservation system, making deals with travel agents to divert traffic to their hub, program such as frequent fliers lock in customers to the disadvantage of new competitors [Cooper, 2001].
The lower costs of hub operations are not passed on to the consumer, further mergers will take the new giants to new heights of anti consumer practices and will be to the detriment of the consumer and new entrants to the airline industry. The Monopolistic hub operating practices are already hurting the consumers. As the competitor enter the hubs, the customers benefit as the frequency of flights increases while the prices go down. Under the competition even the incumbents reduce prices. The fortress hub policy is therefore detrimental to the interest of the consumer.
What is even clearer is that reducing competition through more mergers will increase fares and reduce performance and services. [Cooper, 2001] argues that the big 6 monopolistic control over the airline industry and operations through hubs has kept the air fares high. He shows that oil prices dropped by almost 50% since the mid 1980s (to 2001) and the cost of capital also dropped by almost 20% during this period. Despite these drops in the two major components of airlines cost the fare did not drop but increased steadily in terms of consumer price index.
The big 6 airlines and their existing control over the airline industry has only been to the detriment of the consumers. Any future mergers and consolidation need to be vigorously opposed by the consumers and also by watchdog bodies. Antitrust Issues The airline mergers require clearance in three steps [Bailey, 2006]. • the Transportation Department must determine that a merger is financially viable, • the Federal Aviation Administration must approve a certificate of safety, and
• the Justice Department must determine that there are no antitrust issues As mentioned above the airline industry is already concentrated in a few companies and the highly concentrated market raises anti-trust issues if further mergers result in even fewer competitors. Until the US Airways hostile takeover issue fizzled out on February 1, 2007, the consumers were concerned that if this merger was allowed to go through the other mergers will follow as a defensive move and the consensus was that the consumer will be the looser.
It appears that DOJ has recognized that mergers will be not in the interest of the industry. DOJ rejected a US Airways/United merger after an investigation lasting more than a year [Ramos, 2006]. When Delta/US airways hostile merger bid became known a senior lawyer rightly claimed” It appears from a factual standpoint, this is a merger that clearly has a lot of antitrust issues attached to it. “The antitrust risk here is quite high [Ramos, 2006]. “
The consumer union in its testimony to the Senate Committee [Consumer, 2007] opposed US Airways/ Delta Airlines merger insisting that “Mergers like USAIR-Delta that are being proposed will result in rising prices and reduced service because they eliminate competition on thousands of routes where there are already too few competitors to prevent price gouging and abuse of market power,” In his testimony the Director of Consumer Federation pointed out that: • Approval of merger between the Delta/US Airways could lead to a wave of future mergers. • Merger will eliminate competition on many routes and will reduce service and increase fares
• Lack of competition triggers abuse • The airline industry is already moderately concentrated and any further merges will create a monopoly situation • Mergers resulting in lack of head to head competition reduce consumer choices and increase prices • Concentration of airline industry among the new giants will prevent entry of new entrants as the big airline will drive the competition out. • Market power concentrated into a few hands is not in the interest of the industry and the consumers [Bailey, 2006] point out some of the effects of mergers of the past years.
The number of planes reduced from 4462 in 2000 to 3938 in 2005, a fall of 12%. The fare increased by 15% in just 2005 alone. The number of workers in airline industry reduced by 37%, from 420,000 in September 2001 to 264,000 in September 2006 showing how the airlines reduced services to consumers and affected their employees. [Brock, 2005] arguing against further mergers points out that if mergers into larger airline was the real solution of the problems being faced by the airlines then the mergers and liquidation of the late 1980s would have solved the problem.
The major carrier emerging from the mergers of the last 20 years only exploited the consumers through hub monopolies and the market power to fail the small competitors through predatory prices, creating obstruction for the small competitors at the hubs through controls over landing slots, terminals access, gate controls etc. Any further concentration of airlines into fewer hands would run the competitors out in even a shorter time leaving the airline passengers at the mercy of the new giants. The large legacy carriers have already benefited from billions of dollars of bailout, loan guarantees, and grants.
The smaller and efficient airlines like JetBlue and Air Tran are making profits while the big 6 are moaning their losses and asking for greater protections and using their market power to bankrupt the more profitable but small airlines. The consumers breathed a sigh of relief when Delta managed to avoid the hostile takeover bid by US Airways. Brock says that the customers are relieved because any further ‘consolidation’ will “force even more passengers traveling even farther distances to escape sky-high fares at monopoly hubs, and wasting even more gasoline and driving time in the process”.
Any further mergers “will see the innate advantages of air travel — speed, ease convenience — eroded even more. In short, we would suffer the disadvantages of airline monopoly on a nationwide scale” [Brock, 2005]. The Pros and cons of US airline mergers show that the advantages of mergers have been very few. The short term benefits gained by mergers have largely been squandered and the airlines are once again facing financial difficulties. During this period the market power techniques were employed to run the new entrants out of business.
Predatory pricing techniques, exploitation of hub monopolies have driven many of the new entrants to bankruptcy. [Brock, 2005] argues that provision of subsidies, loan guarantees and wasting billions of dollars of taxpayer funds is not going to help the failed mega carriers and the new entrants who have demonstrated their ability to run healthy airlines should be allowed to takeover or at least freed from the stranglehold on the big 6 on the hubs so that the airline industry can find its way back to profitability.
Open Sky policy announced only yesterday (22nd March 2007) will open the Europe’s and US air space to more competition and the alliances built on financial viability and open competition instead of mergers and government support and subsidy will be helpful in restoring profitability to the airline industry and free the consumer from the impact of monopolistic practices being practiced by the big 6.