Put a fork in the US Airways/American Airlines merger

Yeah, it’s pretty unlikely that it’s happening. You see, when the U.S. Department of Justice filed suit today to block the two airlines from merging, it didn’t just claim that the deal was bad for competition at Washington’s Reagan National Airport (DCA). Rather, the DOJ also claimed that the proposed merger was anti-competitive in general. The issue here centers in part around a critical feature of US Airways — its inability to generate the sort of fare premiums American, Delta, and United get. From the DOJ’s complaint:

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.

US Airways’ own executives — who would run the new American — have long been “proponents of consolidation.” US Airways believes that the industry — before 2005 — had “too many” competitors, causing an “irrational business model.” Since 2005, there has been a wave of consolidation in the industry. US Airways has cheered these successive mergers, with its CEO stating in 2011 that “fewer airlines” is a “good thing.” US Airways’ President explained this thinking that same year: “Three successful fare increases – [we are] able to pass along to customers because of consolidation.” (emphasis added). Similarly, he boasted at a 2012 industry conference: “Consolidation has also . . . allowed the industry to do things like ancillary revenues [e.g., checked bag and ticket change fees] . . . . That is a structural permanent change to the industry and one that’s impossible to overstate the benefit from it.” In essence, industry consolidation has left fewer, more-similar airlines, making it easier for the remaining airlines to raise prices, impose new or higher baggage and other ancillary fees, and reduce capacity and service. This merger positions US Airways’ management to continue the trend — at the expense of consumers.

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.

Unlike the DCA slot issue, it’s difficult to imagine a way that US Airways and American Airlines can mitigate a claim that their deal is broadly anti-competitive to get the DOJ’s blessing. And that’s especially true as the objection is based upon the very unique nature of US Airways. So if there’s no deal, then it’s off to federal court… not that that should encourage US Airways or American Airlines. The DOJ’s Antitrust Division has only lost once in the last 10 years in court when challenging mergers, winning the other 84 times it sued to prevent a deal from going through. So the odds of the deal being approved by a judge would seem rather slim.