August 28 - FAQs Regarding U.S. DOJ Challenge To US/AA Merger


The American Antitrust Institute (AAI) and Business Travel Coalition (BTC) offer answers to a number of frequently asked questions (FAQs) about the move to block the proposed merger of US Airways and American Airlines (US Airways-AA) by the U.S. Department of Justice (DOJ) and Attorneys General of six states (Arizona, Florida, Tennessee, Texas, Pennsylvania, and Virginia) and the District of Columbia. These FAQs cover a variety of topics involving the merger, ranging from the effect of the merger on competition and consumers, to the litigation process. Should you have any further questions, please visit the link to the AAI and BTC White Paper on the US Airways-AA merger or consult the “Contact Us” link on our homepages at www.antitrustinstitute.org and www.btc.travel.

1. Why would the DOJ block this airline merger and not previous airline mergers?

Because the industry competitive landscape has changed dramatically over the last decade, in large part due to unchallenged previous airline mergers. The purpose of U.S. merger law is to prevent illegal mergers, the effect of which “may be substantially to lessen competition, or to tend to create a monopoly.” The DOJ, six states, and the District of Columbia investigated whether the US Airways-AA merger was legal under Section 7 of the Clayton Act. The agencies determined that it was not legal. The loss of competition would very likely result in higher fares and “ancillary” fees (e.g., baggage, preferred seating, advance boarding, etc.), cutbacks in service and capacity, and reductions in the quality of customer-service.

Airline mergers require a forward-looking analysis based on the current competitive landscape of the market. This landscape has changed since the mergers of Delta-Northwest, United-Continental, and Southwest-AirTran. As the DOJ’s Complaint explains, there were nine major airlines in 2005. If US Airways-AA merged, there would be only four major airlines left. A merged US Airways-AA – along with Delta, United, and Southwest – would account for over 80 percent of the domestic scheduled passenger market. Evaluating a merger against the backdrop of only four major airline systems in 2013 produces a very different result than when the DOJ looked at Delta-Northwest in 2008, or even United-Continental in 2010.

One of the DOJ’s major concerns about the US Airways-AA merger is that there are so few carriers that the combination could make it easier for the remaining firms to tacitly “coordinate” on service and capacity cutbacks, fares and fees, and quality. In other words, with so few competitors left after the merger, carriers would have less incentive to aggressively compete head-to-head and instead “go along” with their rivals. The Complaint illustrates this point repeatedly with evidence and analysis.

The Complaint identifies over 1,000 non-stop and connecting “overlap” routes or markets where the merger eliminates either US Airways or American as a competitor. On those routes, the increases in market concentration due to the merger, and levels of market concentration after the merger, would be “presumptively illegal” under the U.S. Federal Trade Commission/U.S. Department of Justice Horizontal Merger Guidelines (2010).

In past airline mergers, the DOJ determined that the probable harmful effects on competition were limited and/or could be mitigated by cost savings or “efficiencies.” This is not the case in US Airways-AA where the DOJ finds widespread potential anticompetitive harm and insufficient merger-related efficiencies necessary to overcome such harm.

2. Does the fact that the DOJ did not move to block other large airline mergers have any legal consequences for the pending   challenge?

Probably not. While the question has not received much attention in litigated court challenges, there is no reason that the DOJ's choice not to challenge one merger should have any relevance for its review of subsequent mergers. First, a well-recognized rule of law known as "prosecutorial discretion" provides that a government enforcer is entitled to choose whom to sue, and the party sued may not raise as a defense the fact that the government did not challenge other mergers under similar circumstances. This rule allows government enforcers to make judgments about resources and priorities, their likelihood of success, and other factors that courts are not well positioned to second-guess.

More important, it would be very poor policy if a failure to challenge one merger in an industry were a legal barrier to challenging subsequent ones. If that were the law, then if the government failed to challenge a merger of, say, two of the six leading firms in a market, it might be prevented from challenging a subsequent merger of five-to-four, and then four-to-three, and so on, even though those subsequent mergers obviously would pose increasingly serious competitive risks.

It could also be argued that the DOJ has access to far more information than people viewing the transaction from the outside. The DOJ receives a large volume of documents from the merging parties, and has the ability to obtain documents from the merging parties’ customers and competitors as well. This confidential information may yield different conclusions from those reached by those lacking such information, not only about the merits of bringing challenge, but also whether or not the DOJ would win such a challenge.

3. What are the next steps in the government’s enforcement action to block the proposed merger?

U.S. antitrust agencies do not approve or disapprove mergers. Rather, they sue to block potentially anticompetitive mergers. This process is governed by the Hart-Scott-Rodino (HSR) Act of 1976 (as amended in 2001) for mergers that meet certain transaction value thresholds. The HSR process imposes notification requirements on the merging parties and sets forth general timetables governing the government’s requests for additional information.

Review of the US Airways-AA merger passed through what is called a “second request” under HSR. This process involves the collection and analysis of information, interviews with a variety of market participants, and negotiations with the merging parties as part of a full investigation of the potential competitive effects of the proposed merger. At the end of this process, the DOJ likely determined that it could not find a remedy that would alleviate its competitive concerns.

As result, the DOJ, six states, and District of Columbia all challenged the US Airways-AA transaction. The plaintiffs filed a Complaint in U.S. District Court for the District of Columbia seeking a permanent injunction to stop the parties from consummating the merger. Judge Colleen Kollar-Kotelly will preside over what is usually a hearing on the merits of the arguments made by the government and the merging carriers and decide whether to order the parties not to merge. If the injunction is granted, the parties could terminate their proposed merger or appeal to a federal circuit court of appeals. Because time is often of the essence to merging parties, relatively few merger decisions are actually appealed.

4. Shouldn’t antitrust enforcement account for the fact that US Airways and American have already incurred significant costs in trying to merge?

No. Merger and acquisition attempts entail risk and significant costs for the parties. These costs include the financial, accounting, regulatory, transactional, and potential litigation expenses associated with a merger proposal. They are, in short, a “cost of doing business.” The government also incurs significant costs in investigating and challenging proposed mergers that could harm competition and consumers. As a result, the DOJ makes careful choices in spending taxpayer dollars regarding merger cases they decide to challenge. Over the last ten years, only about 3.3 percent of reported mergers, on average, received “second requests.”

Sometimes merging companies are so confident that antitrust enforcers will not challenge their merger that they often pursue a “soft implementation,” thereby incurring significant costs just short of consummating their deal. US Airways and American have done this. For example, they relocated personnel before the DOJ reached a decision on whether to challenge the proposed transaction. This was a calculated choice by the carriers, particularly when the scope of the government’s investigation foretold the significant competitive concerns in the Complaint.

Failing to challenge the merger might save the parties the money they spent preparing the merger, but only at the cost of significant damage to consumers in the form of higher fares and fees, cutbacks in service and capacity, and lower quality. If the fact that the parties already spent a lot preparing the merger was a defense to a government challenge, that would just encourage firms to spend a lot on proposed mergers – to thwart enforcement. The bottom line is that antitrust enforcement is designed to protect and promote competition and consumers, not shareholders of private corporations.

5. How can DOJ and the airlines be so far apart in their estimates of how much the proposed merger will affect competition?

It is not unusual in a merger challenge for the antitrust agencies and parties to differ. US Airways and American have advocated their case and tried to present their position in the best possible light. The carriers argue that their networks are "complementary," rather than "overlapping." They emphasize that the only important competition that they provide each other is on a handful of non-stop routes, for which connecting service is a poor substitute.

The DOJ argues, on the other hand, that the merger would end meaningful competition between the two merging carriers on more than 1,000 routes, including non-stops and connecting flights. Non-stop fares have increased so much, due largely to prior mergers, that connecting flights are now the only choice for many passengers. Connecting service also acts in many cases as the only competitive discipline for the prices carriers charge on non-stop flights.

These questions will be explored in the district court hearing. However, the DOJ’s Complaint contains persuasive evidence that network carriers engage in pricing strategies assuming that non-stop competes with connecting service. US Airways, in fact, priced service on some connecting routes specifically to compete with non-stop service. Given that a US Airways-AA merger would very likely have a widespread, adverse impact on competition and consumers, one obvious question is why the public should spend its resources on trying to fix the deal.

6. Why can’t problems with the proposed merger be resolved by slot divestitures at Reagan Washington National (DCA) airport?

Slot divestitures might cure competitive problems at DCA but not the broader concerns raised in the Complaint. DCA has attracted attention because the combined carriers’ would control 69 percent of total slots and 63 percent of total non-stop routes served out of the airport. Slot-controlled airports are particularly hard for rivals to enter or expand at, so the effects of the US Airways-AA merger are particularly severe at DCA. In seeking to remedy a merger under the HSR process, the antitrust agencies more often than not will attempt to negotiate a remedy that fixes competitive problems at the same time it allows the firm to realize any projected cost-savings.

In an airline merger with more limited competitive impact and significant efficiencies, the government might have been satisfied that slot divestitures would protect competition and consumers. However, given the breadth of the DOJ’s concerns over the anticompetitive effects of the proposed merger, slot divestitures at DCA are inadequate. It might also be the case that the parties were unwilling or unable to agree to a package of remedies necessary to make the merger legal. This could be because an adequate remedy would prevent the combined firm from exercising its enhanced market power – and thereby earning higher prices and profits – after the merger.

7. Won't American fail without the merger?

Not likely. This question comes up because under the U.S. merger guidelines, a “failing firm” defense can be a safe harbor if “…a merger [is] not likely to enhance market power if imminent failure…of one of the merging firms would cause the assets of that firm to exit the relevant market.” Based on these criteria, it is clear that the failure of American is not imminent, even though the carrier is in bankruptcy proceedings. Both airlines are actually performing quite well, and there is no reason to believe that American will not be able to survive without the merger. Executives of both US Airways and American have said so and indeed, American just this week recorded record company profits for July.  

There have been many airline mergers in the 35 years since deregulation, most of which were defended as necessary to keep one or both of the merging firms from failing. This is largely a red herring argument, for two reasons. First, in spite of all the mergers – and even in cases where airlines have merged – many carriers still ended up back in bankruptcy court, occasionally being fully liquidated. Second, other major carriers declared and successfully emerged from bankruptcy on numerous occasions. Bankruptcy has, in fact, become something of a “business as usual” condition in the airline industry, where carriers enter and exit bankruptcy but remain viable economic entities.

The bottom line is that airline mergers have served the interests of domestic carriers in generating higher fares and profits by closing down routes to smaller communities, driving traffic to large hubs, increasing load factors by cutting service and capacity, and removing basic amenities for most passengers.

8. Won’t Southwest Airlines and other low-cost carriers ensure competition and keep the big legacy carriers, including a merged US Airways-American, in check?

Probably not. For many years, but not anymore, Southwest played the important role of “maverick” in domestic airline markets with low fares and efficient service. Mavericks are often low cost, aggressive firms that provide important competitive discipline for other firms in the market. Southwest was one of the only smaller airlines to meaningfully challenge the major airlines in head-to-head competition without being forced out of markets or acquired by a larger firm. Its ability to discipline fares charged by legacy carriers was well documented and came to be known as the "Southwest effect."

The problem is that Southwest is now itself a very big airline – very much like its large legacy sisters Delta and United. Its point-to-point network model has come to look more like a “hybrid” network, with some characteristics of the hub-and-spoke model of the legacy airlines. Moreover, Southwest offers service in many markets with only a few large players and a small and dwindling group of low-cost carriers (LCCs). Southwest therefore does not compete and contribute to pricing discipline as dynamically as it once did.

Southwest’s dominance in the market was enhanced by its acquisition of AirTran, which was an important maverick in the domestic industry. With AirTran gone, the major competitor that kept Southwest on its toes is also gone. The DOJ successfully challenged the acquisition of T-Mobile (a maverick in the telecommunications markets) by AT&T for this very reason. The remaining LCCs such as JetBlue, Spirit, Allegiant, and Frontier do not have as much ability to effectively discipline the large carriers. A merged US Airways-AA could further diminish this possibility because after the merger, LCCs would likely find it even harder to get access to “fortress” hubs that are dominated by the large network carriers.

9. Aren’t mergers a way to ensure that the airlines are profitable?

The airlines are profitable and have been for quite a while. Anticompetitive mergers that generate higher profits because the combined firm exercises its enhanced market power come at the expense of consumers, who pay higher fares and fees and experience service and capacity cutbacks, lower quality, and less choice. This is why the DOJ challenged the merger of US Airways-AA.

Even mergers that are pro-competitive are not a magic bullet for improving profitability. Pro-competitive mergers are those that reduce costs or create firms that can provide quality, innovative products and services and get them to market faster. However, history tells us that many of the efficiency claims made by merging airlines have been either overstated or failed to bear fruit altogether.

Airlines often argue that they would be more profitable if they were allowed to merge because of challenging factors such as high capital costs, exposure to economic cycles and changes in demand, and volatile input prices such as fuel. Without a doubt, this can be a difficult business environment. However, some airlines have found ways to hedge fuel price volatility and respond more quickly to changing economic conditions. There are also examples of carriers remaining profitable despite facing all the same challenges as the legacies. Moreover, some airlines continue to perform poorly even after mergers. In sum, there are not many good arguments for why mergers are necessary to enhance profitability.

10. Is challenging the merger bad for U.S. businesses?

No. Challenging the US Airways-AA merger is probably good for U.S. businesses. The airline industry is the one that virtually all others depend on to service their customers and grow their industries. The Complaint argues that the merger is bad for consumers because of a reduction of competition on hundreds of routes. Those routes include hub-to-hub routes that involve large cities serving businesses. The merger may therefore injure business passengers living in, or frequenting, those cities because they are either forced to pay a higher fare, take a longer connecting flight, or both. This will, in turn, raise costs to those businesses, making them less competitive. For businesses in smaller cities, cutbacks in service and capacity on routes affected by the merger may impair local economic development. So, while the merger may be viewed by some as in the interests of the merging parties, that by itself does not mean the US Airways-AA merger is good for business.

11. Why did the government address airline “ancillary” fees in the Complaint, and how is the move to challenge the merger related to other regulatory issues involving fees?

The latest round of airline industry consolidation has resulted in carriers unbundling their products and charging fees for ancillary services (e.g., baggage, preferred seating, and advance boarding) that were previously included in the price of an airplane ticket. These fees can represent 40 percent or more of the price of air travel for a consumer and have grown into multi-billion dollar revenue streams for many airlines.

Price transparency is important for the competitive process to function properly. Consumers can benefit from this, but not without transparency in prices – something the airlines have largely resisted. For example, they have resisted requests for fee information from some of their largest customers and the U.S. Department of Transportation and Congress. In doing this, the airlines effectively mask the “all-in” price of air travel. This prevents consumers from comparison-shopping across multiple airlines. It also means that fee levels are not disciplined by market forces.

Strong rivalry among airlines should create incentives for the carriers to inform consumers about the pricing, quality and availability of their products. But a US Airways-AA merger could further diminish consumer choice and price transparency through stronger incentives to coordinate (instead of compete) on fees, to withhold ancillary fee information from travel agencies, or to otherwise impede comparison-shopping that requires price transparency. Indeed, the airline industry dislikes the competition induced by price transparency and comparison-shopping – something that is driving the effort by the International Air Transport Association to remove consumer anonymity from the purchasing process and to “standardize” distribution of airline products. This effort, if it proves successful, would eliminate valuable competition between different distribution “channels.” A loss of competition strengthens all of these incentives, particularly in the case of US Airways-AA where the merger eliminates competition across hundreds of markets, resulting in high levels of market concentration.

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