Posted September 1, 2010

A Case Of Strange Bedfellows In NJ: United + Continental = Southwest Boon At Newark

The big news from last week was not that United and Continental passed Department of Justice scrutiny. It was that they did it by giving Southwest an incredible gift. In a behind-the-scenes deal, Southwest was granted 36 slots at Newark from Continental as part of a slot divestiture that cleared the merger of the DOJ's one area of concern. As a result, the DOJ dropped anti-trust proceedings and the merger has cleared a major hurdle on its way to approval. 

You can read the Washington Post's coverage of the DOJ hearing here: Justice Department clears United, Continental merger for takeoff

But what is being written as the secondary story - Southwest's grant of slots at Newark - is actually the big news. The DOJ has stated in its report that the only area of concern regarding the proposed merger is the monopoly on routes between United and Continental's hubs. Namely, between Newark, Houston, Chicago, and Denver. Since Newark is the most slot constrained airport of the bunch (Chicago O'Hare is gate constrained, but not slot constrained), it boils down to whether there is any room to add competition on these routes. The clear answer to allay anti-trust concerns is to demand slot divestiture by the merging carriers, as they can ideally combine flights into larger equipment to serve this market (e.g. United's A320s between ORD and EWR can go, and the merged carrier can upgrade equipment to 753s on those routes to make up for it).

So far this sounds like a pretty straightforward story. But remember that in the past (for example, US Airways and Delta's slot swaps at LGA and DCA), airlines have viewed LCC entry as a prohibitive prerequisite for anything. Meaning any deal that required the divestiture of slots to an LCC would be a deal breaker. Obviously a merger is very different than a slot swap regarding the importance of the deal, but why did United and Continental bow down to the DOJ so easily, even before they publicly made their remarks? Also, why didn't they find a less threatening carrier to provide with the slots, rather than the feared Southwest?

There are two great answers to this, creating a delicious strategic move by United and Continental.

1) Southwest is the epitome of pro-competitive moves. It means the DOJ doesn't have an opportunity to think about approving the plan, it's an automatic "yes". It means Continental and United are serious about listening to DOJ concerns and doing what it takes to make the merger a success. In other words: It's a guarantee of positive outcome. Given all the moving parts, sensitive timelines, and wary legislature (who, by the way, can still block this merger), it was a shrewd move by United and Continental to try to put to rest any concerns of anti-competitive behavior. If they had tried to give the slots to Sun Country, AirTran, Spirit, and USA 3000, they would have been met with skeptical responses and ongoing legal hassle. Southwest is a cure-all. Brilliant.

2) Of course Southwest comes at a price. But let's review the three markets we're talking about here: Newark-Houston, Newark-Denver, and Newark-Chicago. For two of those markets, Southwest uses a secondary airport (Hobby for Houston, and Midway for Chicago). This means that even if Southwest opens the "directly competing" route to the merger carrier, it won't actually compete. How's that for strategy! At Denver, of course, there could be some strong competition. But remember that with Continental, United is no longer an O&D feeder into Newark. It's Denver-Newark travelers might be connecting all over the world. Additionally, the combined carrier has such a frequent flier business traveler base in the NY metro area, it's likely only going to cede leisure, low yield, travelers to Southwest. No big deal. The same goes for most other routes Southwest might choose to compete on at Newark. It's never a good idea to let Southwest into your hub, but the strategic risk for the new United is far less than for other carriers given their strong international route network out of that airport (e.g. Southwest at Denver is a much bigger risk for United, since it's primarily a domestic hub).

So win-win, for the DOJ, the public, Southwest, and United/Continental, right?

Well, there is one area that keeps bothering me. What will Southwest do with the slots? They have no obligation to use them to fly to Midway, Hobby, and Denver. If past moves by Southwest are any indication (a la entry into LaGuardia), they'll use some for Midway and Baltimore. The others? Hobby probably. Denver? Maybe, maybe not. But here's the real kicker: Are Houston Hobby and Bush Intercontinental airports considered the same market? What about Midway and O'Hare in Chicago? In the DOJ's analysis for prior mergers and potentially anti-competitive actions by airlines, the DOJ has determined pretty clearly that different airports within a metro area are NOT the same market. Previously this sniff test has been applied to the three main airports in NY (EWR, LGA, and JFK), and the three in the Washington DC area (DCA, IAD, BWI). The DOJ has confirmed that market share in one cannot be combined with another to test for market power, they have to be analyzed as separate markets. So why suddenly in this case are the Houston and Chicago airports being considered as unified markets?

Hard to say, and there is no public response to that question. But it rolls up into the issue that Southwest hasn't promised to use the routes specifically to counter United and Continental's route monopoly either. So if they don't fly to Hobby, well then, it hardly matters if it's the same market at Intercontinental or not, does it? It might just be that giving 36 slots to Southwest is a big enough give-away regardless of how they're used and how it impacts the specific potential monopoly routes outlined by the DOJ.

Shrewd move by United and Continental, for sure. Great move by Southwest to get into Newark in a meaningful way (significantly more than their presence at LaGuardia!). Unclear if the results will directly attack the merger monopoly concern, but Southwest's presence at Newark will clearly have a positive competitive impact on the market, so there's reason to be optimistic about that. Will the new United learn to rue the day they became bed-felllows with Southwest? Very likely. But either way, it will be fun to watch it play out in 2011.

Evan Konwiser is co-founder of FlightCaster. These thoughts are excerpted with permission from his blog

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Posted by: Evan Konwiser | More by Evan Konwiser

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