Concerns On CO-UA Proposed Merger

Business Travel Coalition (BTC) has long viewed airline mergers and industry consolidation with a good measure of skepticism regarding anticipated benefits for all stakeholders. While we are still working to formulate a public position on the proposed Continental (CO) – United (UA) merger, there are several areas of concern worth noting ahead of U.S. Senate and House hearings that suggest the antitrust analysis should go beyond management spin that this is an end-to-end network combination made in heaven that will drive benefits for all and that should be approved post haste.
The concern over the Delta – Northwest proposed merger in 2008 that prompted BTC to testify in the House and Senate in opposition to it was that it would trigger radical consolidation to 3 mega carriers against a history of failed mergers while raising prices and reducing service. Soaring jet fuel prices and worsening airline financial results in 2008 effectively put consolidation on hold.

A CO-UA merger would likely cause an American Airlines combination with US Airways, and thus, 3 mega carriers would result. Even non-CO or UA executives publically exclaim, as non-merger participants, the benefits to their airlines from the capacity removed, and attendant pricing power achieved, by this proposed merger.

Rationale to support a CO-UA merger would include that in the 2 years since DL-NWA (1) low cost carriers have continued their growth, (2) network airlines’ balance sheets have continued to deteriorate, (3) jet-fuel prices are on the upswing again, (4) business travel volume and yields still have not recovered and (5) low cost new entry is poised to increase as parked aircraft and crews are available and capital markets are loosening.

Some analysts argue that 3 major network carriers are all that the U.S. market can handle if supply is to be right-sized to demand for the purpose of enabling these carriers to recover their cost of capital over a full economic cycle. However, these same analysts agree that due to low barriers to entry for low-cost carriers (equipment, crews, capital) there will always be excess capacity in their view and thus airlines will never represent attractive long-term investments. These two arguments are contradictory. Mergers and consolidation, aside from a near-term valuation play, are not usually effective industry solutions and could cause significant problems for many stakeholders.

These analysts likewise argue that 3 strong national network airlines would provide effective competition for all consumers. However, this does not recognize the unique hub-market dominate structure of the industry and that corporations located in hubs do not always have the ability to successfully play one supplier off against another as is the case in other industries. No one of these 3 national network carriers would be able to meet the vast majority of most corporations’ air travel needs, thus corporations’ parity at the negotiation table could be greatly impaired. In contrast, Boeing or Airbus can meet virtually 100% of an airline’s wide-body aircraft needs; thus, airlines benefit from near-perfect price competition with just two suppliers. Consolidation to 3 network carriers would enable these firms to further fortify their hubs to the possible detriment of corporate buyers.

With 3 mega-network carriers and their alliance partners acting as a single buyer there is the risk of these groupings exercising monopsony power, i.e. driving pricing for all manner of services below competitive levels. At risk are travel agents, global distribution systems, airports, food service providers, labor, equipment manufacturers and many other services providers. As a consequence, it could be easier by an order of magnitude for these behemoths to shift distribution and other costs to the consumer.

With 3 mega-network carriers and their alliance partners acting as a single seller there is also the risk of these groupings exercising monopoly power, i.e. driving pricing for air services above competitive levels. For example, under current airline alliance antitrust immunity provisions, an alliance can refuse to deal with a corporate buyer unless that buyer agrees to deal only with the alliance, versus individual members. Radical consolidation would likely further strengthen these alliances in dealings with corporate customers driving down the value of their contracts.

With one less major network carrier, in an oligopolistic industry, the Coordinated Effects Doctrine becomes relevant as there would be one less veto vote available to reject system-wide fare increases, or fare surcharges for peak summer travel. Once consolidated to 3 major carriers, concentration at the national, hub and city-pair market levels becomes less relevant as across-the-board fare and fee increases would be much more easily facilitated.

Analysts argue that the alternative to mergers and consolidation is a slow liquidation for network carriers. Antitrust law does allow for the Failing Firm Doctrine under carefully specified conditions, however, the laws are not concerned with shareholders’ interests or the fact that an industry is unprofitable. Rather, antitrust laws are purposed to protect competition and the consumer against combinations that will likely lead to higher prices, less output and lower quality. Moreover, one or two failures would in fact allow more efficient airline operators to acquire the assets and deploy them at higher and better economic uses to the consumer’s benefit. This outcome could be superior to structurally institutionalizing failed businesses on the backs of consumers.

Evaluation of the CO-UA proposed merger would need to assume the collapse of network carriers to 3. Remedies would need to be considered that reflect the unique competitive structure of the industry wherein in mega carriers would be able to more easily wield their power against consumers as well as supply chain participants.