Airline Antitrust Hawks Lose Altitude

Vol. 53 No. 2

By

Richard D. Cudahy is a senior circuit judge of the United States Court of Appeals for the Seventh Circuit. Prior to his appointment to the court, he was the resident partner in the Washington, D.C., office of the former Chicago law firm of Isham, Lincoln, and Beale.

The proposed merger of American and US Airways airlines has taken a swift but bumpy flight from announcement to government antitrust complaint to settlement, barely touching the runway at any point. The reversal of sentiment by regulators, participants, and onlookers was perhaps the most striking aspect of the whole business.1 When the merger was announced, there was only sporadic adverse comment, but a complaint filed by the Antitrust Division of the Department of Justice evoked a veritable firestorm of criticism of the proposed merger. Critics including a variety of antitrust gurus registered their disapproval (and featured such luminaries as Irwin Stelzer2 and Herbert Hovenkamp3), perhaps carrying on in the tradition of Alfred Kahn, who, as their regulator, had released the airlines into the raging storms of competition in 1978. Thereafter, Kahn, from time to time, had prodded the government to pursue antitrust remedies in the interest of competition. The government complaint, among other things, alleged that the proposed merger would seriously undermine competition between American’s nonstop service to various destinations and US Airways one-stop service to the same points. There were intimations in some accounts of the pending lawsuit that the matter might be settled through American’s surrender of a number of its “slots” at Reagan in Washington, D.C., and LaGuardia in New York to other airlines. Most media comment, however, seemed to regard this possibility as unlikely and inconsistent with aggressive demands by the Antitrust Division.4

Certainly, the fiery rhetoric emanating from Justice did not seem to invite efforts at settlement, and the emergence of a settlement within three months of the filing of the complaint was certainly not an easily foreseeable conclusion. But an antitrust critique has not been the only subject widely discussed in this context; there has also been commentary focused on the changes to the structure of airline competition in the 35 years since deregulation.5 Two facts are indisputable: that the airline industry as a whole has been unprofitable during the period since deregulation; and this state of affairs has been hammered home by no less an authority than Warren Buffett, who has warned repeatedly against investment in airlines.6 Another significant fact has been that the number of airlines, particularly large and comprehensive airlines (“legacies” in common parlance) has been drastically reduced since deregulation. It is this reduction in numbers of competitors through consolidation that has led to suggestions of oligopoly7—in some instances characterized as a form of antitrust violation and in others as simply a statement of the inevitable evolution of deregulation seeking profitability without overriding concern for antitrust principles. In fact, some have claimed that deregulation is merely a thinly disguised cover of oligopoly. As a fellow traveler and admirer of the late Alfred Kahn, I would be reluctant to see his work so characterized, but one must strive to remain anchored in reality rather than carried away by semantics.

Of course, there are numerous and inescapable problems that have affected the airlines recently, and even before that. One of the most obvious of these is the cost of fuel, and another is the threat of terrorist activities like those of 9/11. The airlines have responded to attacks on their profitability through the adoption of policies that in a number of ways have eroded their popularity, such as cutting amenities and imposing discrete and specific charges for various services to increase revenues. All of this, however, does not seem to have offset their unbreakable habit of meeting competition with fares that sink downward, to the delight of passengers. In any event, even the most unpopular attempts to generate revenues have not reversed the persistence of unprofitability, which, apparently, has recognized consolidation as its most effective antidote.8 Moreover, the government had seemingly recognized consolidation as an unavoidable endpoint in the deregulatory process, by approving several major mergers preceding the current one. The managers of the airlines have seemed determined to put an end to the frequent and all-encompassing bankruptcies that have confronted them since the advent of deregulation. There have been 196 bankruptcies since deregulation, some resulting in liquidation and others in Chapter 11 operations, or in both.9 And management’s obvious device to improve financial performance is through mergers and more mergers. For whatever it may be worth, railroads have followed the same path; there are now only four remaining major railroad systems in the country: CSX, BNSF, Union Pacific, and Norfolk Southern.10

A proposed United-US Airways merger was abandoned after facing government objections in 2001. This was followed by the successful mergers of US Airways with America West in 2005; Delta with Northwest in 2008; Southwest with AirTran in 2011; and United with Continental in the same year. So the proposed marriage of American to US Airways more recently seems to fit comfortably into this trend, justified as creating a new airline of a scale matching those that had become their competitors in recent years.11 In fact, the government complaint at this juncture has been most commonly criticized on the grounds that it objected to precisely the same development that the antitrust regulators had been swallowing whole for years. Underlying this criticism was the belief that American could not compete successfully, for example, against the new Delta, mainly because an unmerged American would lack a competitive number of destinations and routes and airplanes, putting American at a disadvantage, especially with large corporate accounts, which are the most profitable. American simply does not have the scope and reach that consolidation would give it.

The term “oligopoly” was introduced into the discussion more or less as shorthand for the sharp decline in the number of competing airlines that has occurred, without any particular ramifications for the antitrust laws. Of course, there are persuasive grounds for imbuing the word with the same negative connotations as its close cousin, monopoly. Relying on the principle that competition is good, oligopoly is indeed a bad thing. So then, it may be a surprise that some commentators viewed oligopoly as an inevitability, or even a necessity, whatever its antitrust implications. From this standpoint, applying the term “oligopoly” is not a critical choice, but a suggestion that simple deregulation within the strict parameters of the antitrust laws does not work or, more specifically, does not produce financially healthy airlines. Thus, there is a hint that the financial health of the industry requires consolidation and oligopoly for survival, whether precisely consonant with a strict interpretation of antitrust laws, or not.

I am certainly not attempting to pass judgment on all this. One of the arguments you will hear is that the persistent losses recorded by the airlines since deregulation do not inescapably point to the future and there is a chance that more skillful management would lead the airlines to profitability without recourse to mergers.12 But this may be betting against the odds. No one knows exactly why airlines are losers, but experience since the Wright brothers says that they are; hence, the drive for consolidation as a promising escape from unprofitability, and the consequent trend toward mergers and talk of oligopoly.

Interestingly, this leaves questions about deregulation. Why is it that the airline industry, operating without economic regulation and, restrained only by competition, seems incapable of turning a profit? And why is it that history may suggest to us, together with very sophisticated airline managers, that the most effective solution to the problem is consolidation through merger? I am sure the answer to these questions is poorly understood, if it is understood at all. Some have suggested (including this writer at one time) that there is such a thing as destructive competition, and the airlines are rife with it. Well, perhaps, but let’s not throw the antitrust manual in the trash. In any event, there does not appear to be an end to efforts to improve airline economics through merger, despite the prospect of persistent antitrust challenges.

A related and important issue is what this analysis says about the full applicability of deregulation itself and its ultimate prospect for airlines. What does it mean that the ultimate stage of commercial airline deregulation is oligopoly? Certainly, it suggests that airlines are different, and their disposition cannot simply be left to the usual workings of competition, or for that matter entirely to a conventional interpretation of the antitrust laws. As a friend and admirer of the late Alfred Kahn, one of the principal instigators of deregulation, it is not for me to pass judgment here on this central question. And there is no denying the impact of deregulation in lowering fares and opening airline travel to many new passengers previously uninitiated in flying. But compatibility of the airline industry with usual understandings of competition and antitrust is challenged by commentary that positively equates mergers with oligopoly, seeing consolidation as the straight road to necessary profits in the industry.

The presumptive final chapter (of course, subject to judicial approval) in the proposed merger of American with US Airways is the recent settlement announcement. This involves the transfer of a number of slots at Dulles, LaGuardia, and Logan airports to “low-price” carriers, together with the surrender of a few gates elsewhere and a few other concessions, which I have mentioned above in part as a suggested basis of a settlement. These terms have been defended by the antitrust authorities (in a surprising reversal of attitude) as significant and appropriate but denounced by such a heavyweight as The New York Times editorial page as merely face-saving.13 I suppose that the pros and cons of the situation will be chewed over for some time to come, since what has happened over the last decade has effected a fundamental change in the structure of the US airline industry. If it can put the industry on a profitable basis, and at the same time lower fares and increase choices for passengers, it may qualify as the economic miracle of our times. In any event, consolidation seems to be the place we are headed, and whether it will lead us eventually to four airlines or two or even one remains to be seen. As an agnostic about the relative merits of economies of scale weighed against competition, I could be persuaded of just about anything applicable to the airline conundrum. But, I do think we are headed for virgin territory in airline economics.

Endnotes

1. See, e.g., James B. Stewart, Baffling About-Face in American-US Airways Merger, NY Times, Nov. 15, 2013, http://tinyurl.com/n6d9eb8.

2. See, e.g., Irwin Stelzer, An Airline Merger that Might Not Get Off the Ground, The Weekly Standard, Aug. 17, 2013, http://tinyurl.com/m7kussy.

3. See, e.g., James B. Stewart, For Airlines, It May Be One Merger Too Many, NY Times, Aug. 16, 2013, http://tinyurl.com/kazujb8.

4. Cf. John Q. Mulligan, The End of Prosecutorial Discretion for Airlines: The DOJ’s Challenge to the AMR/US Airways Merger, 13 (No. 1) Issues in Aviation Law and Policy (Autumn 2013).

5. See, e.g., Eduardo Porter, Competition, Not Mergers, May Bolster the Airlines, N.Y. Times, Aug. 13, 2013, http://tinyurl.com/le2tvro; Kevin C. Murphy, Letter to the Editor, N.Y. Times, Aug. 23, 2013, http://tinyurl.com/lj83p62.

6. Joe Nocera, Merge is What Airlines Do, N.Y. Times, Aug. 16, 2013, http://tinyurl.com/.

7. Id.

8. Susan Carey, Airline Fees Keep Climbing, Wall St. J., July 4, 2013, http://tinyurl.com/mzmltoc.

9. U.S. Airline Bankruptcies and Service Cessations, Airlines for America, www.airlines.org /Pages/U.S.-Airline-Bankruptcies-and-Service-Cessations.aspx (last visited Oct. 16, 2013).

10. Mark Cooper, Bulk Commodities and the Rails: Still Crazy After All These Years, Report, Consumer Federation of America, May 2009, available at http://tinyurl.com/oh4ml7l.

11. Cf. Porter, supra, note 5.

12. See e.g., Nocera, supra note 6.

13. Editorial Board, An Unwise Airline Merger, NY Times, Nov. 14, 2013, at A32.

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