Delivering the Benefits? Efficiencies and Airline Mergers

Abstract

The merger of US Airways and American – a deal that will create the largest domestic passenger airline – will be a watershed for antitrust enforcement involving commercial aviation. It is the first contested case in which arguments that the merger would be likely to adversely affect competition and consumers drew upon direct evidence of higher fares and service cutbacks in previous airline mergers. This evidence bolstered the case made by the U.S. Department of Justice (DOJ), along with seven states and the District of Columbia, to enjoin the merger.2 US Airways-American, on the other hand, focused much of their response to the government’s Complaint on how the combination would produce substantial efficiencies, in the form of cost savings and consumer (“network”) benefits.Now that a settlement between the DOJ and the airlines has been reached, the opportunity for the court to explore US Airways-American efficiencies “defense” has passed. That process would likely have relied, in part, on direct evidence of whether promised efficiencies in previous airline mergers actually materialized.4 Indeed, if prior mergers had produced the predicted cost savings and network benefits, other things being equal, airline fares should be lower and consumers the beneficiaries of greater “connectivity.” But mounting evidence indicates that this is not the case.5 Moreover, public backlash to previous mergers is significant, as reflected in criticism of protracted system integrations, service cutbacks, and the deteriorating quality of commercial passenger service.This AAI White Paper explores these issues by examining the record on efficiencies that were promised in previous airline mergers. It goes the extra step to ask whether past mergers created inefficiencies that impose costs on consumers. The paper begins with a brief overview of how efficiencies are treated under the recently revised, 2010 U.S. Department of Justice (DOJ)/Federal Trade Commission (FTC) HORIZONTAL MERGER GUIDELINES (GUIDELINES).6 Next is an analysis of the types of efficiencies that are typically projected in airline mergers. The paper then frames and answers a number of key questions: (1) How do the actual costs of integrating systems in previous mergers of hub-and-spoke network airlines compare to predicted costs? (2) What can be said about whether network benefits such as increased “connectivity” projected in previous mergers have materialized? (3) Do mergers of large hub-and-spoke network airlines produce inefficiencies that impose costs on consumers? The final section draws conclusions and offers some insight into the implications of the recent US Airways-American settlement for airline efficiencies analysis. Major themes that emerge from the analysis include: Skepticism about projected efficiencies has likely caused airlines to load most of their projected efficiencies onto consumer (network) benefits, which are harder for antitrust enforcers to verify. System integration (e.g., integrating reservation and IT systems and combining workforces) in some past mergers has been difficult, protracted, and more costly than what was predicted by the airlines. Promises of network benefits involving increased “connectivity” in past mergers appear not to have fully materialized. Airlines cut airport-pairs from their systems after their mergers. Changes in carrier-caused delays since the last wave of airline consolidation emphasize the importance of further examining whether more intensive, merger-induced “hubbing” has exacerbated congestion. Expensive system integrations, loss of connectivity, and increased network congestion in the wake of previous airline mergers imply that promised efficiencies were overestimated, have not materialized as predicted, and potentially create inefficiencies. These effects limit cost savings and the potential for lower fares, shrink consumer benefits, and impose additional costs on consumers. In the event future airline mergers are proposed, antitrust enforcers should significantly discount predicted efficiencies and “net” estimated merger- induced inefficiencies from the carrier’s predictions.