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Flaws found in US DOJ lawsuit against American/US Airways merger

Last month, the US Department of Justice (DOJ) filed a lawsuit attempting to block the proposed merger between American Airlines (AA) and US Airways, which would create the world’s largest airline by passengers. As part of the lawsuit, the DOJ presented a list of 1,044 markets in which it believed the merger would be illegal in due to changes in the Herfindahl-Hirschman Index (HHI) of greater than 200 points. Aspire Aviation analysed these 1,044 markets utilising US Department of Transportation (DOT) origin and destination (O&D) data during the first quarter of 2013 and found several problems with the DOJ’s analysis. Additionally, for the markets where there was actually a significant loss of competition due to the merger, Aspire Aviation has prepared a proposed settlement addressing the anti-trust concerns.

Earlier, Aspire Aviation prepared an analysis of the Government Accountability Office’s (GAO) flawed testimony against the merger, which was also used by the DOJ in the lawsuit.

Image Courtesy of The Associated Press

Flaws in DOJ’s analysis

Market concentration is one useful indicator of the level of competitive vigour in a market, and the likely competitive effects of a merger. The more concentrated a market, and the more a transaction would increase concentration in a market, the more likely it is that a transaction would result in a meaningful reduction in competition. Concentration in relevant markets is typically measured by the Herfindahl-Hirschman Index (“HHI”). Markets in which the HHI exceeds 2,500 points are considered highly concentrated. Post-merger increases in HHI of more than 200 points are considered to be significant increases in concentration.

In more than 1,000 of the city pair markets in which American and US Airways currently compete head-to-head, the post-merger HHI would exceed 2,500 points and the merger would increase the HHI by more than 200 points. For example, on the Charlotte-Dallas city pair, the post-merger HHI will increase by 4,648 to 9,319 (out of 10,000). In these markets, US Airways and American annually serve more than 14 million passengers and collect more than US$6 billion in fares. The substantial increases in concentration in these highly concentrated markets demonstrate that in these relevant markets, the merger is presumed, as a matter of law, to be anti-competitive. The relevant markets described in this paragraph are listed in Appendix A.

Despite paying lip service to the idea of city pairs being the proper analytical tool, the DOJ still falls into the same trap of considering airport pairs for several of its 1,044 markets listed as seeing HHI increases of greater than 200.

For example, the list of markets includes Austin-Los Angeles area under Orange County (SNA) airport for the Los Angeles area. But it then turns around and lists Austin-Los Angeles again under LAX airport 3 pages later, throwing in Austin-Ontario as a separate market for good measure. So for the sake of this analysis, we made the following combinations:

  • Aspire Aviation counted Ontario (ONT) properly as part of the Los Angeles area (as it is for DOT statistics), and eliminated overlaps where both Orange County (SNA) and Los Angeles (LAX) were mentioned as different markets with the same city origin.
  • Aspire Aviation counted San Jose (SJC) as a part of the San Francisco area along with San Francisco (SFO) and Oakland (OAK)
  • Aspire Aviation counted West Palm Beach (PBI) as part of the Miami area along with Miami (MIA) and Fort Lauderdale (FLL)
  • Aspire Aviation counted Westchester County (HPN) as part of the New York metropolitan area along with (JFK), La Guardia (LGA), Newark (EWR), Islip (ISP), and Stewart (SWF). One should bear in mind that Westchester County is nearly 20 miles closer to Manhattan than Stewart and the DOT counts Stewart as part of the NYC metropolitan area.

Having made these changes, Aspire Aviation re-calculated the relevant markets from the DOJ’s list and ended up with two results. When combined, the city pair markets either saw a lower increase in HHI albeit still above 200, or fell off the list entirely. This simple conversion from airport-pair to city-pair analysis eliminates 97 markets from the DOJ’s list of 1,044.

After completing the calculations, Aspire Aviation also decided to eliminate any market with less than 10 passengers worth of per-day-each-way (PDEW) demand. This is not a number Aspire Aviation picked randomly. Rather, it is the cut-off used by the Department of Transportation (DOT) for the DOT’s quarterly Consumer Air Fare Report, which is published by the DOT with the stated purpose of educating consumers about trends and shifts in air fares. If the DOT does not find markets of this size or smaller relevant when providing fare analysis to consumers, then the DOJ should not use these markets in attempting to analyse the effect of the American Airlines/US Airways merger. Moreover, when running the numbers on these markets, they are found to be susceptible to wide statistical variation over time: more than 60% of these markets’ post-merger change in HHI either increased or decreased by 100 points or more when the timeframe of analysis was shifted from 2012 to the first quarter of 2013. Eliminating all markets with less than 10 passengers PDEW reduces another 150 markets from the DOJ’s list.

Now, as the DOJ’s list market-by-market was analysed, Aspire Aviation also excluded markets where the merged carrier would not offer the route non-stop, but one or more other carriers would. Even though such markets would see increases of more than 200 points in HHI, the merger would not have much effect in terms of increasing fares, because, as the DOJ puts it in the lawsuit document itself, “On routes where one legacy airline offers non-stop service, the other legacies generally respect the pricing of the non-stop carrier.” The non-stop carriers would retain pricing power post-merger, which strikes another 70 markets from the list, including 13 markets where 2 separate carriers offer nonstops, and one, Orlando-San Juan with 3 non-stop competitors.

By the same token, markets where another airline held dominant pricing power with more than a 70% share of origin and destination (O&D) in the market that would not change post-merger were excluded, which eliminated another 26 markets.

This left a total of 701 markets where the merger is likely to have a significant and adverse impact on competition per the DOJ’s definition where the increase in HHI is greater than 200 points.

Furthermore, Aspire Aviation found that in 17 of the 701 such markets, either US Airways or American was the O&D market share leader in the market, while the other carrier involved had the lowest fares in the markets. In 2 of the markets (Chicago and Philadelphia to St. Croix), the merged carrier would actually hold a monopoly on O&D traffic. Those 17 markets are displayed in the table below.

City Pair

Market Share Leader

Lowest Fare Airline

Tampa – Tucson

American

US Airways

Miami – Santa Barbara (CA)

American

US Airways

Chicago – Huntsville (AL)

American

US Airways

Chicago – St. Croix

American

US Airways

Phildelphia – St. Croix

American

US Airways

New York City – Fayetteville (AR)

American

US Airways

Richmond – San Francisco

US Airways

American

Fresno – Kansas City

US Airways

American

Harrisburg – St. Louis

US Airways

American

Phoenix – Richmond

US Airways

American

Des Moines – Philadelphia

US Airways

American

Charleston (WV) – New York City

US Airways

American

Fresno – Minneapolis St. Paul

US Airways

American

Fresno – Philadelphia

US Airways

American

El Paso – Fresno

US Airways

American

Charlottesville (VA) – Los Angeles Area

US Airways

American

Even within those 701 markets, the merger does not uniformly give the new American a licence to print money by raising fares unilaterally, as there is at least 1 non-stop competitor in 92 of the 168 non-stop markets that the merged American/US Airways will serve, with 2 non-stop competitors in 43 of these non-stop markets. 19 and 5 of these markets also have 3 and 4 non-stop competing carriers, respectively.

Additionally, there are 112 more markets where a single airline other than American Airlines or US Airways holds at least a 50% O&D market share, which is a significant check on the pricing power of the merged American.

This left 492 markets, which would be sufficiently addressed in the settlement proposal below. That said, one should caution that even in these 492 markets, the DOJ is treating the airline market as a static, unchanging market, instead of a dynamic market that changes over time, which is inconsistent with the competitive nature of the US airline industry.

For example, there are a couple of major factors being ignored by the US DOJ, such as 29 of the 492 markets involved San Juan, a market where American has some residual strength due to its once formidable hub in the market. However, over the past few years, American has steadily shrunk its San Juan presence as rival low cost carrier (LCC) JetBlue has increased flights in San Juan. JetBlue already is the largest carrier in the San Juan market with more than 34% in market share, and for the 29 relevant markets, it is likely that JetBlue will continue to grow its O&D share in these markets, as evident by the fact that the merged carrier’s share of traffic in these 29 markets declined significantly when the timeline being considered shifted from 2012 to 2013 first-quarter. The long-term trend in the San Juan market is towards increased LCC penetration, less concentration, and lower fares – whether or not the American/US Airways merger is allowed to proceed.

In addition, 42 of the markets involved the Dallas-Fort Worth metropolitan area, which ignores 2 important underlying long-term trends in market concentration in the area. The first is the rapid growth of ultra-low cost carrier (ULCC) Spirit Airlines in the market, which is now Spirit’s second-largest operation with nearly 33 peak day departures to 25 destinations, and Spirit has stated that it is looking to grow in Dallas-Fort Worth in the future as it inducts a further 134 aircraft into its fleet by the end of the decade against a current fleet of 51 aircraft.

More importantly, the Wright Amendment, which restricts rival Southwest Airlines from flying to any destinations in the US from Dallas’ Love Field outside of Texas, Oklahoma, Arkansas, or New Mexico, is set to lapse in 2014 albeit with a restriction on the number of gates it can use. This will directly impact concentration in those 42 markets, as Aspire Aviation projects that 8 of these markets – Tucson, Indianapolis, Columbus, Fort Myers, Jacksonville, Sacramento, Pittsburgh and Raleigh-Durham, are likely to receive non-stop service from Southwest post the repeal of Wright Amendment, with 6 more that could potentially see new service – Richmond, Louisville, Reno, Charlotte, Hartford and Charleston.

Image Courtesy of Aidan Formigoni

Image Courtesy of Aidan Formigoni

Aspire Aviation’s proposed settlement
Thus, Aspire Aviation has prepared the following proposed settlement, which will allow US Airways and American to merge so long as the following conditions are met.

  • Sell the 18 Washington Reagan slot pairs mentioned in the lawsuit (8 leased via the slot swap with JetBlue plus 10 additional pairs) to JetBlue at a price approved by the US DOJ
  • Divest an additional 35 slot pairs to the federal government for the DOT and/or DOJ to redistribute as it sees fit. The combined carrier would hold around 300 slot pairs post-merger ceteris paribus (250 US Airways, 50 American); such a divestiture would keep the merged carrier’s Reagan slot share at roughly the same level as that of pre-merger US Airways, which the DOJ explicitly signed off when it approved the US Airways/Delta slot swap in 2010.
  • The merged carrier would be required to sell a Brazil route authority to serve Sao Paulo, along with a Sao Paulo slot pair to any carrier that desires it at a price approved by the DOJ. If no airline decides to purchase the slot pair within one year, the merged carrier would be allowed to keep the slot pair and route authority without penalty and would continue operating to Sao Paulo with the authority and slot pair during the sale period.
  • Support legislation to immediately repeal the Wright Amendment versus its current termination date and increase the cap on number of gates allowed to be in use at Dallas Love from 20 to 28.
  • Require the merged carrier to make up to 5 gates available at Charlotte’s Concourse B available for use by competing airlines under a common-use scheme. The merged carrier would be allowed to continue using these gates when not requested by other airlines.
  • Require the merged carrier to commit to continue operating the following routes non-stop for a duration of at least 5 years from the date of the closing of the merger unless the market gains new non-stop service from a competing carrier and/or the merged carrier fails to record a net profit for six straight quarters.
    • Phoenix-Honolulu, Kona, Lihue, and Kahului (nearly 15% of the markets involve these four destinations)
    • St. Thomas-Charlotte, Philadelphia, Miami, and New York John F. Kennedy
    • St. Croix-Charlotte
    • Require the merged carrier to serve at least 76 non-stop destinations from Washington Reagan at any given moment so as to protect small city access to Reagan
    • Require the merged carrier to make up to 5 gates available on Chicago O’Hare Terminal 3, Concourse K available for use by competing airlines under a common-use scheme. The merged carrier would be allowed to continue using these gates when not requested by other airlines. The merged carrier would also be required to withdraw any objection to expansion and/or construction of a new terminal at Chicago O’Hare.

Violating any of these conditions would require the merged carrier to pay a pre-negotiated fine to the US DOJ.

With these conditions, Aspire Aviation believes that the anti-trust problems with the American/US Airways merger will have been addressed to a sufficient degree that the merger should be allowed to proceed given the merits of the merger, such as an expanded network that has the scale to compete with United Continental and Delta Air Lines.

Image Courtesy of Bloomberg

Image Courtesy of Bloomberg

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