When airlines don’t compete

November 18, 2013

James Stewart is not happy about the settlement which allows American Airlines and US Airways to merge.

A bit of context: Historically, the US government has smiled on the national airlines, allowing them to merge when they want to, and bailing them out in times of trouble. (They got $15 billion, for instance, after the 9/11 attacks.) But in August, all that changed, quite suddenly and unexpectedly. The Department of Justice, along with a smattering of state attorneys general, sued American Airlines’ parent company AMR and US Airways, saying that their proposed merger would cause “substantial harm to consumers”. At the heart of the suit was the idea that American and US Air currently compete head-to-head on “thousands of heavily traveled nonstop and connecting routes”, which benefits consumers; and that consolidation in the airline industry more broadly “would make it easier for the remaining airlines to cooperate, rather than compete, on price and service”.

The final settlement, however, as Stewart notes, fails to address any of those concerns. Instead, the merger will basically be allowed to go ahead as planned, in return for the merged airlines giving up 104 landing slots at National airport in Washington DC, as well as a smattering of other airport assets. This is not a huge concession: US Air is currently the largest airline at National, and after the merger and divestitures it’s going to be even bigger there than it is right now.

Stewart’s narrative is a perfectly reasonable one: the normally-supine regulatory apparatus briefly raised an eyelid and snarled, but just as quickly rolled over and went back to sleep. This constitutes, says Stewart, a “baffling about-face”, although in reality it’s more like two about-faces, with the Justice Department pretty much ending up exactly where it started.

The question is, which position is preferable? There are basically two ways of looking at airline competition, and it’s pretty clear that Stewart prefers the one in August’s Justice complaint, which is admittedly the more intuitive one. Under this view, the amount of competition can be measured pretty easily, by looking at two numbers: how many big airlines there are, and how many routes they compete on. Looked at that way, there’s less competition in the US airline industry now than in living memory: Delta merged with Northwest, United with Continental, and now American with US Air. Even Southwest bought AirTran. Once the latest merger is complete, the four merged companies between them will control some 80% of domestic air service — and there’s very little indication that the three largest carriers have any particular inclination to compete on price.

But in a way, that’s exactly the point lying behind the other way of looking at airline competition. The big legacy carriers don’t compete on price at the moment, when there are four of them, and they won’t compete on price in future, when there are only three. In fact, big legacy carriers rarely compete on price. The only airlines which are built to compete on price are so-called “low cost” carriers — and the only way to encourage the formation of such creatures is to open up landing slots for them, in deals like the one that Justice just did. Those 104 slots at National, for instance, can’t go to Delta: they have to go to smaller upstarts — the kind of airlines who can and will compete on price. Under this view, the only way to create real competition in the airline industry is for there to be a lot of new airlines. Think Europe. Some of those new airlines will fail, but as a group, they will provide downward pressure on prices in a way that legacy airlines never could — especially given their legacy obligations.

I’m inclined to pessimism on both fronts: I think that merging US Airways and American will surely mean less competition and higher prices, at the margin — and I also think that the national dominance of the big legacy carriers makes it very difficult for any new airline to succeed. If you look at the history of airlines like JetBlue and Virgin America, they tend to start off with high hopes, but it doesn’t take long for their prices to start rising up to big-carrier levels. At that point, they compete mainly on service rather than price, which doesn’t make it any easier to attract the millions of travelers who feel locked in to a big carrier’s loyalty program. (Indeed, the economics of the airline industry are a bit like the economics of gas stations: where gas stations lose money on gasoline and make all their profits on convenience-store sales, legacy airlines lose money on the actual flights, while making all their profits from their loyalty programs, selling miles to credit-card companies and the like.)

The American-US Air merger, then, is surely going to be bad for prices, overall, especially out of airports other than National and LaGuardia. And the concessions aren’t going to be remotely enough to kick-start a new wave of low-cost airline startups.

The real problem here is that the root-cause bad decision was made in 2001, when the US government decided to bail out the legacy airlines rather than letting them fail. If they had failed, there would have been a period during which flying around the country would have been a lot more difficult. But it wouldn’t have taken long for a lot of smaller airlines to be created in order to fill that need. And we’d all be in a much better place right now. At this point, however, the chances for real competition in the airline industry have never been lower — regardless of what the Justice Department does.


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