Transportation Planning Casebook/Airline Merger

Overview

The airline industry has experienced dramatic changes since the Deregulation Act in 1978. The number of airlines has gone down because of bankruptcies and mergers. After the Delta-Northwest and United-Continental mergers, the industry has become unprecedentedly concentrated. The trend is airline mergers has not come to an end as American Airlines and US Airways announced their plans to merge. The scale of the American-US merger is even greater than the previous two major mergers. The U.S. Department of Justice opposes the airlines' plan to create the largest airline in the world. The federal government, several states, and consumer groups are concerned that the merger would result in higher costs for travelers due to less competition. Supporters of the merger argue that it would allow the new American Airlines to better compete with Delta and United, and offer a wider choice of destinations for travelers. The cycle of regulation and deregulation is not only found in the airline industry, but also the railroads. As a "mother logic" of the airline industry, studying the history of railroad mergers can help us better understand the American-US Airways case.

History of Mergers and Regulations in Transportation

Railroads

After extensive railroad growth from the 1830s to 1873, the United States Congress established the Interstate Commerce Commission (ICC) in 1887 to oversee and regulate shipping prices to ensure fair rates and eliminate rate discrimination. In response to this, financier and railroad owner J.P. Morgan held a conference with competitors in 1889 and 1890 that brought together railroad presidents in order to help the industry follow the new laws and write agreements for the maintenance of "public, reasonable, uniform and stable rates." These meetings helped spark interest in creating railroad monopolies and foreshadowed the first attempts at railroad mergers, eventually seen in the 20th century.

In response to the railroad discussions and continuing worries over consumer exploitation, Congress passed the Sherman Antitrust Act in 1890 in order to prevent certain monopolies and industry cartels from forming. The Act attempted to prevent the artificial raising of prices for goods by restriction of trade and supply. The Act was used to stop other industries from forming monopolies, including oil and mining companies.

The Panic of 1893 resulted from the overbuilding of rail networks, and led to the bankruptcy of large providers, such as the Union Pacific and The Atchinson, Topeka & Santa Fe Railroads. Consolidation and purchasing for the next fifteen years resulted in two-thirds of the rail network being controlled by seven entities in 1906.

The first major railroad merge block was the attempted acquisition of the Southern Pacific Railroad by the Union Pacific Railroad. In 1901, Union Pacific had purchased all stock of the Southern Pacific. The Federal Government claimed it had violated the Sherman Trust Act, and in 1913 forced UP to sacrifice all of its SP stock. This was alarming for many at the time, since UP and SP were not considered to be major competitors.

After World War II, many railroads faced extreme competition from automobile and airplane usage, and began consolidating and merging to face competition. However, due to the ICCs hold on setting prices, railroads were unable to adjust to market forces as efficiently as auto trucks and other freight modes. In the late 1960s and early 1970s, many rail companies merged and declared bankruptcy. Two of the largest railway companies at the time, the Pennsylvania and New York Central, merged with the New York, New Haven and Hartford Railroad in 1969 to form Penn Central Railroad. Penn Central declared bankruptcy in 1970. Nationalization in the form of entities like passenger-based Amtrak and freight-based Conrail occurred in 1971 and 1973, respectively. Large deregulation strategies for freight rail occurred in 1980 with the Staggers Rail Act. The ICC was decommissioned in 1995, and was loosely replaced by the Surface Transportation Board. Since deregulation, freight rail companies have been more competitive with advancements in double-stacked cargo technology, and have been able to make investments to rail infrastructure. Amtrak ridership has seen noticeable annual ridership increases since 2002.

Airlines

Regulation Cycle

Airline companies have been merging since commercial flights have become a viable transportation source. The Air Mail Act of 1934 allowed airline growth to occur through by allowing government to subsidize mail transport. Increased competition by passengers resulted in the laissez-faire lowering of airline pricing. In 1935, the Federal Aviation Commission, a precursor to the FAA, declared that the market-driven lower prices did not incentivize safety improvements for planes. As such, the Civil Aeronautics Act of 1938 allowed Congress to create the Civil Aeronautics Authority (CAA) and the Civil Aeronautics Board (CAB) to oversee the economic and safety regulation over the airline industry.

Many provisions and amendments were made to the Aeronautics Act, and in 1958 the CAA was replaced by the Federal Aeronautics Administration to regulate safety. Economic regulation was still overseen by the CAB throughout the 1960’s and most of the 1970’s.

During the OPEC oil crisis in the 1970’s, many airlines began to see declining profits and the money draining in less profitable routes that were regulated by the CAB. A popular opinion to deregulate the airline industry began with the vision of free market adjustments rather than forced pricing and network establishing. These ideas were generally opposed by major airlines at the time due to their fear of more competition and labor unions due to their fear of hiring a non-labor workforce. Deregulation was accelerated by Jimmy Carter during his administration, and the Airline Deregulation Act of 1978 ended airline regulation, and the CAB was banished altogether in 1984.

Due to the deregulation, more companies joined the market, and established airlines cut non-profitable routes while increasing the frequency of well-used flights. From increased competition, flight networks still grew and increased competition lowered prices in the short-term. The economic recession of the early 1980’s impacted the previously booming airlines, as increased fuel prices and economic instability caused profits to drop. Braniff Airlines, a major line that once flew to 52 destinations, completely collapsed in 1982.

Airline Mergers & Collapses in the Post-Regulation Era

Since 1978, there have been a number of significant airline mergers in the United States. After the passing of the Airline Deregulation Act of 1978, many new airlines were formed, including Southwest, New York Air, and People’s Express. However, due to increased competition and more expensive fuels, several large airlines merged. Northwest and Republic Airlines merged on October 1st, 1986, and Delta and Western Airlines merged several months later on December 16th. Frontier, People’s Express, and New York Air merged into Continental on February 1st, 1987. As a result of elevated oil prices and company mismanagement, Eastern and Pan American Airlines both ceased to exist in 1991.

After several years of regaining profit in the mid-1990’s, airlines began to merge once again to remain competitive. American maintained its name after merging with TWA in April 2001, but profit margins declined rapidly after the September 11th, 2001 terrorist attacks made the airline industry come to a halt for the next days. Passenger airline traffic decreased by 5.2% from 2000 to 2001.

The two common tails used from the Delta & Northwest merger in 2008.

Major airline mergers continued in 2005 with the merger of America West and US Airways. The Great Recession was claimed to cause further large airline mergers, starting with Delta buying Northwest in 2009, which created the largest US provider at the time. United and Continental merged in October 2010, creating a larger airline than the new Delta/Northwest collaboration. The proposed merger of American and US Airways would create, in some aspects, the largest airline in the world, with 26% of the US airline market share.

Timeline of U.S. Airways-American Airlines Merger

November 29, 2011 - American Airlines officially declares bankruptcy and files for protection. They are the last legacy U.S. airline that had not previously gone bankrupt.

January 2012 - US Airways CEO Doug Parker expressed interest in acquiring the bankrupt American Airlines in a merger.

March 2012 - Tom Horton, CEO of American Airlines, states that he is open to merger discussions.

April 2012 - Three unions associated with American Airlines state they have reached a tentative labor agreement with US Airways, and state they support a possible merger.

August 31, 2012 - American Airlines parent AMR Corp. and US Airways sign a non-disclosure agreement that officially open discussion to a possible merger.

February 14, 2013 - American Airlines and US Airways officially announce their plans to merge in an $11 billion deal. The merging of the two airlines will create the world's largest airline by fleet, with 6,700 daily passengers. American CEO Tom Horton will receive a $20 million severance package. The airline will retain the American Airlines name, and will move its headquarters to Fort Worth, Texas.

July 15, 2013 - US Airways shareholders approve the pending merger.

August 15, 2013 - The US Justice Department, along with the states of Texas, Arizona, Tennessee, Florida, Virginia, and Pennsylvania, files a lawsuit against the merger. The entities claim that the merger will lead to higher prices and less service for consumers. The Justice Department reveals internal documents that state the airline merger is not needed and would lead to cuts in programs that benefit travelers. American Airlines reveals it has no "plan B" and will take the proceedings to court.

Airline	Daily Flights	Destinations	Countries	Operating Revenue (FY 2012)
American	3,500	273	51	$24.85 billion
US Airways	3,000	206	32	$13.83 billion
Merged Airline	6,700	336	56	$40 billion (projected)

The merged airline will control many large airport controlling stakes, including holding 74% of daily flights out of Dallas (DFW), 70% of flights out of Charlotte (CLT), and 54% of flights out of Philadelphia (PHL).

Proposed Hubs of Combined Airline - sorted by # of daily flights

Airport	Destinations	Daily flights	Hub Airline before merger	Share AA	Share US	Share AA+US
DFW	172	797	American	67%	7%	74%
CLT	131	665	US Airways	7%	63%	70%
ORD	113	522	American	36%	7%	43%
PHL	107	469	US Airways	5%	49%	54%
PHX	74	316	US Airways	5%	27%	32%
MIA	109	310	American	66%	6%	72%
DCA	75	292	US Airways	15%	34%	49%
LAX	44	180	American	18%	5%	23%
JFK	50	97	American	15%	3%	18%

Major Players

The key players in the American Airlines-US Airways merger are the two airlines, and the U.S. Department of Justice. While both airlines are in favor of the merger, the closing of the deal is still dependent on the approval of government agencies. The U.S. Department of Justice is the most prominent government entity in this case.

U.S. Airways

US Airways Boeing 737-300 at the Phoenix Hub

Similar to most major airlines in the United States, US Airways is emerged as one of the major player of the aviation industry through a series of mergers. The acquisition of six smaller airlines substantially increased the market share of Allegheny (a former name of the airline). One year after the Airline Deregulation Act in 1978, the airline changed its name to USAir and started to expand to southeastern United States. USAir’s acquisition of Pacific Southwest Airlines (PSA) added the West Coast into its network. Purchasing Piedmont Airlines guaranteed the airline’s strong East Coast presence that remains today. The merger with America West is one of the most significant events for U.S. Airways. Despite the US Airways was actually acquired by America West, the name of the company remained as US Airways due to better brand recognition. After the US Airways-America West merger, the improvement of services and managements reversed net losses into net profit. Performance of US Airways continued to improve as its net profit at the end of 2012 doubled the amount from the previous year. The stock price of US Airways also surged 168 percent within months after the merger.

The airline’s improvement in its financial performance does not correlate with service quality Customers’ satisfaction of U.S. airways ranks last in 2007 and 2011, according to the Consumer Report survey.

U.S Airways is currently the fifth largest airlines in the United States in terms of passenger volume, after Delta, United, Southwest and American. As a smaller company among the major airlines, U.S. Airways was a target of acquisition for United Airlines in 2000, but the merger was not completed due to complications with antitrust laws and labor unions. Charlotte, Phoenix, Philadelphia, and Washington, D.C. are the hubs of U.S Airways. Like other airlines with a hub-and-spoke model, hundreds of flights leave and arrive one of the hubs daily to provide numerous connection opportunities for travelers. U.S. Airways has a strong domestic network, but a relatively low international reach. Within the United States, the airline has a main focus on services on the East Coast and the Southwest. The Delta-Northwest and United-Continental mergers further weakened the competitiveness of U.S. Airways. Shortly after Delta acquired Northwest, United Airlines were actively pursuing a merger with U.S Airways. The talks between the two companies were described to be at a “very advance” stage. The close ties between United and U.S Airways is noteworthy because the two airlines have codeshare agreements and belong to the same alliance (link this). U.S Airways were again close to be merged with United Airlines, but the merger was never realized. The expansion of Delta and United urged U.S. Airways to seek an opportunity with American Airlines. Scott Kirby, the president of U.S. Airways, said merging with American Airlines can help the company to stay competitive in the industry. Merging with American Airlines will likely to end the codeshare agreement with United Airlines and other Star Alliance partners, but it will allow the airline to expand its reach American’s own routes as well as its partners from Oneworld.

American Airlines

American Airlines destinations.      United States      American Airlines destinations

Delta has a more extensive global reach than American

The conglomeration of over 80 small airlines marked the initial development of “American Airways”. The acquisition of Southern Air Transport in Texas, Southern Air Fast Express on the West Coast, and Universal Aviation in the Midwest, granted the early American Airlines with extensive presence throughout the United States. The company expanded first to Europe by acquiring American Export Airlines, then to Mexico by creating a subsidiary called Líneas Aéreas Americanas de México S.A. As a pioneer to Latin America, the airline still leads in connecting the region with the United States. Routes and schedules of commercial airlines were more similar to railroads and more linear during the early stage of development. Intermediary stops between stops were common, which was adapted from the “mother logic” of railroads and other ground transportation. The network design of American Airlines evolved from lines with stopping points to a network of direct services. The route map of the airline is 1968 resembles largely with today’s airlines. After airline deregulations in the 1970s, American adapted a hub-and-spoke strategy and acquired Trans World Airlines. Both events mark the milestone for American Airlines to become an industry leader. The airline was also first to introduce electronic tickets and automated check-in systems.

In 1981, American Airlines established its hub in Dallas/Fort Worth, and further expanded its hub-and-spoke network. Today, the airline operates over 3400 flights daily, serving over 250 cities in over 40 countries.

The global reach of American Airlines exceeds that of U.S. Airways, but it lags behind Delta and United. American Airlines ranks fourth in terms of passengers, Delta, United and Southwest. Merging with U.S. Airways will not only make the airline the largest in the United States, but also in the world. The combined passenger traffic of American Airlines and U.S. Airways is estimated to be over 131 million in 2013. The combined fleet of American Airlines and U.S. Airways will also surpass Delta (currently has the largest fleet in the world).

American Airlines announced its plan to merge with U.S. Airways in February 2013. AMR, the parent company of American Airlines, will own 72% of the new airline and U.S. Airways shareholders will own the remaining 28%.

The merging plan has not yet received approval from the government. Tom Horton, the CEO of American Airlines, claims the merger will help the airline to better compete with Delta and United. The company is actively seeking political support in order to fully complete the merger.

U.S. Department of Justice

The Justice Department filed a lawsuit against the merger, arguing that the merger violates antitrust law. The government expects an increase in fare and passenger fee due to less competition. Further consolidation in the industry could make low-cost alternatives even harder to compete. Bill Baer, assistant attorney general of the antitrust division, said consumers will ultimately be the loser of this deal. The department expects an increase of $120 million in total fee charged to customers. Higher fare will also cost travelers $3 million on the Dallas-Charlotte route alone. Internal documents from the airlines was also cited to show that the merger isn't needed, and it would lead to cuts in programs that benefit travelers. Another reason for the U.S. Department of Justice to block the merger is that the airlines are now making profits. Delta and United were allowed to acquire Northwest and Continental during economic downturn. The process for previous merger were smooth because the industry was losing money. The U.S Airways-American Airline merger is not approved partly because the industry is now making a profit. The airlines are determined to fight the government’s lawsuit and complete the merger. American Airlines general counsel said the company will vigorously defend the case, and insisted that the merger will benefit the new airline as well as customers. The states of Texas and Arizona, the home states of the airlines, along with Florida, Pennsylvania, Tennessee, Virginia and the District of Columbia, are in favor of the lawsuit to prevent the airlines from merging. American Airlines and U.S. Airways also rallied the mayors from seven hub cities to support their defense in the lawsuit. The mayors of Charlotte, Chicago, Dallas, Fort Worth, Miami, Philadelphia and Phoenix, sent a letter to Attorney General Eric Holder, asking him "to reconsider this ill-conceived lawsuit." The municipal governments of these cities are major stakeholders because the airlines are major employers. The mayors are convinced that the merger would help the new American Airlines to grow and ultimately benefit the local economy. However, the cities may face the risk of “dehubbing” and closure of maintenance facilities due to the newly arisen duplication. Due to cost and operational decisions, American Airlines closed the former TWA hub in St. Louis and Delta reduced the size of the former Northwest hub in Cincinnati. The merger will likely to eliminate the need for some of the existing hubs, which can cause damages to the local economies.

Policy Issues

Antitrust Laws

American Antitrust Laws emerged in the late 19th and early 20th centuries as courts and the federal government re-interpreted the often contradictory and unclear provisions and precedents of Common Law involved with the regulation of markets. Common Law within the United States had been imported from England with the establishment of the colonies. English Common Law is flexible and based on societal customs and precedent decisions, as opposed to legislative enactments. Within common law, judges are obliged to follow precedent decisions made by higher level courts whose jurisdictions they are in as well as precedent decisions made by their own court. However, as social customs change and new controversies emerge and come to the court, judges are able to reevaluate precedent cases and interpret the implications of former decisions and the application of the law to unprecedented controversies. Disputes and controversies are presented to the court, a neutral party, via arguments and evidence from all involved parties. Then the neutral party, a judge or jury, weighs the evidence and applies the law and precedent decisions as appropriate to render a verdict.

Modern competition law, such as the Antitrust Laws, evolved from the English common law of restraint of trade. The basic premise of this branch of the common law was that trade agreements counter to public policy were to be prohibited unless a reasonable argument could be provided to support the need for the agreement. The 1602 Case of Monopolies further defined a monopoly as a restrictive trade practice having the following results: increases in prices and decreases in product quality. Precedent cases in other Many European countries also determined that trade agreements intended to restrict trade or fix prices between companies were unlawful and reduced competition resulting in harm to the consumer. However, as depression spread across Europe in the late nineteenth century, the ideal of competition lost its grandeur and the courts began to allow companies to make agreements and otherwise cooperate in order to meet the pressures on prices and profits.

Unlike European countries, in the late nineteenth century the United States was experiencing the problems associated with monopolies and trusts, rather than a pressuring economy which made it difficult for companies to individually stay afloat. Considerable outcry from the public called for the end of trusts, or at least their reform. Trusts in the United States had evolved as supply exceeded demand following the Industrial Revolution and Civil Wars. Competition became fierce and rivals sought security through agreements to reduce output and set prices. Eventually, this led to the domination of United States manufacturing and mining by a few powerful people and the monopolies they ran. Using their power, monopolies could temporarily reduce prices drastically to force new competitors out of the market and then raise prices to any level they desired without having to worry about significant loss of market shares. The difficulties this caused for consumers and the public outcry against these trusts resulted in a call for reform. Sorting through contradictory precedent common law cases throughout Europe and America, reformers eventually created the Antitrust laws.

The Sherman Act (1890) -- prohibits competition limiting agreements between competitors as well as monopolies, which eliminate competition via unfair business practices.

The Clayton Act (1914) -- adds to the restrictions placed by the Sherman Act by giving the government the ability to stop mergers and acquisitions in order to prevent the formation of monopolies which will likely result in higher prices and reduced product quality due to the removal of competition from the market.

The Federal Trade Commission Act (1914) -- created the Federal Trade Commission and gave it the authority to investigate and litigate suspicious or unjust business practices.

The three antitrust laws listed above were created to protect the American public, or the consumer, from unfair business practices resulting in prices hikes and low product quality through the fostering of competition within markets. These laws were not intended to protect businesses from aggressive competitive tactics, as these tactics are viewed as beneficial for the consumer. Today, these laws are enforced by both the Federal Trade Commission and the United States Department of Justice. In addition many states have their own versions of these laws.

It is important to realize that the Federal Trade Administration and the Department of Justice do not oppose all mergers, only those which they believe will be harmful to competition. There is a very stringent evaluation of horizontal mergers to determine what impacts the mergers will have on the market as a whole; this evaluation is intended to both aid the agencies in determining which horizontal merges will be competitively harmful and also to reduce and mitigate impacts that the process will have on competitively beneficial or neutral mergers. The following criteria are frequently used to evaluate the potential harm a merger may cause for a consumer: past experience with mergers of a similar nature, the merging parties’ current market shares and potential for concentrations of shares in sub-markets, the merging parties’ current levels of direct competition, and finally the disruptive role that one or more of the merging parties plays, or may be expected to play absent the merger, within the market as a whole. Markets are defined by both products and geographic locations. Please note, if an industry is exhibiting hardship it is recognized that it may be competitively beneficial to allow horizontal mergers.

Examples of some mergers being allowed and others denied can be found in more than just transportation industries. Many communications companies consolidated or merged in the late twentieth century past. According to Department of Justice Antitrust Division Attorney General Joel Klein shortly after the Telecommunications Act of 1996 was passed hundreds of radio station mergers occurred. Of those, 15 mergers were determined to be anti-competitive and required intervention from the Department of Justice. By this logic, the Department of Justice could easily have allowed the mergers of Delta Airlines with Northwest Airlines and United Airlines with Continental Airlines while not allowing a merger between American Airlines and US Airways while consistently following standard policy, as long as evaluations of the first two mergers did not indicate that those mergers would harm the competition levels within the industry, but the evaluation of the final merger did. As such, the current opposition that the Department of Justice is providing in the case of the American Airlines and US Airways potential merger is not a breach of policy or an inconsistency in treatment. The advantages and disadvantages of the American Airlines and US Airways merger from the perspectives of the airlines, the Department of Justice, and third parties are discussed below.

Advantages

Reported by the Airlines

• Customers of the merged new American will have access to a more complete network than could be provided by either carrier on its own. This is the result of the complementary nature of the two airlines current networks. The new American is proposed to provide 6,700 daily flights with access to 336 destinations in 56 countries.

This will provide 130 new destinations to US Airways customers and 62 new destinations to American Airlines customers.

• The current hubs of both networks will be maintained either at the current level of service or with additional flight options. New routes will be created for destinations around the country.

• All miles earned in both of the airlines will be honored by the combined companies’ loyalty program. In addition, the expanded network will provide customers with more opportunities to earn miles and more destinations to use them for.

• The new American will continue to be a member of the international alliance that the current American Airlines is a member of, the oneworld Alliance. However, the combined company will have access to additional international destinations.

• The new American will take its place as the fourth large carrier. This will allow the combined company to effectively compete with other merged companies Delta/Northwest, United/Continental and Southwest/Air Tran as well as smaller low-cost carriers. It is the belief of the airlines that this will provide customers with improved services and a larger variety of choices.

• Due to the attractiveness of the larger and more diverse network, US Airways and American Airlines anticipate that the combined company will be able to invest in new airplanes which feature additional legroom, Wi-Fi, and improved entertainment systems.

Reported by Other Supporters of the Merger

• Competitive fares for customers.

• Enhanced job security and financial stability for the employees of both US Airways and American Airlines.

• Economic growth throughout the state of Texas.

Reported by Others

• The combined network will provide greater access to a variety of national and international destinations and may provide the best of both loyalty programs.

• American Airlines has been improving amenities on its fleet and the combined airline is being branded as American, so customers can expect more amenities.

Disadvantages

Reported by the Department of Justice

• Merger will eliminate existing competition between US Airways and American Airlines on their current overlapping routes and likely result in higher prices and reduced services for consumers.

American and US Airways compete on more than a thousand routes where they offer connecting services.

The airlines have indicated that they can succeed without merging.

In recent years large airlines have together raised fares, imposed new fees and reduced services.

• After such a merger 80% of United States commercial air travel would be served by only 4 carriers. There is concern that monopolies will result. Furthermore, there is evidence that the reduced number of major carriers makes it easier to coordinate fare increases and introduce fees.

It is anticipated that the combined company would charge consumers to redeem miles, American Airlines customers currently do not pay fees when they redeem miles.

Additionally the combined company would likely charge higher fees for such amenities as additional leg-room and checked bags.

• A merged American Airlines and US Airways would control 69% of the take-off and landing slots at Washington Reagan National Airport and a monopoly on 63% of non-stop routes at the airport. This would greatly reduce competition in the Washington DC area.

• A merger would remove the incentive for US Airways to continue its Advantage Fares program, which currently offers up to 40% discounts for passengers that take US Airways connecting flights instead of another carrier’s non-stop route. This will result in increased fares for millions of customers.

Reported by Others

• Labor difficulties as employees of the current US Airways and American Airlines struggle to work together. It is anticipated that the current employees from the separate airlines will like common contracts and seniority rules for years to come and be unable to work with one another.

• Poor passenger service is likely to result as both of the current airlines have a history of cancelling and delaying flights and are unlikely to cause each other to improve service.

• Shareholders are unlikely to receive significant benefit from the merger.