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Search Terms: United Airlines AND U.S. Airways AND Merger, House or Senate or Joint

Document 58 of 110.

June 15, 2000, Thursday

SECTION: PREPARED TESTIMONY

LENGTH: 2171 words

HEADLINE: PREPARED STATEMENT OF STEVEN A. MORRISON PROFESSOR AND CHAIR OF ECONOMICS NORTHEASTERN UNIVERSITY

BEFORE THE HOUSE COMMITTEE ON TRANSPORTATION AND INFRASTRUCTURE

BODY:
Introduction

Although it has been more than 20 years since airlines were deregulated, airline competition continues to evolve. During the mid- 1980s the industry experienced a merger wave during which ten significant mergers took place.1 At the time, some of those mergers were the subject of much controversy. On May 24, United Airlines and US Airways announced their intention to merge. The prospect of this merger has also been controversial and has led to speculation that another merger wave is about to sweep the airline industry. In this testimony I provide an overview of the nature of airline competition, the motivations for airline mergers, and an assessment of factors to be considered when evaluating airline mergers. Based on that, I speculate about the effects of a merger between United and US Airways and the effects of other mergers that may occur as a reaction to United and US Airways. The Nature of Airline Competition

There have been many studies of the factors that influence the fares airlines charge. Of particular relevance here is the extent of route competition and the extent to which airports comprising the route are dominated by one or two carriers. Recent research I have undertaken2 shows that as the number of carders serving a route increases, fares decrease. But all carders do not have the same effect on fares: low- fare carders in general and Southwest Airlines in particular are the impetus for lower fares. When Southwest Airlines serves a route, fares are 46 percent lower than on comparable routes it does not serve. When a low-fare carder other than Southwest serves a route, fares are 21 percent lower than on comparable routes. When a carrier that is not a low-fare carder or a major carder serves a mute, fares are 11 percent lower. Finally, when the number of major carders on a route increases by one, fares fall by 3 percent. These different effects stem from the different business models of the carriers. Low-fare carders typically target price sensitive leisure travelers while the (network) major carriers' primary focus is on relatively price insensitive--but service sensitive--business travelers.

Fares also increase when one carder dominates traffic at a hub airport. In a forthcoming paper,3 my colleague Cliff Winston and I found that fares on routes involving hubs dominated by one airline are 18 percent higher than on otherwise comparable routes.

The Motivations for Airline Mergers4

The academic literature offers three broad explanations for mergers: operational and financial motives, anticompetitive motives, and industry-wide forces. My colleague Cliff Winston and I estimated a statistical model to measure the relative importance of these factors in explaining why some airlines merge (and who they merge with) while others do not.

Our results indicate that carders are more likely to seek a merger if it increases their traffic density, expands their international markets, and if they have common aircraft types, while they are less likely to seek a merger if their pilots, mechanics, and flight attendants are represented by unions. In addition, the smaller the minimum of the two carriers' cash flow and assets, the more likely the carriers will seek a merger. This finding suggests that airline mergers can be motivated by financial distress.

Anticompetitive motives cannot be dismissed because carriers are attracted to mergers that are expected, within limits, to raise their prices and that eliminate competition with a fierce rival. And the economy matters. Mergers are more likely when interest rates fail.

Our findings appear to defy any sharp conclusions because they support many explanations of airline mergers. But sharp conclusions do emerge from the quantitative importance of these factors in explaining the share of merger activity attributable to each variable in our model.

Operational and financial motives account for 72 percent of merger activity during 1978-95, industry-wide forces 22 percent, and anticompetitive motives just 6 percent. Greater international coverage, financial distress, and lower financing costs are the leading explanations for mergers since deregulation. Mergers are an attractive way for carriers to expand service on international routes and overcome regulatory impediments to entry. Being able to raise prices or stifle competition has not played a large role in carders' merger decisions.

Merger Policy

As indicated above, airlines merge for a host of reasons, most of them socially beneficial, some of them not. Any potential merger will offer a mix of beneficial and harmful effects. Although some observers take a negative view of an airline merger based on the sheer size of the airlines involved, size by itself does not tell us anything about the potential benefits and costs of an airline merger. What matters is what happens at the route--and airport--level where competition actually takes place. Consider two extreme cases. In the first case the two airlines are identical--they have the same network, serve the same cities, and use the same airports as hubs. Although there could be some cost savings from such a consolidation, such a merger would reduce competition on all routes by one carrier, would increase hub dominance, and would not generate any offsetting service benefits from an expanded network-- clearly a "bad" merger. At the other extreme, consider two airlines that have complementary route systems with no overlap. Such a merger would yield positive network service effects with no reduction in competition at the route or airport levels---a "good" merger. Thus, what matters is the extent of "overlap" between the two carriers' networks. Of course, actual mergers will offer a mix of positive and negative effects that must be weighed against one another in an assessment of the merger's desirability. But, given that a requirement for merger approval could be some amount of asset/route divestiture, it is possible to obtain the network benefits of consolidation with little or no cost in term of less competition at the route level.

The United-US Airways Proposed Merger

Table 1 shows the results of an analysis I Undertook to measure the extent of route overlap involved in hypothetical mergers between each pair of the ten major passenger airlines in the United States. As shown in the table, United and US Airways compete on routes that account for 5.4 percent of domestic passenger miles. Thus, not taking into account any asset/route divestiture or subsequent entry by other carriers, the number of competitors will fail by one on those routes. Given the estimate reported above that one additional major carrier on a route reduces fares by 3 percent, I estimate that fares will increase by 3 percent on the affected routes. Since the affected routes account for 5.4 percent of domestic traffic, nationally the merger would raise fares by about 0.2 percent. Although this is already quite a small number, it is important to note that this calculation does not take into account any subsequent entry that may take place by other carriers.

Given the small amount of overlap between the two carriers, my assessment is that the motives for this merger are in line with the results of my study of past merges-primarily driven by a desire for a more efficient route network, especially as it applies to access to international routes.

Possible Downstream Effects

If United and US Airways merge, what other mergers are likely to take place? Before addressing this it is important to understand why such a reaction is expected. The merged carrier expects that by expanding its network and providing more convenient flights, it will attract more passengers, especially lucrative business travelers who are service sensitive. Where will these passengers come from? Other airlines, of course. Thus, it is precisely because the merged carrier will offer a superior product that other carriers will seek to merge to remain competitive.

There have been reports in the press about discussions between American and Northwest, American and Delta, and Delta and Northwest. As shown in the table, the percentage of domestic passenger miles that would be affected by a merger Of American and Delta is 11.9 percent, the third highest overlap of any possible merger. These two carriers also share a hub at Dallas-Fort Worth. The other two suggested mergers fall in the range of 3.9 percent to 4.2 percent, both less than the overlap for United-US Airways.

A Dynamic Industry

Notwithstanding my attempts at predicting the effects of mergers, predicting such effects is difficult because carriers are constantly entering and exiting routes responding to new opportunities. In previous research5 I assessed the long-run effects lasting up to eight years after three airline mergers that were part of the airline merger wave in the mid-1980s: Northwest-Republic, TWA-Ozark, and USAir- Piedmont, the first two of which were quite controversial and were opposed by the Department of Justice. My results indicate that fares on routes affected by the Northwest-Republic merger were only about 2.5 percent higher than they were before. For TWA-Ozark, fares decreased by 15.3 percent. Finally, for USAir-Piedmont, fares increased by 22.8 percent.6 All this is to say that the effect of mergers on airfares is difficult to predict: of the two mergers that were objected to by Justice, one resulted in a slight increase in fares and the other resulted in a significant decrease. Of the three mergers, the one with the largest fare increases was the one that Justice did not object to. This difficulty of predicting the effect of airline mergers arises from the dynamic nature of the industry. Carriers are constantly entering and exiting routes both with and without mergers so that the network configuration and extent of competition after a merger need not equal the sum of the two airlines' networks. For example, USAir eventually dropped all the routes it acquired from PSA in their 1987 merger and American Airlines eventually dropped all the routes it acquired from Air California in their 1987 merger.

Conclusion

Predicting the effects of mergers is difficult because of the dynamic nature of the airline industry. Nonetheless, the key variable in making an assessment is the extent of overlap in the two carriers' networks rather than the size of the carriers per se. Because United and US Airways have a modest amount of route overlap, I believe the benefits to travelers from an enhanced network outweigh the anticompetitive effects on those routes where there is overlap. With appropriate divestiture of assets/routes these negative effects can be minimized. The mergers that have been suggested as possible reactions to the United-US Airways have varying degrees of overlap. But once again, with appropriate divestiture, further consolidation of the industry can lead to enhanced benefits to consumers.

FOOTNOTES:

1 1985: People Express-Frontier, Southwest-Muse; 1986: Continental- Eastern, Continental-People Express, Northwest-Republic, TWA-Ozark, Delta-Western; 1987: American-Air Cal, USAir-Pacific Southwest, USAir- Piedmont.

2 Steven A. Morrison, "Actual, Adjacent, and Potential Competition: Estimating the Full Effect of Southwest Airlines," unpublished manuscript, March 2000. This paper is available on my web site (www.dac.neu.edu/economics/morrison/research).

3 Steven A. Morrison and Clifford Winston, "The Remaining Role of Government Policy in the Deregulated Airline Industry," in Sam Peltzman and Clifford Winston, eds., Deregulation of Network Industries: What's Next?, Washington, DC: The Brookings Institution, 2000 (forthcoming). This paper is available on my web site (www.dac.neu.edu/economics/morrison/research).

4 This section draws upon and is, in part, extracted from Steven A. Morrison and Clifford Winston, "The Remaining Role of Government Policy in the Deregulated Airline Industry," in Sam Peltzman and Clifford Winston, eds., Deregulation of Network Industries: What's Next?, Washington, DC: The Brookings Institution, 2000 (forthcoming). This paper is available on my web site (www.dac.neu.edu/economics/morrison/research).

5 Steven A. Morrison, "Airline Mergers: A Longer View," Journal of Transport Economics and Policy, 30, September 1996, pp. 237-250.

6 ln the case of Northwest-Republic, fares on routes affected by the merger were 10.3 percent higher before the merger than on otherwise comparable routes. From one year after the merger to 1995:3 (the latest data available at the time of the analysis) fares on those routes were 13.1 percent higher than on comparable routes, for a net increase of 2.5 percent. For TWA-Ozark, fares were 9.2 percent higher than on otherwise comparable routes before the merger and 7.5 percent lower after, for a net decrease of 15.3 percent. Finally, for USAir- Piedmont, fares were 4.5 percent higher before and 28.3 higher after, for a net increase of 22.8 percent.

END

LOAD-DATE: June 21, 2000

Document 58 of 110.


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