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Federal Document Clearing House
Congressional Testimony
June 21, 2000, Wednesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 4774 words
HEADLINE:
TESTIMONY June 21, 2000 ALBERT A FOER PRESIDENT AMERICAN ANTITRUST INSTITUTE
SENATE COMMERCE, SCIENCE AND TRANSPORTATION UNITED ARLINES -
US AIRWAY MERGER
BODY:
JUNE 21,
2000 TESTIMONY OF ALBERT A. FOER ON BEHALF OF THE AMERICAN ANTITRUST INSTITUTE
Concerning Airline Mergers BEFORE THE COMMERCE, SCIENCE AND
TRANSPORTATION COMMITTEE UNITED STATES SENA'TE Mr. Chairman and Members of the
Committee: Thank you for this opportunity to present this statement on behalf of
the American Antitrust Institute regarding the proposed acquisition of USAirways
by United Airlines. I am Albert A. Foer, President of the
American Antitrust Institute. The American Antitrust Institute is an independent
non-profit education, research and advocacy organization described on the
Internet at www.antitrustinstitute.org . We are generally centrist and pro-
competition in orientation and operate with the assistance of an advisory board
composed of many of the leaders of the antitrust community, including
academicians and practitioners in the fields of law, economics, and business. It
is always difficult for an outsider to comment on the impact of a particular
proposed merger. The Department of Justice Antitrust Division,
investigating whether the proposed- acquisition of USAirways by United
Airlines violates Section 7 of the Clayton Act, will have the advantage
of proprietary information, strategic planning documents, commentary of
competitors and industry experts, and detailed economic analysis to which we are
not privy. Nevertheless, a transaction of this size, creating a single airline
with over one-quarter of the national market and a dramatically larger share for
many city pairs, naturally raises a variety of questions for consumers of air
transportation. Our statement will focus on three questions: How well is airline
competition working currently? What effect will this merger
have on competition and consumers? -And is there a viable remedy short of
blocking the merger? 1. How well is airline competition working
currently? The deregulation of air transportation that has occurred since 1978
has had mixed results. On the one hand, prices are relatively low for many
routes and consumers are flying far more than they were in 1978. These are
substantial benefits. On the other hand, for city pairs where there is little,
if any, competition, rates are inordinately high. Consumers often report that
they do not feel very sovereign in their experiences with air travel,
criticizing both price and service components. With respect to prices, the
airlines have mastered the art of price discrimination, in an attempt to charge
each customer the highest price that customer is willing to pay for a
reservation. (Ironically, this price is called, in economics, the consumer's
"reservation price".) Price discrimination on is only possible where there is
market power and the extraordinary role that price discrimination plays in air
transportation reflects that the airlines do generally have a high degree of
market power. Where does this market power come from? At first glance, the
industry appears to be structured in a reasonably competitive way. On a national
level, there are three dominant airlines of approximate parity (United,
American, and Delta) but there are three additional major players, USAirways,
Northwestern, and Continental, which bring real competition to certain regions
and routes. (Northwestern and Continental are in the process of merging but have
been challenged by the Antitrust Division.) In addition, Southwest has a
significant impact as the low price maverick in those markets where it has a
presence, and a modest number of small carriers also provide the consumer with a
degree of choice on some routes. But one must also look at several other
factors, which work to reduce the intensity of rivalry. These include: (1)A
system of alliances that enhances the seamlessness of travel for many consumers
but also undermines the degree of competitive threat that an airline represents
in regard to its allies. Alliances can be viewed as partial mergers, and in that
view we already have only three truly separate national air systems. The
collaborative nature of the industry implies that there is less vigorous rivalry
than meets the eye. (2)A hub-and-spoke system facilitates more frequent flights
and more efficient use of equipment, but in conjunction with strategic practices
that deter entry, has resulted in elimination of most competition from most hubs
and permits prices at such hubs to rise to high levels. Although exclusionary
practices at hubs are currently being challenged by the Antitrust Division in
its suit against American Airlines and are the subject of proposed guidelines
that appear to be languishing at the Department of Transportation, we have to
assume that fortress hubs are a continuing part of the industry landscape.
(3)Entry barriers are relatively high. There was a time, in the 1980's, when it
was believed by some economists that because the equipment for air transit was
so mobile, entry to any overpriced route would be easy and we would not have to
worry about concentration. Indeed, numerous airline mergers were permitted on
the basis of this so-called 'contestable markets" theory, including several that
the Department of Transportation approved over the objection of the Antitrust
Division. What has become clear since the 80's is that contestable markets
theory was catastrophically wrong. Entry is not easy. (No new entrant has been
able to get into Reagan National Airport in 15 years. Gates at many airports,
especially hubs, are unavailable.) Market power in the air transportation
context has proved to be persistent and durable. The single most successful
example of new entry, Southwest, has rested on a strategy of offering
point-to-point service using non- hub terminals so as to confront the majors
indirectly rather than head-on. (4)The major airlines often collaborate in ways
that can reduce the intensity of competition. For example, the "T-2" joint
venture now being constructed to offer electronic travel services, may have the
ultimate impact of destroying independent ticket agencies and electronic
alternatives such as Expedia, Priceline, and Travelocity. If this occurs,
consumers will lose the independent "navigator" that can help them find the
lowest fares and the least expensive alternative routes, something that is
particularly valuable in an industry where there are so many prices and so many
routes that information overload and information manipulation can be effective
sales tools. It is reported that the Antitrust Division is investigating this
joint venture. You can tell the story of domestic airline competition in three
different ways: (1) we have a competitively structured air system that is
continually finding new ways to enhance efficiency and better serve consumers;
or (2) we have a system that is in reality far less competitive than it appears
to be, and is already the locus of so much market power that consumers are not
well-served; or (3) we have a system that contains important elements of both
collaboration and rivalry, but in which rivals are constantly seeking ways to
reduce the intensity of competition. If the first story is the true one, then a
merger of the first and the sixth airlines might not be terribly threatening to
competition. If the second view is correct, then this merger can only make a bad
situation worse and must clearly be blocked. But if, as I believe to be the
case, the third view is most accurate, we need to scrutinize this merger with
great care in order to weigh the facts and reach a firm conclusion on its
ramifications. 2. What effect will this merger have on the industry and on
consumers? The Clayton Act is an incipiency statute. The Congressional intent
was for the law to stop mergers whose effect substantially "may" be to lessen
competition. By its choice of language and legislative history, Congress made
clear that it did not want law enforcement to wait until the damage has already
been done and it did not want a standard of absolute certainty. Congress
understood that prediction is inherent in the process of merger evaluation. The
Clayton Act invites the Antitrust Division to take into account all of the
likely effects of a merger. For example, if the United/USAirways deal were
likely to trigger additional deals, it would be relevant to the determination of
whether the United acquisition should be permitted. Recall that United, Delta,
and American are currently more or less equals. News reports strongly suggest
that American and Delta are already investigating counter-strategic mergers,
both with others and with each other, in response to the dramatic expansion of
United that will be accomplished if the merger is permitted. If American and
Delta believe that they must maintain some rough size parity in order to
maintain competitive parity, then additional mergers are reasonably likely. This
presents a difficult problem for the Antitrust Division. It should not stop the
United merger based on mere speculation about the future; but it should not
close its eyes to reasonably strong evidence that other mergers will quickly
follow. The confounding fact is, to let the merger go through represents as much
a prediction as a decision to stop it. A decision to approve the merger, even
with conditions, should not be made without also having an answer to the next
question: if this merger is approved, how can the following merger or the one
after that be disapproved? Will we ever draw a line and if not here, where? Even
if the Antitrust Division were to conclude that the United/USAirways merger is
not likely to trigger additional mergers, it should also focus on the effects of
the merger on potential competition. Might USAirways be one of a small number of
potential competitors that could enter the concentrated markets of other large
carriers? If so, it may have an impact as a potential competitor on competition
in markets where it does not presently compete. The likelihood of this needs to
be examined because it is doubtful that a smaller newcomer will be able to play
a similar role for many years. Conversely, United claims that it needs to expand
into the northeast so that it can better serve consumers. Perhaps United itself
should be viewed as an important potential entrant whose ability to enter from
outside, without a merger, has an effect that should not be easily dismissed.
The impact of this merger on consumers will depend on many factors. Those most
immediately at risk, of course, are people who depend on airports that are
currently served by both United and USAirways and who will find themselves
deprived of one of what had already been a limited number of choices. It should
be stressed that choice is what competition is all about. Price is often a
workable proxy for choice, but even if price were taken off the table in this
transaction through a meaningful promise not to raise prices, consumers would
still be impacted in a negative way by the reduction of options. Why is it that
when an airplane lands and taxies toward the terminal, the steward or stewardess
so often announces, "Thank you for flying with ABC Airline. We know you have a
choice and we want you to choose us again next time you fly." I think this
mantra recognizes that consumers are aware that in fact they really have few
choices, but that choice is important to them. If we were to go from six major
airlines to five, an important element of choice would be lost. But how often
does a given consumer booking a given trip actually have six airlines to choose
among? And if this merger triggers others, how much choice will be lost? My
point is that merger enforcement cannot hide from the need to make predictions.
The Antitrust Division must collect as much information as possible that will
help it to make the best predictions it can and then it must boldly make a
judgment. Some of its information will not be public and cannot be made public,
but the public will be owed an explanation of what prediction the Division
ultimately relied upon and the reasoning by which it reached its judgment. 3. Is
there a viable remedy short of blocking the merger? Most mergers today are
either permitted to be consummated or are conditionally approved, subject to the
divestiture of overlapping assets. It is reported that United has proposed two
concessions in order to take antitrust issues off the table. First, it will hold
prices in place for two years. Second, it will spin off certain assets at Reagan
National Airport in order to create a new regional carrier to be based there.
Before addressing these proposed concessions, it is necessary to put the matter
in perspective. The Clayton Act is violated whenever competition may be
substantially lessened in any line of commerce or in any geographic market. If
there is one geographic market where the illegal effect may occur, the merger is
technically illegal. Now, the agencies typically don't act on this severe
interpretation because it would be wasteful of resources. If there were a minor
overlap in one small market, and the whole merger were blocked, this would be
easy to fix by selling off an offending asset and starting the merger all over
again. To avoid this inefficient process, the antitrust agencies routinely
negotiate with merging parties to fix the identified problem areas, without
sending the parties back to square one. The agencies have substantial bargaining
power, however, since they do have the right to go to court to try to stop a
merger. They must use this power to ensure that the merger will not be likely to
lessen competition. It isn't enough that the recipient of divested assets be
"viable"; divested assets must also be employed so that they pose the same
threat to coordinated interaction and the same level of choice to consumers, as
is now provided by USAirways. This is the standard against which United's
proposals should be measured. I stress this question of divestiture
effectiveness because it has become an important issue in antitrust policy in
recent years, with particular attention brought to a head in a significant FTC
staff study released last August. The study found that many divestitures that
had been accepted by the FTC as conditions of approving a merger turned out not
to preserve competition very well. In consequence, there has been a trend of the
agencies paying more attention to this aspect of merger enforcement. Congress
should be encouraging this trend and insisting that any divestitures that may be
conditions for this merger to be approved will indeed be robust for competition.
With respect to the two-year moratorium on price increases, the Antitrust
Division should be skeptical. If there is not a likelihood of a price increase
flowing from the merger, one wonders why United raised the issue? The merger,
like a diamond, may be forever. If this merger makes it possible for United to
raise prices in year three, as a result of increased market power, then it
should be blocked and the two-year concession rejected. But in an industry where
price discrimination is so sophisticated and widespread, it is also necessary to
ask, what is meant by a price freeze? The mix of seats sold at different prices
changes daily, sometimes hourly. To hold one seat at a low price while selling
many more at a higher price, albeit no higher than the current highest price,
would be a gimmick of no substantive value to consumers. To enforce a price
freeze in this context would be very difficult if not impossible. What about
spinning off assets to a new airline that can fly in and out of Reagan National?
Unless the new airline will be at least as efficient as USAirways, it will not
be able to replace USAirways as a competitor. The relevant questions appear to
be: (a) Will this new airline have enough assets to survive? (b) Will the assets
be sufficiently independent of United so that they can be used in direct
competition against United? (c) Will the assets include enough valuable routes
so that the carrier can survive? (d) Will the carrier have sufficiently
competent and air-expert management to survive in a market place that will
probably quickly come to include more competition from low-price Southwest and
from new regional jets? Or, put another way, from the viewpoint of the consumer,
will this start-up realistically be able to step into USAirways' much larger
shoes? This question in itself subsumes another: what would be the fate of
USAirways in the absence of this merger? Clearly, it has not always flown in
calm skies and there has been speculation about its future. The Antitrust
Division will again have to make a prediction and the public will again be
entitled to an explanation of the prediction. If USAirways 'in effect has no
future as a viable competitor, antitrust policy will have less reason to seek
the continuity of its franchise. This is not to suggest the presence of a
"failing company" defense, which is well recognized in the antitrust law but is
apparently not being claimed here, or of a "floundering company" defense, which
in any event is not recognized. It is, rather, to say that the public has a
right to expect that any airline to which is divested assets of USAirways will
in fact be able to step into the competitive shoes of USAirways. There is a
final question we would pose: if the, merger is to be allowed to go through,
what are the best means for assuring that divestitures result in no loss of
competition? is it by allowing United to spin off selected assets to a
hand-chosen competitor? Is it by auction of slots? And of course this question
must be asked with regard to each route in which the merger will raise
concentration to unhealthy levels. Conclusion Determining whether this merger is
legal or how it can be made legal through various conditions that might be
imposed, requires the Antitrust Division to undertake a detailed evaluation of
facts and to make sophisticated predictions. A thorough analysis, in our
opinion, requires consideration of USAirways' ability to survive as a
competitive airline, its role as a potential competitor, United's role as a
potential competitor, and the likelihood that this merger will trigger
additional mergers. Ultimately, what is required is a vision of how concentrated
we will allow the market for domestic air transportation to become. This can be
established in the course of antitrust analysis or it can become established by
specific act of Congress. But once an industry becomes as concentrated as air
transportation, it makes no sense to treat each merger on an ad hoc basis
without a larger vision of where we are headed.
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