By: Alex Edquist
Business has been tough for airlines since September 11, 2001—they have been $55 billion in the red since that day. Ten airlines have filed for bankruptcy since September 11; US Airways has filed for bankruptcy twice. The terrorist attacks themselves were responsible for a large amount of the losses by changing consumer’s perceptions of the safety of air travel. Demand for flights was cut by 7.4 percent two years after the attacks for this reason.
However, travelers’ recent fears of air travel are not the only reason airlines have struggled. The new security regulations put into place after September 11 have made air travel more time-consuming and inconvenient, further reducing demand. And of course, the recession has caused a significant decrease in consumers’ willingness to pay for air travel. The airlines have also suffered on the supply side: soaring oil prices have caused skyrocketing jet fuel prices. Before 2001, fuel costs accounted for only 13 percent of the airlines’ costs; in 2011, they were 30 percent.
Airlines have responded first by raising fares, reducing services, and imposing many new fees in attempts to raise revenues and cut costs. Certainly those efforts have not enticed customers back, and high jet fuel prices mean that only full flights are profitable ones. Since the marginal fuel cost of an additional passenger’s weight is much less than the marginal benefit of that passenger’s ticket price, airlines have also reduced the number of flights. In that they have been successful: flights are, on average, 80 percent full.
Airline carriers have done one other thing to stay operating: merge. The air travel industry is one based upon a network—the more airports out of which an airline travels, the more it can offer its consumers, and the more successful it will be. Therefore, airlines have also undergone a rash of mergers since September 11 to combine their networks and make themselves bigger and stronger. Northwest merged with Delta in 2009, Continental with United in 2010, and AirTran with Southwest in 2011. Delta and United are now by far the United States’ biggest carriers.
In February, American Airlines, the United States’ current third biggest carrier, and US Airways proposed to merge; the new, merged American Airlines would become the world’s largest carrier. Both airlines had struggled on their own: US Airways has been bankrupt twice since 2001 and American Airlines is currently going through bankruptcy proceedings of its own. However, last week, the Department of Justice filed suit against the airlines, opposing the merger on the grounds that the merger would be anticompetitive.
In many ways the Department of Justice’s claims are valid. The merged airlines would have an extremely large share of the gates at some airports: the most frequently mentioned in the news is Washington, D.C.’s Ronald Reagan airport, where the new American Airlines would have 69 percent of the gates. The merger would also substantially reduce competition on over 1000 routes, almost certainly leading to higher fares. Finally, the United States would be left with only four major carriers: Delta, United, Southwest, and American.
However, many analysts say that the Department of Justice’s lawsuit is a negotiating tactic being used to make American Airlines and US Airways concede things like the aforementioned gates at Ronald Reagan before being allowed to merge. After all, the Department of Justice has allowed many other merges to go through in the last decade. The stockholders and employees of both airlines as well as the creditors of the bankrupt American Airlines both support the merger and have vowed to fight the lawsuit.
Five states joined the Department of Justice’s lawsuit: Arizona, Pennsylvania, Tennessee, Texas, and Florida. The District of Columbia also joined. Arizona’s concerns are for U.S. Airway’s Phoenix hub and for the loss of U.S. Airway’s headquarters as it joins the American Airline headquarters near Dallas. Pennsylvania is concerned for its Philadelphia hub, which could become less important because of the new American Airline’s hub at New York City’s JFK airport.
While the merger is not ideal, nothing in the air travel industry is. American Airlines is a bankrupt company; merging allows it to be under the excellent management of Doug Parker, who has guided U.S. Airways out of its second bankruptcy and back into profitability, and U.S. Airways can become part of American Airline’s larger network, making both companies more likely to remain profitable and less likely to go into bankruptcy again. The Department of Justice will not manage to lower fares by refusing this merger: competition does reduce fares, but factors that the airlines cannot control such as fuel prices and consumer demand mean that fares will not come down to their previous lows anytime soon. And although the Department of Justice is concerned about the five major U.S. carriers being reduced to four, the merger will allow American Airlines to compete with the other two largest airlines instead of playing a distant third fiddle to Delta and United.
Furthermore, as mentioned earlier, the airline business is a networked one, and the larger a company’s network is, the more positive externalities for its customers, such as more opportunity to gain frequent flier miles and access to more destinations. The Department of Justice may bemoan fewer flights along certain routes, but eliminating redundant routes makes the airlines more economically efficient, and the $55 billion in losses since 2001 is any indication, it is the type of streamlining carriers need to do.
While the American Airlines and U.S. Airways merger has many legitimate issues, especially in airports where it will have an unusually high share of gates, the Department of Justice should settle these issues rather than refuse the entire merger. Slightly less competition is the price that consumers will have to pay for an efficient, sustainable airline industry.