The Sky-High Price You’ll Pay for Airline Mergers

  • Share
  • Read Later
Lester Lefkowitz / Getty Images

If you want to understand why the U.S. Department of Justice is playing hardball over the pending American Airlines/US Airways Group merger, consider Detroit. The Motor City once harbored hub dreams and built a new Detroit Metro airport to fulfill that desire. Then, you know, the U.S. auto industry wrecked along with the rest of the economy. And airlines went bust before autos, sending Northwest, Detroit’s home team, into the arms of Delta, another bankrupt. Detroit Metro got downgraded to a spoke rather than a hub and lost a ton of flights, which has made it, paradoxically, a very pleasant place to travel to and from.

Today the city of Detroit may be broke but with the auto industry cranking again Metro is a lot busier—and dominated by dominant, post-consolidation legacy airlines. One result: when I needed to book a trip to Motown with a week’s notice the round trip fares ranged from $1,374 to $2,000 on the legacy carriers. Guess who had the highest price? American. That is, until Delta upped the ante to $2,010, which American promptly matched. The only other nonstop option was plucky Spirit Air, priced at $335, but I couldn’t make either of its two daily flights. The next best option was a one-stop through Washington on American’s betrothed, USAirways, at $329.

That is the kind of oligopolistic pricing that has DOJ’s knickers in a twist: a city pair dominated by the big three collecting economic rent and the best second option is the airline that’s going to disappear in the merger. Why does Detroit have such high prices? Some of it can be explained by the fact that, (no offense Motowners), few people fly to Detroit for a vacation. It’s a business market. Most of the passengers aren’t paying for their own tickets so they are not price sensitive. This price inelasticity translates to more pricing power for the airlines. The Dallas-Detroit market appears to have similar characteristics.

(MOREHome Depot Apologizes for Racist Tweet)

Still, it’s a little amazing that American would let itself be the high-price leader with the trust-busters bearing down on them, but the airline pricing engines don’t play politics, they just seek maximum yield. The Justice Dept., American and US Airways are negotiating a deal but if DOJ doesn’t get what it wants—including the surrender of precious slots at airports such as LaGuardia in New York City and Washington’s Reagan National—the two sides have a court date later this month. A judge is now allowing Southwest to file a brief demanding that the merged airline give up some of these coveted slots to a low-cost carrier like Southwest. In a market like Detroit-New York, Southwest will make the case that it can provide the competition that antitrust law seeks to preserve.

Detroit’s pricing sticks out when you compare it to other cities. When I priced a trip to Chicago for the same times, the fares were entirely different. American offered a $359 round trip, even though Chicago is a greater distance from New York than Detroit. How do you explain such a variance? First, Chicago is a hub, so there are tons of flights here. Second, JetBlue flies to Chicago from New York. The presence of a high-quality, low-cost carrier such as JetBlue keeps the legacy carriers honest. And Spirit also serves Chicago from New York, offering even more cut-rate fares. Same with Los Angeles, farther still, where the round trip fares are ranged from $606 on Virgin America (a terrific airline) to $650 on United, Delta and JetBlue to $713 on US Airways to a high of $948 on, hmm, American.

In its report to Congress on the proposed merger, the General Accounting Office said that the AA/US merger would mean the loss of one effective competitor in 1,665 airport-pair markets, affecting more than 53 million passengers. More to the point, GAO said that the merger would reduce the number of competitors from 4 to 3 in 749 city pairs. That’s way more than the 454 cases of 4-to-3 reductions that occurred with the United-Continental merger.

(MORE: Abercrombie & Fitch Begs the Fat Kids for Another Chance)

When top competitors merge their combined pricing power improves; heck, it’s the whole point? They can reduce the number of seats available in a market, raise fares—or both— because big airlines today are less interested in price wars. This is DOJ’s point. The AA/US merger doesn’t look bad on paper, given that only 12 of their non-stop routes overlap directly. But in the aftermath of the United/Continental and Delta/Northwest mergers DOJ says the reduction in competition is more pronounced.

There are still a lot of reasons to support the AA/US merger: it will preserve jobs, improve options for the elite cadre of global travelers and ensure a profitable future for the combined entity, which is a good thing. But there’s a price to be paid for it, and that’s what DOJ is trying to figure out. In the meantime, I’m looking at $1,400 to get to Motown midweek. There oughta be a law. Oh wait, there is.