The Wave of Mergers of the Mid1980s

Between 1985 and 1988, a series of mergers took place, the more significant of which were: American acquired the former intrastate carrier Air California; Delta merged with Western; Northwest acquired Republic; TWA acquired Ozark; Texas Air (originally a small local service carrier which in 1981 had acquired Continental) acquired People Express and Eastern; United acquired the Pacific Division of Pan American; and USAir acquired Piedmont and the former intrastate carrier Pacific Southwest. In addition, during this period several of these major airlines acquired, or bought part ownership in, commuter air carriers.

Of the foregoing, only the United purchase of the Pan American Pacific operation appears motivated by the old-fashioned pre-deregulation motive of acquiring operating rights. Since international operations still require foreign government approvals through bilateral agreements and carrier selection by DOT, United bought itself a transpacific service it otherwise had little chance of obtaining. (To be sure, it also acquired aircraft and personnel already thoroughly broken in; only Pan American's serious financial straits allowed United so good a deal.)

In the other instances, what was acquired involved largely domestic services, and the acquiring carrier, under the free entry of deregulation, could simply have initiated service over the routes it wanted without need for any merger action. But apparently the airlines have found that the practical way to enter new markets effectively is to buy up a carrier already in being, with its aircraft, personnel, airport gates and slots, and public identification in those markets. Other motives, such as scale economies and the control of markets by eliminating a competitor, also entered the picture with many of these mergers. TWA's acquisition of Ozark, for example, served to eliminate a competitor at St. Louis and make TWA the heavily dominant competitor there. Similarly, Northwest's acquisition of Republic gave the merged airline a heavily dominant position at its Minneapolis hub.

Obviously this wave of mergers, which by 1988 had reduced the number of major passenger airlines to eight, has given rise to concern that the airline industry is trending toward an ever-tighter oligopoly where the competition sought by deregulation will be greatly reduced. Yet DOT granted the required approval to all of these mergers, putting a limiting condition on only oneā€”that Texas Air in acquiring Eastern had to assure that Pan American's competing shuttle service in the northeast corridor would have enough slots at the New York and Washington airports. Certainly DOT has recognized the danger of overconcentration. In one merger order, while noting that "the threat of new entry will ordinarily curb the exercise of market power by an incumbent to increase prices or reduce service," it goes on to say:

However . .. factors such as restraints on airport access may insulate an incumbent carrier from competitive forces by making new entry more difficult or time consuming. Likewise, other factors, such as the importance of feed traffic or other efficiencies from hubbing, may make new entry more expensive, or at least more risky. Such factors may also insulate an incumbent carrier from competitive forces and permit the exercise of market power.20

But DOT went on to note that a potential entrant may have certain advantages as against an incumbent carrier, such as a lower cost structure, having hubs at the other ends of city pairs, or having access to some local and interline feed traffic. Moreover, the ADA had shifted the burden of proof in merger cases from the applicant airlines to the opponents; in short, in case of doubt as to anticompetitive effects, the merger was supposed to be approved.

In the lexicon of antitrust enforcement, the term market power is a familiar one. It has been defined as "the power to raise prices or reduce services profitably while restricting the entry of competitors."21

By the time DOJ took over the control of airline mergers in 1989, concern had been expressed in Congress that merger policy had been too lax. The theory of "contestability" had been a basic tenet of the earlier proponents of deregulation. By this theory, deregulation would make entry so easy that an incumbent carrier in a market would always face the threat of a potential entrant if it began monopoly-style pricing. The assumption of contestability appears to have been a guiding principle in DOT's easy attitude toward mergers in the 1985-88 period. DOJ, taking over in 1989, seems to have largely abandoned this concept and instead assumed that contestability was not generally applicable to the airline industry, that competition could not be assumed, and that, left to its own devices, the industry could gravitate toward dominance by a shrinking number of giant carriers.

The early 1990s, however, saw the trend to such dominance continue, but not so much by mergers as by the demise of Eastern and Pan American, and by the continued shrinking of TWA through the sale of some of its routes. American, Delta, and United were acquiring routes of these three carriers and were emerging as the three giants. In 1991, a committee of experts under the auspices of the Transportation Research Board recommended that DOJ should oppose not only mergers but route acquisitions if the carriers shared a hub airport and/or if they competed in many markets. Mergers or route acquisitions might be acceptable, however, if they joined routes end-to-end.22

With the advent of the Clinton administration in 1993, the government's policy was tightened further. The new secretary of transportation stated that "in the future, we will insist that mergers, acquisitions and sales of route authority be well-grounded, pro-competitive and financially viable."23

The latter 1990s have seen a trend away from mergers toward relationships among U.S. carriers called domestic partnerships or alliances. These terms have no specific definition. They may include one, more, or all of the following: coordinating schedules, coordinating baggage handling and airport gates, allowing frequent flyer mileage earned on one carrier to be used on the other, joint marketing of one another's flights, and code sharing. (The growing use of such alliances among U.S. and foreign airlines will be covered shortly under international entry.) Arrangements of this general sort have been proposed, for example, be tween American Airlines and US Airways; Northwest and Continental; Delta and United.

The advantages to an airline of this type of arrangement by contrast to a merger or acquisition have been well described by one authority as follows:

Among the recent major developments in the industry are airlines trying to form alliances instead of implementing mergers and acquisitions. Depending on how they are structured, we estimate that the carriers can obtain anywhere from 30 to 80 percent of the benefits of a merger without incurring most of the risks involved in a merger. In the past, mergers in this industry have caused much disruption and costs as the two carriers integrated fleets, labor, operations, and cultures.24

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