The US carriers faced the post 9/11 demand shock, while the European intercontinental flag carriers were facing increased competition in the Middle East and Asia. The consolidation movement was a reaction to these short-term problems.
How could a major, highly visible industry shift from robust competition to permanent cartel conditions in just a few years? How could widely supported liberal pro-competitive government policies that visibly produced major improvements in airline industry efficiency and consumer welfare suddenly be totally reversed?
As shown in Exhibit 1, the counter-revolution against liberal international airline competition began in 2004 with the radical consolidation of the North Atlantic market. It was almost completely in place before the 2008 economic collapse, and the loose ends had been tied up by 2013. This program focused initially on the North Atlantic, the most lucrative intercontinental market, because these carriers knew that North Atlantic consolidation would inevitably force the consolidation of the domestic US, transpacific and other major markets.
|9 of 27 North Atlantic competitors eliminated 1993-2003||15 of 18 North Atlantic competitors eliminated since 2004||Only 3 viableNorth Atlantic competitors today|
|Northwest (1993 into KL)Sabena (1995 into SR, later LH)#Delta (1995 into SR, later AF)Austrian (1995 into SR, later LH)#United (1997 into LH)SAS (1997 into LH)British Midland (2001)#TWA (2002 into AA)CSA Czech (2002 into AF)||#USAir (2004 into LH then AA)#KLM (2004 into AF)#Air Canada (2005 into LH)#Swissair/Swiss (2005 into LH)LOT Polish (2005 into LH)TAP Air Portugal (2005 into LH)Aeroflot (2006 into AF)Turkish (2008 into LH)#Continental (2009 into LH)#American (2010 into BA)Iberia (2010 into BA)Finnair (2010 into BA)#Virgin Atlantic (2014 into AF)Aeromexico (2011 into AF)Aer Lingus (2015 into BA)||3 viable surviving competitorsLufthansa(LH)-led collusive allianceAir France(AF)-led collusive allianceBritish Airways(BA)-led collusive alliance plus 2 niche carriers not seen as viable NorwegianAlitalia (had previously been part of AF-led alliance) #–these ten carriers had operated at least 5% of total North Atlantic capacity during this period|
Part Two of this series described the—largely successful–airline deregulation/liberalization policies that the post-2004 consolidation movement needed to reverse. Those policies had replaced the pre-1980s regime that allowed the most powerful industry incumbents to capture the regulatory process with a regime focused on maintaining level-playing field competitive conditions. The innovations spurred by this increased competition increased both profitability and consumer welfare.
More robust competition also increased the industry’s ability to support stronger growth and better withstand cyclical and external shocks. The industry’s ability to recover from the coronavirus crisis has been seriously weakened because of the consolidation movement’s success in shrinking many major markets into a permanent oligopoly of Too Big To Fail airlines.
“Industry consolidation” to fix profit problems
The gains from these pro-competitive policies were not evenly distributed, and a two-tier industry emerged. The legacy carriers (who had predated deregulation) converged around a domestic hub model in America and an intercontinental hub model in Europe and elsewhere. These could efficiently serve most, but not all traffic, and various forms of “low-cost carriers” (LCCs) demonstrated they could much more efficiently serve high-volume shorthaul markets than the two legacy models. These shorthaul/narrowbody carriers enjoyed the full benefits of the new pro-competitive policies but the intercontinental/widebody carriers had not.
Unfortunately, the legacy carriers refused to accept the fact that they now faced a huge competitive disadvantage in these serve high-volume shorthaul markets.
Instead of refocusing networks on the (much larger set of) markets where they had competitive advantage, they kept investing in LCC dominated markets which they could not serve profitably.
Margins at these companies had also slumped at the turn of the century due to dot-com era overcapacity, and the recession that began in 2000 linked to a major fuel price spike (2001 was up 40% over 1999).
The US carriers faced the additional burden of the short-term post 9/11 demand shock, while the European intercontinental flag carriers were facing increased competition from longhaul carriers in the Middle East and Asia.
The post-2004 consolidation movement was a reaction to these short-term profit problems.
Beginning in 2002 almost all of the large legacy US carriers filed for bankruptcy protection. These carriers failed to acknowledge any responsibility for any of their financial problems. claiming their descent into bankruptcy was entirely the result of the post 9/11 demand shock.
The US bankruptcy laws had always been an integral part of its competition policies, designed to protect assets that could still contribute to overall economic welfare. They did a reasonable job of fixing bad airline capital allocation problems in the 80s and 90s, because the courts welcomed competing reorganization proposals and focused on protecting these asset values in order to maximize creditor recovery, and ensuring that restructuring burdens were equitably distributed.
They failed to work in the 21st Century cases, because the bankruptcy process has been “captured” just as pre-1980s Civil Aeronautics Board industry oversight had been captured.
Instead of prioritizing asset values, creditor recovery, and the reallocation of industry resources to more efficient uses, the courts prioritized the personal interests of the senior executives who believed their past decisions had nothing to do with their company’s collapse into bankruptcy. The courts gave them exclusive control of reorganization process and blocked all efforts to present competing plans.
As a result, airline plans failed to fix bad investment decisions or other supply/demand problems, and forced labor to suffer a disproportionate share of burdens they had not created. Since none of these plans could produce a credible business turnaround, these carriers remained bankrupt for years, and continued to operate unsustainable routes with operations funded by advance payments from the banks that issued the extremely profitable credit cards linked to their frequent flyer programs.
The senior executives who had maintained control of the process over these years inevitably ended up enriched by tens of millions in newly issued stock.
The Antitrust Immunity Applications
The post-2004 consolidation movement was entirely driven by the largest North Atlantic carriers, especially Lufthansa, Air France, United and Delta. The triggering event was the 2004 merger of Air France and KLM, which was quickly rubber stamped by the EU.
As will be seen with every subsequent major merger, the higher cost airline took over a more efficient competitor, which in this case was the main source of price competition in European longhaul markets. Air France paid a 40% premium over KLM’s prior equity value, indicating how highly these reductions in competition were valued.
The Air France-KLM merger triggered multiple rounds of further consolidation. By reducing the European longhaul market to just 3 competitors (a duopoly in Continental Europe plus the British Airways hub in London), the Air France-KLM merger forced the reduction of the North Atlantic market (which then had 8 significant competitors) into a permanent 3-player oligopoly/cartel, led by the senior partners of the three collusive alliances.
Since US legacy carriers depended heavily on international traffic, and the North Atlantic was the largest international market, this meant that approval of Air France-KLM meant that three of the six US legacy carriers had no hope of surviving independently.
The second (and most important) stage of this orchestrated program was three new antitrust immunity applications to the US Department of Transportation (DOT). Delta went first, applying to merge the Delta-Air France and Northwest-KLM into a single collusive alliance that was now the largest competitor on the North Atlantic.
The original 1993 antitrust immunity (ATI) allowed Northwest and KLM to effectively “merge” into a single marketplace entity where partners could collude on pricing and all other competitive decisions. This met the stringent legal requirements governing ATI grants, as they produced readily verifiable consumer welfare gains and the combination of smaller carriers posed negligible competitive risks. DOT was now granting ATI in cases that would dramatically reduce competition.
At each step, the DOT refused to consider competitive impacts, so that it was impossible to challenge individual applications as part of an orchestrated program to consolidate the industry. The idea that United and Lufthansa would want to respond to an ATI approval giving the Air France-led group nearly twice LH/UA’s existing market share, with an application allowing it to reclaim market leadership was treated as a totally unforeseeable surprise.
Each subsequent ATI application (United/Continental and British Airways/American Airlines) raised far greater competitive issues but DOT ignored these in order to foster “inter-alliance competition” with the Air France-led grouping. DOT approvals also ignored the question of how allegedly independent US airlines (Delta/Northwest, United/Continental) could actively share data and collusively set prices and schedules in their most lucrative market while remaining aggressive competitors in domestic US markets.
The third direct result of the Air France-KLM merger was consolidation of six US legacy hub carriers into just three. Again, in each case a higher cost airline took control of a more efficient competitor, and did so at very low cost, because the DOT’s ATI decisions had destroyed the corporate value of the three Legacy airlines that did not control one of the three collusive alliance franchise that DOT had allowed.
Originally, the alliance carriers expected the full consolidation of both the North Atlantic and domestic US hub carriers, to be completed before the end of the Bush Administration in 2008 but this was delayed two years because of the extended negotiations over the new EU-US treaty, and the 2008 economic crash.
The Nort-Atlantic cartel
The EU actively defended the power of the North Atlantic cartel. After rubber stamping Air France-KLM, it refused to allow a merger between Ryanair and Aer Lingus, much smaller airlines but ones that threatened the cartel with aggressive price competition. Any airline wishing to feed longhaul passengers to or from North America or Europe had to deal with the cartel on its terms, and smaller European flag carriers could not survive unless they became (very) junior alliance members.
The distortions to domestic US competition went beyond the initial 50% reduction in competition between legacy hub carriers. Southwest correctly realized that after rubber stamping these mergers the government would do nothing to stop its acquisition of Airtran, the only other large scale LCC in America. As with Air France-KLM, antitrust officials ignored that the huge acquisition premium Southwest paid could only be explained by the elimination of its major price competitor and that future entry that might discipline market power abuses was totally impossible.
Other major domestic US distortions are explained by the how the orchestrated consolidation effort had been structured. For both the antitrust immunity and merger decisions, Delta went first, United went second and American went third. This gave Delta an artificial head start on exploiting their larger and more powerful position before others could catch up. United applied for expanded antitrust immunity less than 60 days after DOT had approved the DL-NW-AF-KL deal, but could not begin merger implementation before the 2008 economic crash. The American-USAirways integration could not begin until seven years after Delta-Northwest.
This huge Delta competitive advantage was totally due to the artificial nature of the orchestrated Alliance/DOT process for reducing competition.
The PR program
US airline deregulation was only implemented in the 1970s after an extensive, transparent public debate. When these pro-competition policies were reversed after 2004, there were no independent analyses of issues or options, and no public debates before the DOT or Congress. Coverage in the industry and business press was completely limited to a one-sided barrage of PR claims presented by the Alliance carriers, with United CEO Glen Tilton taking the lead role in the U.S. where the critical ATI decisions would be made.
Since Tilton and the Alliance carriers had no economic evidence that would support their claim that consumers would be much better off if the number of airlines was dramatically reduced, they needed to mount an overwhelming PR effort designed to create the sense that the “debate” was already over, and that consolidation was inevitable.
Alliance PR aggressively exploited confusion and ignorance of actual industry economics, and never bothered to explain what exact changes “consolidation” would involve.
US politicians and reporters tended to improperly assume that all markets everywhere were just as competitive as domestic US markets had been in the 1990s, had little understanding of hub network economics, and were unaware that international markets were the critical drivers of Legacy carrier profitability. The prospect of new consolidation would not have troubled reporters and politicians who did not understand United, Lufthansa, SAS, Austrian and TAP had already been merged into a single integrated competitor.
As the data in Exhibit 5 documents, its claim that there were far more airlines than the public needed misrepresented an exclusively shorthaul issue as an excuse to reduce competition in the already stagnant intercontinental market. The claim that a shakeout was inevitable result of “market forces” misrepresented industry dynamics (demand was still growing robustly), industry economics (United Airlines was not too small to compete efficiently) and the actual consolidation process (driven entirely by governmental decisions, not by the judgement of capital markets about relative efficiency levels).
Alliance PR always called the alliances “Star” “Skyteam” and “Oneworld” in order to confuse the ATI petitions to expand collusive alliances with the branded marketing alliances focused on more benign things like frequent flyer reciprocity and shared lounges. Occasionally the PR would cross over from misrepresentation to outright fabrications, such as the claim that liberalizing “cross-border investment” (so that the EU carriers could own and fully control their US partners) would create more new jobs that the combined employment of Delta and Continental, and would create more new revenue than the combined revenue of Northwest and Southwest.
The Alliances’ “consolidation is necessary and inevitable” message got across because no other voices could be heard. Nobody at the DOT or the EU’s Competition Directorate was publishing analysis of airline competition issues. The political leadership of these agencies were focused on supporting the largest corporate interests, not consumers.
There were no competing views in the industry since all of the large legacy airlines would benefit from consolidation, and neither the LCCs nor the aviation industry press thought it was sensible to challenge the well-organized Alliance advocacy program. The only jobs available for policymakers, lawyers and consultants were ones supporting radical industry consolidation.
The biggest barrier to intercontinental consolidation were the US laws that established strict evidentiary requirements before antitrust immunity could be approved. If those laws had been obeyed, none of the post-2006 ATI applications would have been granted, none of the subsequent US mergers would have occurred, the North Atlantic would not have been reduced to a permanent 3-played oligopoly/cartel.
The industry would not have undermined the resiliency needed to deal with the coronavirus crisis. But those laws were not obeyed, and Part Four will describe the false and deliberately misleading claims the alliance carriers and DOT used to evade and nullify the laws designed to protect competition and consumers.