The chief executives of Delta Air Lines and Northwest Airlineslast week were on Capitol Hill to defend the proposed merger between the two companies. They touted the virtues of the "complementary" nature of the combination, saying it would not harm competition, but witnesses disagreed with those sentiments.
Meanwhile, Continental Airlines on Sunday removed itself from merger speculation. "The risks of a merger at this time outweigh the potential rewards, as compared to Continental's prospects on a standalone basis," according to a statement by Continental CEO Larry Kellner and president Jeff Smisek. "We have significant cultural, operational and financial strengths compared to the rest of the industry, and we want to protect and enhance those strengths--which we believe would be placed at risk in a merger with another carrier in today's environment."
Kellner and Smisek also said Continental is "considering alternatives" to its current SkyTeam alliance affiliation.
Citing sources "briefed on the matter," Reutersreported that Continental is "in advanced talks with British Airways and American Airlines about a potential alliance, with plans to seek antitrust immunity." While American and British Airways previously balked at the number of London Heathrow Airport slots they'd be forced to surrender in exchange for antitrust immunity, AA executives recently hinted that a new request could be in the offing.
Evidently rebuffed by Continental, United Airlines CEO Glenn Tilton issued a statement a few hours later. "Our strategy is consistent," he said. "Consolidation is underway; ensuring you have the right partner is everything. We will pursue all options."
Press and analyst reports now speculate that United may seek to merge with Star Alliance and codeshare partner US Airways, a combination proposed at the beginning of the decade then withdrawn amid regulatory scrutiny.
JPMorgan Securities analyst Jamie Baker in a research note suggested "considerable merit to a United-US Airways combination," including some degree of fleet commonality and no alliance complications. "United was interested in America West in 1998, US Air in 2000. Today, both are available under one roof," Baker wrote. "An integrated United-US Airways management structure could potentially be more committed to supply cuts and hub rationalization than a Continental-United team."
But their domestic networks overlap, potentially causing competitive concerns in markets like Washington, D.C. FareCompare CEO Rick Seaney said the overlap is "about tenfold more domestically than the minimal overlap of the Delta/Northwest merger--112 city pairs after removing code shares. Competition is the main driver of pricing, and 12 percent overlap is significant enough to cause a good portion of travelers some heartburn related to removal of this competition."
Having already picked each other as merger partners, the leaders of Delta and Northwest last week testified during a U.S. Senate Judiciary Committee hearing. In his opening remarks, Sen. Herb Kohl (D-Wis.), chairman of the Subcommittee on Antitrust, Competition Policy and Consumer Rights, said careful examination is required to ensure service to smaller communities is not sacrificed. "While there may always be ample competition between New York and Los Angeles, what does this deal tell us about the future of competition for the rest of us?" he asked. "We need to be sure that the announcement that we've all heard flight attendants say at the end of a flight--'We know that you have a choice among airlines'--does not become as obsolete as airlines like TWA, Pan Am, Eastern, Braniff, ATA, and now perhaps Northwest."
According to Delta CEO Richard Anderson's written testimony, the combined entity would be "a more secure, financially stronger company in these times of increased foreign competition, record-setting fuel prices and a weakening economy."
According to Northwest CEO Doug Steenland's written testimony, the merger would result in "only 12 domestic nonstop [route] overlaps, none of which will cause competitive problems." Steenland also pointed to strong competition from low-cost carriers and pricing transparency provided by Internet selling channels. "Customers have become far more sophisticated at comparing the offerings of competing carriers, and airline consumers have more tools at their disposal than do consumers in the vast majority of industries in the United States," Steenland asserted.
Furthermore, Steenland stressed that the new Delta would maintain all U.S. hubs and serve "over 140 small communities--nearly double the amount of our next largest competitor."
Business Travel Coalition chairman Kevin Mitchell offered the committee an opposing view. "Mega carriers" like a combined Delta-Northwest, he said, "would fortify their hubs with near-exclusive contracts with corporations and travel management companies, and other well-tested practices, such as gate hoarding, schedule bracketing, triple frequent flyer points and travel agency override programs, making the barriers to entry for low-cost carriers of the 1990s seem low."
Mitchell also suggested that mergers between major carriers would exacerbate customer service deficiencies and facilitate coordinated pricing around the industry. In countering Delta's and Northwest's assertions of the financial benefits, Mitchell asked, "How can there be billions of dollars in untapped cost savings at two airlines that just underwent years of cost cutting in bankruptcy? How can one accept that there are billions of dollars in revenue synergy when there are no plans to restructure either network?"
Darren Bush, an associate professor of law at the University of Houston and a former attorney for the U.S. Department of Justice's antitrust division, in his prepared comments also disputed the Delta-Northwest claim of efficiencies generated by the proposed merger. "Unless more concrete and tangible information is provided, the only realistic efficiency is the reduction in management and staff," according to Bush. "The problem is that there is a rich history of airline mergers. There is little history of, in spite of these transactions in the past, the airline industry getting better. It is difficult to see how two dysfunctional organizations combined make a better airline. In fact, in announcing their proposed merger, Delta and Northwest emphasized that no airport hubs would be closed and no compulsory pink slips would be issued. In other words, it would be 'business as usual,' albeit in a much-larger combined company. Business as usual has not been working, and it should not be incumbent upon the airline passenger to subsidize a potentially anticompetitive merger because a dominant carrier has the ability to extract dollars from the wallets of consumers."
While Bush acknowledged the challenges of fuel costs and economic recession, he disagreed that such factors warrant consolidation: "These [airline] firms are not failing in any sense of the term, except perhaps failing to understand the nature of their own markets such that they continue to look toward consolidation as the answer to every challenge."
Contrary to what many industry observers would advise, the combined entity would maintain "all hubs" in the United States, including smaller ones in Cincinnati, Memphis, Tenn., and Salt Lake City. "This merger is not predicated on domestic capacity rationalization," said Delta president and CFO Ed Bastian. "The hubs we have today are self-sufficient and profitable."
Long seeking deeper domestic capacity cuts to help the airline industry weather another challenging period, Wall Street analysts rejected the notion that the airline need not close hubs. "We have little doubt that smaller hubs will be deemphasized," according to UBS' Crissey.
"Unfortunately, by the time Delta and Northwest consummate their marriage (if at all) and potentially revisit their aversion to hub closures, industry losses are expected to have escalated," according to JPMorgan's Baker, who ascribed an "80 percent probability" to the deal closing by next year's first quarter.