<B> DOT Tops Ally Buzz</B>
<I>Airline Consolidation Vs. Regulation</I>
By Jay Campbell
The forces of consolidation appeared to be colliding with the forces of regulation in the airline industry last week as talks between Delta and United and between US Airways and American or United were overshadowed only by the Department of Transportation's proposal for curbing anti-competitive practices.
DOT's preliminary policy (see box, page 38) is open for comment from interested parties for the next 60 days. The policy likely will be implemented in late summer, and may even stave off any immediate effort among the majors to link up, particularly such a behemoth deal as Delta-United.
"In the next three to six months, right on top of the new competition policy, I don't think you'll see Delta-United," said an airline industry consultant who declined to be identified because he is "too close" to the issue. "After the wind blows over, maybe. And even then, it really depends on the structure of the agreement."
Other sources on Wall Street and in Washington were skeptical that the federal government would ever allow an alliance between carriers as large as Delta and United, despite the fact that their route structures and hubs do not overlap as much as, say, American-Delta or Delta-US Airways. But, some argued, there's no reason for Delta-United or any other combination to avoid testing the waters with DOT, which has been open to alliances and, for that matter, mergers.
Talks among the big six carriers are happening at a more frenzied pace in response to the announcement earlier this year of a major alliance between two of them, Continental and Northwest (<I>BTN</I>, Feb. 23). DOT already has granted tentative approval of 14 Japanese code-share flights for CO-NW. Add KLM and you get the smallest of three potential mega trios.
"I believe one of the risks of Continental-Northwest was that it would set off a round of consolidation," said Standard and Poor's Phillip Baggaley. "Which could mean that all deals will be blocked, including theirs."
"This is airline spin-the-bottle," said Michael Boyd, president of The Boyd Group in Evergreen, Colo. "Monkey see monkey do. But if all the airlines are code sharing, competition is reduced by default. You'll have a consumer backlash that is uglier than what we have now."
DOT is watchful of that point. Like DOJ, the federal agency is reviewing alliances as though they were mergers. DOJ's test of international allainces has been whether the two carriers' route structures are end-to-end or overlapping, but it's unclear whether such a test is the only one that applies to the domestic market. Here, hub-to-hub competition means as much as competition on a single route. As Baggaley pointed out, "Delta and United are mostly end-to-end, but their Denver and Salt Lake City hubs do overlap somewhat for connecting traffic." Baggaley added that the European Union, which has been more openly vigoruous in alliance scrutiny than the U.S. agencies, could cry foul.
"On the surface, none of these guys are talking about a merger, so it should be okay," said Merrill Lynch's Candace Browning. "But really nobody knows if something like Delta-United would pass." Ray Neidl of Furman Selz, LLC, said Delta-United is "just too big."
Any alliance between Delta and United probably would roll in Delta with Lufthansa and others in the Star Alliance. The trio would command nearly all of the German-U.S. market, become the biggest alliance to Europe, add on to United's huge Asian network and challenge American's dominance to Latin America.
If a Delta-United partnership happened, chances are American would respond by picking US Airways. Benefits of that deal would include the frequent flyer loyalty of US Airways Shuttle passengers, a North-South East Coast feed for AA's Miami gateway to Latin America and generally a vastly larger presnece in the Northeast and coastal South. Assuming eventual approval of AA-BA, US Airways, BA's former partner, could be folded in.
In that scenario, the Delta-Lufthansa-United partnership would dwarf the other trios in revenue passenger miles (see chart, page 1). Existing Asian partnerships, All Nippon Airways with United and Japan Airlines with American, would give Delta and US Airways, respectively, excellent code-sharing opportunities there.
Delta is hurting for new international code-sharing opportunities after having lost several key partners. "Of all the big carriers, Delta is probably most poorly positioned in terms of international code shares," said Darryl Jenkins, director of the aviation institute at George Washington University in Washington, D.C.
But sources said Delta is not the only one stirring things up. One analyst said, "United told me they will have a competitive response to Continental-Northwest." If a Delta plan does not work out, United's alternative is US Airways, which some think makes more sense from a likelihood-of-government-approval perspective. In that scenario, American and Delta would be left out in the cold as analysts said an American-Delta deal is extremely unlikely.
Dancing solo is fine with American--which in principle is opposed to code sharing and mergers--unless it allows arch rival United to muscle up in their dueling hubs battle for Chicago. Allying with any major U.S. carrier would enable American or United to share coveted O'Hare gates.
"These guys are pretty much in earnest on these talks right now, from what I hear," said Jenkins. "But with what the DOT is doing right now, it will be difficult for the majors to get anything like this done."
What DOT is doing right now is awaiting comment from all interested parties on its new preliminary guidelines on anti-competitive practices (see box, below). The rules, to be adopted with relevent modifications around August, apply to all airlines. But the activity they define typically is exerted by a major airline on a new low-cost carrier, said assistant secretary of aviation and international affairs Charles Hunnicut. "You don't see the majors doing this to each other because they can't put each other out of business that way," he added. "But we've seen in the last couple years increasing intensity of this unfair exclusionary activity directed at new entrants."
The new policies target the practice of pricing and scheduling in such a way that sacrifices profits for the express purpose of eliminating the competition. DOT said investigations into such activity could be triggered by complaints from airlines or other interested parties or by DOT's own observations of the competitive environment. If a violation is discovered, the agency will first order the major carrier to cease and desist, then levy fines and finally, pursue a court injunction.
The industry response last week, in lieu of comments to be filed with DOT, were quick and loud. Said United Airlines CEO Gerald Greenwald, "DOT is attempting to regulate the number of seats in a market and the price at which they are sold. More importantly, it will hurt consumers by preventing United from competing with carriers and offering the low prices that consumers want," he said, noting the DOT is "trying to fix something that isn't broken."
Some attacked the proposed rules as being too broad, preferring instead that DOJ look at each case individually. And the Air Line Pilots Association criticized the moves for being anti-labor.
Others said these moves don't go far enough. "This competition policy is the most profound pro-consumer policy development in the 20-year history of deregulation," said Kevin Mitchell, chairman of the Business Travel Coalition in Lafayette Hill, Penn. "The DOT has taken the single most important step, of the many required, to level the competitive playing field."
The Transportation Dept. said that it and the Justice Dept. will continue to investigate other barriers to entry, such as gate and slot restrictions, frequent flyer power, travel agency overrides, exclusive corporate deals and CRS bias. But Hunnicut called these measures on predation "the most important.