Merge is what airlines do; suffer is what passengers do

By Joe Nocera — The New York Times, August 20, 2013.

Hey, wait a minute. Wasn’t airline deregulation supposed to bring lower prices and increased competition?

So how is it that, 35 years after the law was passed that deregulated the airline industry, we stand today with two megacarriers, United and Delta, while a third proposed megamerger – of American and US Airways – was all but done before the Justice Department sued to block it this week? In the last few years especially, ticket prices have skyrocketed and consumer choice has diminished. As for what it’s like to fly these days, well, the less said the better.

The answer, in part, is that deregulation worked all too well at first, and then it didn’t work well at all. The natural tendency of companies to seek monopoly power took over, and nobody tried to stop it until now, when it is really too late.

Remember those early years after deregulation? Everybody seemed to be starting up an airline. The legacy carriers like United and American expanded into dozens of new markets. The number of people who flew increased geometrically. Indeed, with the rise of discount tickets, flying became something many Americans could finally afford, at least once in a while. Supporters of deregulation could proudly say that it had worked as envisioned: It had brought about lower prices and greater consumer choice.

The only problem was that the competition was ruinous for airline profitability. This, in fact, has been the eternal struggle of the industry. Just a few months ago, Warren Buffett described airlines as “a death trap for investors.” As the big airlines fought fiercely to hold on to their turf – losing money in the process – many of the smaller startups went out of business. Even large airlines like Eastern and Pan Am failed. Others entered bankruptcy proceedings and engaged in protracted battles with their unions to lower their employee costs.

The first decade of this century was, if anything, even tougher. First came 9/11, which caused people to stop flying. Then came volatile fuel prices: Between 2000 and 2012, fuel costs for the industry rose from $16.8 billion to more than $50 billion. Then came the Great Recession. Over the last decade, according to Robert Mann, an airline consultant, “the industry has destroyed about $70 billion in capital.”

The airlines responded to these problems by doing exactly what you would expect. They began consolidating. There have been four major mergers since 2005, when AmericaWest and US Airways joined forces. After the merged airline cut some routes and streamlined, its stock went through the roof. Then others followed suit: Delta bought Northwest in 2008, Southwest bought AirTran three years ago, and that same year, United merged with Continental. Delta and United are now the largest airlines in the country, with a global network that appeals to the big corporate customers who are the lifeblood of the industry.

What did consolidation give the airlines? Pricing power, as it’s called. As the number of airlines dwindled, so did the number of routes and flights, as the airlines concluded that their health depended on cutting back the number of seats they offered. That’s why when you fly today, the plane is likely to be full; there are simply fewer flights available. And that’s also why airlines have been able to raise prices: Demand hasn’t slackened nearly as much as supply has. Thus, says Mann, “Every month in 2010 and 2011, there was a bump” in the price of airline tickets. Even Southwest Airlines, long a low-cost airline, began raising prices.

What the U.S. airline industry is today is an oligopoly, with two dominant carriers. (Southwest is No. 3.) And oligopolies, by their very nature, are anti-competitive. But it’s a little late to be complaining about oligopolies. The government could have attempted to prevent such an outcome when the Delta and United mergers were announced. Instead, it stood passively by and let the industry consolidate.

Will consumers be further harmed if American and US Airways merge? It’s certainly possible, especially since they have so many overlapping routes. But just about every industry analyst says that prices will continue to rise regardless, and limiting the supply of seats will continue to be central to the airlines’ strategies. They also say that American, which counted on this merger to emerge from bankruptcy, will struggle to compete successfully with United and Delta if it can’t establish that same kind of global network those two have put together. (US Airways, which is extremely well run, is a different story. It makes money consistently.)

“We learned what happened to competition in prior acquisitions,” said Bill Baer, the Justice Department’s antitrust chief, according to The Wall Street Journal. Indeed, we did: Competition dwindled. Prices went up. Consumer choice went down.

Blocking the American-US Airways deal is a little like closing the barn door after the horses are long gone.