Planely Speaking: Growing Pains: Will the Merger Result in Higher Fares and Reduced Service?

Planely Speaking

Guest Editor Aaron Newman
Aaron Newman (small)

Growing Pains: Will the Merger Result in

Higher Fares and Reduced Service?

By Aaron Newman

As I wrote in my previous article, The Department of Justice (DOJ) filed suit in August to stop the proposed merger of American and U.S. Airways on antitrust grounds. The DOJ said the merger, which will create the world’s largest airline, would lead to higher fares for customers and less competition – reducing service to small and medium sized cities. In their suit against the merging airlines, The DOJ claimed the following; “the merger between US Airways and American would likely substantially lessen competition, and tend to create a monopoly, in violation of Section 7 of the Clayton Act.” Will this merger actually create a monopoly or oligopoly resulting in higher fares? Will the travelling public be left to cope with a reduction in service?

Higher Fares?   

With last week’s merger  announcement (see this report by Reuters) the US Airways and American Airlines merger has resulted in four airlines; the new American Airlines, United, Delta and Southwest to control nearly 90 percent of the domestic airline market according to this report by NBC News. Some argue that because of supply and demand, together with rising fuel prices the average cost of fares will potentially rise once the merger is fully implemented. The DOJ initially claimed that rising fares will not be alleviated by new carriers or low-cost carriers.  “Low-cost carriers are not likely to replace the flights that would be cut after a merger between American and US Airway, and the ones that are left will cost more.”

US Airways effectively competes for travelers today by offering discounts of up to 40 percent for connecting flights on other airlines’ nonstop routes with Advantage Fares. Some industry analysts claim once this merger is completed, the combined airline’s pricing structure will look more like the existing American, Delta and United. As a result, the popular Advantage Fares program will likely be eliminated, resulting in higher prices and less services for consumers.

Most analysts, myself included, praise this marriage as the potential end of major financial turbulence for the largest U.S. airlines.  The American-US Airways merger is the latest wave of consolidation that will help return the industry to continued profitability. This report by Reuters explains that with a new, merged airline the public may lose some service, but in the long run we’ll benefit by a stronger, more profitable airline. It shouldn’t surprise if fares went up slightly based on a variety of pricing influences including demand, capacity, and competition. However, the public will benefit more from a stronger merged airline, than the slight fare difference from two stand-alone airlines. Unions at AMR (American’s parent company) and US Airways share this view. The unions have expressed confidence that this deal could reverse years of decline at once-great American, and lift US Airways workers from their below average compensation. “We have the opportunity to transform American into an industry powerhouse.”

US Domestic Airfares Graph

Reduced Service? 

Bill Baer, head of the Justice Department Antitrust Division, said in a statement prior to the agreement of this merger that with the end of competition between US Airways and American, the industry will be deprived of a healthy competitive environment. “Both airlines have stated they can succeed on a standalone basis, and consumers deserve the benefit of that continuing competitive dynamic,” Baer said.

American-US Airways Hubs

“The new American will fly all the routes to all the markets we currently serve,” US Airways Chief Executive Doug Parker told Congress in June. “Where appropriate, we expect to increase such service.” Doug Parker may be a little optimistic with this statement; I project that some cities will lose some routes as the new American will experience growing pains combining nine domestic hubs. Major restructuring will not occur until 2016-2017as part of the DOJ agreement was to maintain all hubs for three years. I do not foresee a situation like Pittsburgh or Memphis, but there will be restructuring in order to grow appropriately.  The two hubs that will see the majority of change will be New York JFK and Los Angeles. With the proximity to Philadelphia, slot restrictions, and tough international competition, New York JFK’s potential is limited. I foresee Philadelphia and Charlotte as the primary east coast domestic hubs. Same scenario applies to LAX; tough competition and limited growth opportunities make Phoenix the smartest choice for a west coast domestic hub. These two cities will obviously not be hurt by a reduction in service from American Airlines.

My Take

This merger will benefit the new airline, customers, and the industry as a whole. The airline industry is currently on a path to sustained profits, and a stronger merged American Airlines will produce similar results. Profitable airlines benefit customers, employees, shareholders and the cities the airlines serve.  Delta Airlines is producing record profits, and United Airlines is near completion of the largest merger to date, American Airlines needed this merger to be a viable competitor to its two larger competitors.

Consumers have benefited from intense price competition in the past; such pricing is not sustainable as past bankruptcies have shown. Going forward, the airlines will likely shift the focus of their competition to service and product offering instead of intense price wars (i.e. industry’s onboard improvements). The combination of American Airlines and US Airways creates a better network than either airline could build on its own. American’s extensive operations throughout the central U.S. from its Chicago and Dallas hubs provide critical coverage where US Airways is undersized. US Airways’ operation in the Northeast does the same for American.  New entrants will find their way into any markets that become underserved by this merger. Spirit Airlines has recently found ways to succeed in fortress hubs (i.e. Dallas and Detroit), and JetBlue has an expansive network that will compete in the northeastern US. These ultra-low cost carriers will find opportunities to fill any void that a merger leaves behind. If legacy airlines let fares climb, then smaller competitors (Spirit, Allegiant, Frontier, and JetBlue) will come in and thrive.

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