STATEMENTOF HUBERT HORAN THEANTI-COMPETITIVE RISKS OF A DELTA-NORTHWESTM ERGER AND EXTREMECONSOLIDATION OFINTERCONTINENTAL

HOUSECOMMITTEE ON TRANSPORTATIONAND INFRASTRUCTURE AVIATIONSUBCOMMITTEE HEARINGS 14 MAY 2OO8

Mr. Chairman,the Oelta/Northwestmerger is part of an organized movementtowards extreme consolidationof large Intercontinentalairlines. My belief that these mergerswill be bad for consumers and bad {or the future economicefficiency of the industryis basedon 25 yearsof experienceas to how these a;rlinesactually compete and how thesetypes of mergersactually work. In my testimonytoday. l'd like to focuson the primary sourcesof the threat to consumersand competition,and why I believethat these mergerscan only be financiallyjustified by arti{icialprofits from anti-competitivebehavior.

Overview-The Anti-CompetitiveRisks of Megamergersand lntercontinentalConsolidation

Delta/Northwestand other Megamergerscan not be justifiedby synergiesand improvedefficiencies; profitsfrom Megamergerswill comefrom highlyanti-competitive behavior. The anti-competitive gainswill occurin two stages--anticompetitive pricing on the NorthAtlantic made possible by the permanentelimination of competition,followed by seriousdistortions to domesticUS competition In the firststage, healthy competition between the USand Europeis completely eliminated, replaced by a duopolyof two collusivealliances, led by Air Franceand ,controlling 90% of all trafficto ContinentalEurope and a third collusivealliance, led by BritishAirways, controlling over 60% of all traffic to the UK. ! "Collusivealliances" are those where airlines have antitrust immunity to colludeon prices, capacity,service and marketing(functioning as a singlecompetitor), and wherethe collusive alliancehas the sameantitrust implications as a full merger.Other alliances that do not haveantitrust immunity do not havethe sameantitrust implications. n The Delta/Northwestand United/USAirwaysmergers focus on the US-ContinentalEurope market, a highlyprofitable, strongly growing market of over30 millionpassengers that had very healthycompetition with low concentrationlevels as recently as five years ago.

HubertHoran has been in aviationfor 25 years,and offersboth the perspectiveof an analystwho has publishedextensively on airlinecompetition issues and the first-handexperience working with overa dozenmajor airline mergers, alliances and restructurings.In additionto consultingwork with over25 carriers,he heldstrategic planning and networkmanagement positions at Northwest,America West, Swissairand ,and was responsiblefor the originaldevelopment of the Northwest-KlMalliance network.His articles have analyzed the financialcrisis and restructuringof Legacyairlines in both Americaand ,the negotiationsleading to the recentUS-EU Open Skies treaty, and the competitionand economicissues behind recent calls for industryconsolidation. He isa graduateof WesleyanUniversity and the YaleUniversity School of Managementand is basedin Phoenix,Arizona.

RecentPublications on AirlineCompetition and Consolidationinclude: "TopTen FalseClaims About the Needfor USAirline Mergers" (Business Travel Coalition, Jan 2008) "AirlineConsolidation: Myth and Reality"(Aviation Strategy, November 2006) "Updateon lndustryConsolidation and EU-USTreatyNegotiations" (Aviation Strategy, March 2OO7) "Why the USIndustry is at a stalemate"(Airline Strategy, January 2005). "The EU-USOpen Access Area" (AviationStrategy, )uly 2003) "Unitedand American:are the turnaroundplans viable?" (Airline Strategy, March 2003) "What isthe future of the EuropeanFlag-Carrier--An analysis of emergingEuropean business models" (AviationStrategy, September 2002). "ls the Big Hub BusinessModel stillviable?-The US network carrier crisis"(Aviation Strategy, July 2002) Followingapproval of the Deltaand Unitedmergers, a new collusivealliance is expected to be proposedbetween and American(and possibly Continental) that would immediatelycontrol 50-70% of the US-UKmarket. lt would not facecompetition from anyonewith morethan a 10-12o/oshare, and neitherof the two EuropeanDuopoly groups would haveany incentiveto competeaggressively. At that point,three collusive groups---the Air Franceand Lufthansaled groupsfocused on ContinentalEurope and the BritishAirways led groupfocused on the UK market-will control over95% of the entireTransatlantic market. Every U5 Legacy carrier will be a memberof one of the threegroups. There is no possibilityof significantfuture competitiveentry. Healthy, dynamiccompetition on the NorthAtlantic will havebeen completely replaced by airlines groupswith full antitrustimmunity to colludeon pricing,capacity and servicelevefs. With overwhelmingmarket dominance and hugeentry barriers,the threecollusive alliances will be ableto raiseprices at will for manyyears to come,with no possibilityof marketplaceor regulatorydiscipline. Thisanti-competitive behavior will createa ongoingstream of artificialsuper-normal profits, largeenough to totallyjustify the costsand risksof thesemergers, and to bolsterthe financialreturns of thesecompanies. The improvement in airlineprofits will havecome from pricegouging made possible by the eliminationof competitionand not from synergies, efficiencies,improved service or increasedproductivity.

I In the secondstage, the Megacarrierswill useprofits from gougingTransatlantic consumers to weakenand distort comoetition in the domesticmarket a Megacarrierswill quicklydistort every domestic market where the megacarrierscompete with airlinesthat don't serveintercontinental markets. In Atlanta,Delta competes directly with Airtranwhich has much lower costs on manydomestic routes. But Deltacan use the artificial profitsfrom IntercontinentaI markets to subsidizeits domestic flying, blocking Airtran's abilityto profitablygrow in Atlanta,completely undermining the way competitivemarkets aresupposed to work.Similar threats exist in anymarkets where the megacarrierscompete with JetBlue,50uthwest, Hawaiian, Alaska or anyother domestic carrier o Themegamergers would createa situationwhere 3 or 4 companiescontrol 80% of the total US airlinerevenue and 100%of manyimportant sectors where low costcarriers do not compete, includingmost mid-sized and smallercities, and the large"fortress hub" citiessuch as Newark, Minneapolisand Cincinnati. While this would not directlycreate the artificial pricing power one would immediatelysee on the NorthAtlantic, it wouldseriously undermine the competitivemarket dynamics that haveexisted since deregulation. These carriers would now be "too big too fail"-lenders and localcommunities could not affordthe costsof any financialor operationalbreakdowns. Competitors or capitalmarkets would havelittle ability to disciplinebad managementor badservice. Costs will riseand qualitywill deteriorateovei time,but no marketor regulatorymechanisms will be abledo anythingabout it. r Overtime, extreme would underminecompetition in other intercontinentalmarkets suchas Asia, the MiddleEast and south America. The three collusive megacarrier groups would controlall networkairline service within the UnitedStates and the EuropeanUnion. Thus any other intercontinentalairline would find it increasinglydifficult to competefor trafficin the world'stwo largestand mostimportant markets. Carriers such as Japan Air Lines,, and manyothers would be forcedto limit serviceto largegateway cities, or to join collusive arrangementswith the threemegacarrier groups on un-fav-orableierms.

Thebalance of thistestimony will be limitedto the immediate(first stage) risks to consumersfrom anti- competitivepricing on the NorthAtlant:c, and the antitrustissues raised by the Deltaand Unitedmerger applications,and will not discussthe serioussecond stage domestic competitive risks. The following sectionswill outlinethe evidencedemonstrating the strongexisting movement towards extreme concentration,and the evidenceo{ specificactions taken to underminecomoetition.

Horantestimony, House Transportation Committee, 14 May 2008 2 1.Delta/Northwest and Other MegamergersCan Not BeJustif ied BySynergies and lmprovedEff iciencies

Mergersthat significantlyreduce competition can sometimes be justifiedif they produceclear, verifiable efficlencygains that couldbe passedonto consumersin the form of lowerprices, expanded service, innovationor lmprovedquality. The claims that Delta/Northwestand Un ited/USAirways will produce billionsin synergieslacks credibility and will not surviveany serious, independent scrutiny.

r Megamergerswill not achievecost savings. Delta, Northwest,United and USAirwaysjust went through yearsof draconiancost cutting while under bankruptcyprotection. The overheadand fat was eliminatedyears ago. r Megamergerscannot achievesavings from increasedscale economies. lt is ludicrousto argue that Deltaand Unitedare not largeenough to be competitive. Becauseof the hugelycomplex implementation process, Megamergers will actuallyincrease costs and worsencash flow for severalyears. The costof integratingreservations, operations control and maintenancesystem will easilywipe out mostsavings from firing redundantstaff. Somenetwork synergies may be achievable,but the magnitudeof revenuesynergies needed to economicallyjustify this mergerwould requireboth majorhub restructuringand majornew growth, and thesemergers will not achieveeither. Delta management has clearly indicated that the sizeof the combinednetwork won't change,and the sizeand rolesof the individualhubs won't materially change.Tweaking a few routeshere and therewill not drivebillions in revenueaway from the competition.Repainting Northwest's red airplanesinto DeltaBlue will not giveconsumers any new servicesor choicesthat they don't havetoday. The Deltaand Northwestnetworks have enormous overlaps. Claims that this isan "end-to-end" mergerare false. The two networksoverlap across alf of NorthAmerica, the entireNorth Atlantic, and from the USto Japan,Korea and .True "end-to-end" benefits are limitedto extremely tiny marketssuch as South Carolina to SoutheastAsia, and North Dakotato SouthAmerica. lsolated scheduleimprovements are possible,but mostwill quicklybe neutralizedby the United/USAirways mergerand othercompetitive responses.

As shown in Appendix A, almost every U5 airline merger sincederegulation (including every merger remotelycomparable to these megamergers)has been a dismalfinancial failure. Like all of the failed mergers,the proposedDelta/Northwest and United/USAirwaysmergers have wildly underestimated implementationcosts and risksand wildly overestimatedcost savingsand network synergies.lf mergers cannot generatesufficient synergies to provide a return on the capital "invested" in the merger, it cannot possiblyprovide additional gainsto consumersto justify the reduction in competition.

The synergy/efficiencyissue involves factual questionsthat must be one of the first prioritiesof the Departmentof Justiceinvestigation. Approval of these megamergersshould not be granted unlessDelta and United fully document their synergyclaims and find a way to convinceindependent, objective experts that these billionsin efficiencygains are readilyachievable, and how they uncoveredsynergy opportunitiesthat no previousairline merger had ever been able to find. PastDOT decisions have taken airlineclaims o{ synergyat face value,without any attempt to independentlyevaluate whether claimshad been inflated by gainsthat would have occurredwithout the merger,whether all implementationand transactioncosts had been properly included,or to understandthe legitimacyof merger synergyclaims in light of the horrible historictrack recordof past mergers.

Delta and United have no hope of achievingthe synergiesthey haveforecast but they were neverthe real sourceof merger profits-

Horantestimony, House Transportation Committee, 14 May 2008 3 2.The US-ContinentalEurope Market is Large, Growing, Highly Profitable and NeverNeeded Mergers.

The USA-ContinentalEurope Market that isthe centralfocus of the Delta/Northwestmerger is a large, healthy,highly profitable market that was neverin any needof mergersor a majorcompetitive shakeout.lt isone of the largestinternational markets in the world,with over30 millionpassengers eachyear. The market grew at an annualaverage rate of 4o/ooyer the last 15 years,and grew at an averagerate of 6% in the last4 years r Intercontinentalmarkets have been the mostimportant recent source of airlineprofitability and growth;they havesignificant entry barriers and there hasbeen very little growth in the numberof competitorsover the years.Domestic US, intra-EU and similarshorthaul markets have few entry barriers,and haveexperienced strong actual entry and pricecompetition, leading to overcapacity and poor profitability.Mergers such as Delta/Northwest and United/U5Airwayscould not address thesedomestic problems without majorcapacity cuts and hub restructuring,which would not be possibleoutside of bankruptcyprotection. Advocates of "industryconsolidation" focus on domestic competitionhoping to createthe impressionthat Megamergerspose no threatto consumers (becauseof abundantexisting competition) and to divertattention from the muchmore restrictive and profitablelonghaul markets where consolidation poses much greater threats to consumers.

The USA-ContinentalEurope Market is a highlyintegrated market that canonly be servedby large hubsand cannotbe servedby "point-to-point"airlines n only a verytiny fractionof marketdemand is in citypairs (such as New York-)large enough to supportnonstop widebody service without heavyreliance on connectingfeed traffic. ! becauseof the highlyfragmented O&D markets,because of entrybarriers at the largest transatlanticairports (Newark, Kennedy, Paris, Frankfurt, etc.) and becauseof the needfor a largefleet of modernwidebody aircraft, there isno possibilitythat low costcarriers such as Southwest,Jetblue, or Easyjetcould ever enter the marketand establisha meaningful overallUS-Europe competitive presence. The hub-basedUS-Continental Europe market must be consideredseparatelyfrom the US-Ul(/lreland market,which is exclusively served by nonstopflights, predominately to .Nobody flies from the USto London,Glasgow or Dublinvia Parisor .British Airways no longerseriously competesfor US-Europetraffic. For the lastdecade it downsizedtransatlantic aircraft that usedto carrylow-yield European connecting traffic and hasreallocated its Heathrowslots to more profitableuses. Competitive and concentrationissues in the Ul(/lrelandmarkets are largelyseparate from the competitionand concentrationissues in the ContinentalEurope market.

a-tl1''l

PAR lr r ZRH MUC MXP F @ FCO

Horantestimony, House Transportation Committee, 14 May 2008 4 3. EU-ContinentalEurooe Concentration Levels Have Dramaticallv lncreased Since 2004 and the Drive TowardsPermanent Market Duopolv ls NearlvComplete

The chart below usesvarious common measuresof concentrationto illustratethe radicalshift away from healthy,profitable competition that began in 2004,and the permanent duopoly concentrationthat consumerswill face after these Megamergersare implemented.

Healthy, Profitable Rapidly Permanent Increasing Duopoly Competition Concentration ith huge even as Alliances grew after 2004 entrybarriers

1993 1995 1997 1999 2001 2003 2007 200e(?) U5-Continlrnenrar trurope concenrraltonti teve top 2 share 32o/o 380h 44% 45o/o so% 55o/o 77 o/o 76% 92% top 3 share 41 Yo 47 o/o ss% 56o/o 61% 67% 8s% 86o/o 97 o/o top 4 share 51% s6% 64o/o 63% 68% 74o/o 92% 93o/o 99% comoetrtorsW ith mrnrmum departure shareo 5o/o 7 7 6 6 7 6 4 4 2 2o/o 12 12 10 10 10 8 5 5 3 Departure share of the US-ContinentalEurope market, DOT Form 41 T100 data forecast 2009 levelsassume the elimination of Continental as an independent competitor

The US-ContinentalEurope market enjoyed vibrant competition with low levelsof concentrationuntil 2004.Increases in concentrationthrough 2003 reflected the normalworkings of a dynamicmarket and posedno threat to consumers. t The three original allianceswith antitrust immunity to colludeon priceand service(KLM-Northwest in 1993,Delta--Sabena in 1995 and United-Lufthansain 1997)developed without damaging the overall market dynamic.Although the alliancesinitially reducedthe number o{ competitors, they developedin an environmentwith low concentration,and consumerlosses from collusion were offset by improvedschedules and expandedprice discounting in alliancemarkets, and by the major expansionof two smallercompetitors, (Continental at Newark,USAirways at Philadelphia). r Severalcarriers exited the market in the decadeorior to 2004.but thesewere either the weakesVworstrun competitors(, TWA, Sabena)or extremelysmall carriers linking up with one of the largergroups.

The shift to extremeconsolidation was triggered by the -KLMmerger in 2004.Prior to Air France-KLM,there were six strong,viable competitorsin the market. The Air Franceand Lufthansagroups eachhad 20-25%of the market,the KlM-Northwest alliancehad 10-15%,three large UScarriers- American,Continental and UsAirways,each had 5-'10%of the market. and varioussmaller niche carriers competed independently.Because each carrier (or alliance)had a slightlydifferent geographic{ocus, actual levelsof competitionwere even higher than these aggregatenumbers suggest. The KLM alliance was fully competitivewith the Air Franceand Lufthansaalliances for tra{{ic from the large pool of "interior" Europeanand UScities. Continental, American and U5Airwayswere strong competitorsin the largerO&Ds from the USto the main Europeangateways.

The 2004Air France-KLMmerger was designedto destroythis healthy competition by making it impossiblefor most mid-sizedairlines to remain competitive,and forcing the market towards an inevitableAir France/LufthansaDuopoly. The entire move towards extremeconcentration is explainedby

Horantestimony, House Transportation Committee, 14 May 2008 5 mergersand externalpressures. None of the movementtopermanent Duopolysince 2004 can be attributedto the normalworkings of a healthycompetitive market.

The mergereliminated competition from KLM, the profitable#3 lntercontinentalcompetitor in Europe,which provided the majorsource of pricecompetition against Lufthansa and Air France(the #1 and #2 competitors) The mergereliminated the KlM-Northwestalliance as a competitoron the NorthAtlantic, so that only two USairlines could possibly have access to the huge Europeantraffic base beyond the large gatewayhubs Northwestwas no longerviable as an independentcompetitor, although sham competition was "preserved"with an interimagreement to maintainthe appearanceof an "independent"KLM- Northwestentity in the market.Northwest faces a "merge-or-die"dilemma at the end of this interimagreement, since it would haveto abandonmost (if not all)of its profitableEuropean flying without an collusivealliance arrangement, and the lossof this large,profitable network could easily drive Northwestback into bankruptcy. Othermid-sized competitors including USAirways, Austrian, LOT and Aeroflotfelt they had no choice but to signup asjunior members of the Air Franceor Lufthansagroups, and the EuropeanUnion activelysupported these efforts towards higher concentration. Swiss and Alitaliawere forcedinto thesegroups as part of effortsto staveoff financialdifficulties. AmericanAirlines found it increasinglydifficult to competefor ContinentalEurope traffic against the growingdominance of the Air France/Lufthansaled groupsand itsmarket share declined from 11o/o in 1995toTo/o. TheAir Franceand Lufthansagroups also discontinued many interline agreement with smallercompetitors, blocking these carriers access to connectingtraffic. I Continentaland lberia,the only othercarriers with a marketshare greater than 2o/o,\Nereunder constantpressure to mergewith one of the Duopolypartners.

4. TheDelta and UnitedMergers Are Partof a Concerted.Well OrqanizedFive Year Effort To Eliminate Competitionon the NorthAtlantic

Therapid movement from healthycompetition to extremeconcentration between the U5and ContinentalEurope since 2004 did not result{rom "marketforces" such as the exitof uncompetitive carriersor the rapidgrowth of highlyproductive airlines. lt resultedfrom proactive,carefully planned effortsby the EuropeanUnion and the largestcarriers to artificiallyreduce competition and increase concentration.Major steps in this proactivecampaign included: r Earlythis decade European Union aviation policy shifted from a hands-off"led the marketdecide" viewof airlinecompetition, to an activeadvocacy for mergersbetween lntercontinental airlines, and supportfor Air Franceand Lufthansa(and to a lesserextent British Airways) as "national champions"in their competitionwith lntercontinentalairlines based outside Europe. D Whilethe EU'sadvocacy is stated in termsof favoring"industry consolidat;on", it hasonly taken activesteps in the longhaulIntercontinenta I sector (which is highly profitable, and where therehad never been any significant growth in the numberof competitors)while largely ignoringthe shorthaulintra-European market, which experienced explosive competitive entry in recentyears, and isarguably much more fragmented, much less profitable, and is hypotheticallymuch more in needo{ "consolidation") r With the activesupport of the EU,Air Franceacquired KLM in 2004,immediately driving a major reductionin Intercontinentalcompetition tr As notedearlier, the mergereliminated the majorcompetitor to the Air France/Lufthansa Duopoly,made it impossiblefor morethan two USairlines to haveaccess to the majorityof the Europeanmarket (cities that werenot majorintercontinental gateways), eliminated the possibilityof seriouscompetition from Northwestand mostother mid-sized competitors

Horantestimony, House Transportation Committee, 14 May 2008 6 The EuropeanUnion actively campaigned for other EUIntercontinental airlines (such as lberia, , Swiss,LOT and TAP)to join eitherthe Air Franceor Lufthansaled collusive groupings, and aggressivelyopposed Ryanair's efforts to enterthe NorthAtlantic via a mergerwith n The EUwas willing to subverttraditional antitrust standards out of explicitfavoritism to Air Franceand Lufthansa.Even though the Air France-KLMmerger eliminated competition in tensof thousandsof Intercontinentalmarkets their antitrustreview looked at nothingexcept a tiny handfulof nonstopO&Ds. When the Aer Lingus-Ryanairmerger threatened to establish a new low fare lntercontinentalcompetitor, they usedradically different antitrust standards, banningthe mergerby claimingthat the simplereduction in the numberof market competitorswas an irremediableviolation of competitionlaw. A majorpress/public relations campaign in the UnitedStates advocating "industry consolidation" was spearheadedby UnitedChairman Glenn Tilton ! As with the EU'scampaign, the claimedneed tor " industryconsolidation" was strictly limited to profitable,high entrybarrier Intercontinental markets, not to the more intensecompetition in mostdomestic US markets. ! All of the publicadvocacy of "industryconsolidation" in the lastfive years has come from either the EU,the dominantairlines in the emergingAir France/Lufthansafed groups,or Wall Street analystsbeholden to thoseairlines. There has been no supportfor Intercontinental"industry consolidation"from smallor mid-sizedairlines in Americaor Europe,from Intercontinental airlinesbased in Asia,the MiddleEast or SouthAmerica, or from any independenteconomists or industryanalysts. Air Francebegan an activedrive for its USpartner (Delta) to acquireNorthwest, Lufthansa began an activedrive for itspartner (United) to acquireContinental, the lastremaining independent competitoron the NorthAtlantic tr Air Franceand Lufthansawere the only two partiesto everexpress a willingnessto investin either of thesetwo mergers tr Delta'sclaim that the Northwestmerger is a responseto today'shigh fuel pricesis false; it had beenconceived and plannedwhen fuel priceswere lessthan half of today'sprices The EuropeanUnion delayed agreeing to a new OpenSkies treaty with the UnitedStates for overfive yearswhile it demanded(unsuccessfully) the rightfor Lufthansaand Air Franceto take muchlarger ownershippositions and to directlycontrol the managementof their USpartners ! Thisfive year delay kept the EUin violationof a 2002European Court of Justiceruf ing which had invalidatedtraditional bilaterals that did not grantequal rights to all EU-basedairlines. The final 2007treaty was virtuallyidentical to termsthat the UnitedStates would have acceptedin 2002but for the EU'spursuit of full Transatlanticmergers Followingthe Delta(Air France)and United(Lufthansa) applications, industry observers have long expectedthat BritishAirways and Americanwould applyfor the samefull antitrustimmunity on NorthAtlantic services that the Air Franceand Lufthansaled groupsenjoy. Recentevents follow the patternof a carefulPR strategy designed to minimizepublic awareness and discussionsabout extreme concentration. By announcing Delta-Northwest first, fewer alarmbells about "competitiveissues" (compared to other Megamergers)because of superficialappearances aboutdomestic route overlap and slotsat constrainedairports. lf pressreports emphasized claims that Delta/Northwestdidn't requireserious antitrust review, there would be lesspressure for a rigorous,independent anafysis of the Delta'sclaims and the actualconsumer and competitive impacts.Rapid approval of Delta/Northwestmakes the approvalof all subsequentMegamergers virtuallycertain. lf Delta'sclaim of hugesynergies and efficienciesdriven by increasedscale and networkscope is accepted, there would be no plausiblebasis for denyingthe samebenefits to United.Once the immunizedAir Franceand Lufthansaled groupshave secured permanent dominanceof the ContinentalEurope market, there isno logicalbasis for denyingimmunity for similarcollusive practices to Americanand BritishAirways.

Horantestimony, House Transportation Committee, 14 May 2008 7 In fiveyears, these actions will havetransformed the Transatlanticmarket from onewith vibrant, profitablecompetition, to onewhere three collusive groups will havepermanent control of over95% of all traffic,and will havethe abilityto raiseprices at will without the possibilityof anycompetitive or regulatorydiscipline.

The"endgame" of thisfive yearprocess is the questionof whetherContinental Airlines joins the Lufthansaled group (via either collusive alliance or mergingwith United)or whetherit joinsthe British Airways-ledcollusive group focused on the UKmarket. U n ited/Luftha nsa aggressively pursued the merger optionfor tour years,knowing this would eliminatethe lastindependent competitor on the North Atlanticand give the Lufthansagroup a marketshare edge over the Air Francegroup. While Continental decidednot to takeon the enormousrisks of a full Unitedmerger at thistime, it remainsextremely unlikelythat it wouldremain independent-its current 10% market share would be not besustainable overtime againstan 85% Duopolyposition. Whether Continental decides to join one of the collusive groupson an alliancebasis, or decidesto wait until morefavorable terms for a Unitedmerger, the result would lock-inpermanent control of the NorthAtlantic for the threecollusive groups.

Meqame D VC Extreme TI ransauantlctl ti cLoncentratlon Levels Continental 2003 2009 UlVlreland 2003 2009 Europe actual post-mergermarket actual post-merger AF group 30% LHqroup 48% BA 33% BA qroup 63% LH qroup 26% AF qroup 44% AA 18% LH group(UA) 11% KLqroup 11% BA qroup(AA) 6o/o VS 12% VS 11% AA 7% other 2o/o UA(ln sroup) 11% AF qroup(DL) 9o/o co 7% assumesCO ioins LH co 8% EI 4% US 5% DL(AFqroup) 5% other 2% other 15o/o Duopoly 92% EI 5o/o assumesCO ioinsBA U5 5o/o 2003data from DOTForm 41 T10A other 3%

5. MegamergersFail Every lmportant Antitrust Test

Megamergersand the extremeconsolidation of Intercontinenta I airlinesviolates all of the following basic testsused to evaluatewhether mergersthat eliminatecompetition might be in the public interest

I ls concentrationincreasing in marketswith low entry barriers? tr No-these transatlanticmarkets have huge barriersto new entry-there is absolutelyno possibilitythat future entrantscould ever achievethe market presenceneeded to discioline anti-competitiveabuses by either the Air France/Lufthansaled Duopoly in ContinentalEurope or the prospectiveBritish Airways led group in the US-UKmarket r lsconcentration increasing because of marketplacesuccess? o NO-all of the movement towards extremeconcentration since 2OO4 results from mer9e6 ano government interferencefavoring the interestsof the very large carriersover the broader interestof consumersor industryefficiency. None o{ the movementtowards Duopoly since 2004 resultsfrom carrierswith lower costs,more efficient operations,lower pricesor superior servicedisplacing less productive, less competitive airlines. r Can regulatorsrely on "market forces" to disciplineany future anti-competitivebehavior? tr No-these marketsare not "contestible "-th e Air France/LufthansaDuopoly would be permanent,as would be the dominanceof the prospectiveBritish AirwayJAmerican/Continentalcol lusive alliance I Would marginal lossesin competition be offset by efficiencygains, that could yield tangibte consumer benefitsin terms of lower pricesor improvedservice?

Horantestimony, House Transportation Committee, 14 May 2008 8 ! NO-at the carrierlevel, true synergiesand efficienciesare very limited, and couldnot possibly justifythe costand risksof theseMegamergers to the carriersshareholders, and thuscould not possiblyprovide tangible consumer gains offsetting the lossof competition.The carrier claimsabout synergy/efficiency gains cannot be takenat facevalue since no comparable airlinemerger in NorthAmerican history has ever justified shareholder costs (much less risks to consumers)based on synergiesand efficiencygains. Would mergerslead to a shakeoutof structurallyuncompetitive, unprofitable industry capacity leadingto a muchmore efficient allocation of capitalacross the industry? ! NO-at the industrylevel, Megamergers and extremeindustry consolidation are designed to makethe shakeoutof unprofitableindustry capacity more difficult and to increasethe misallocationof capital.Delta management is committed to retainingall of its unprofitable domesticcapacity. The marketcapitalization of Deltaand Northwestfell by $1 billionafter the mergerannouncements because Wall Streetfelt that the mergerwould makeneeded capacitychanges more difficult. By usingartificial North Atlantic profits from anti-competitive pricingto distortdomestic competition (as discussed earlier), Megamergers would make competitiveand capitalmisallocation problems across the industryeven worse. Would mergerscreate clear, tangible service and pricingimprovements for consumers? I NO- thesemergers are explicitlydesigned to screwconsumers. The entire economic rationale dependson artificialpricing power. lf you take awaythe anti-competitiveimpacts in Internationalmarkets Delta and Unitedwould haveno interestin a merger.lf these Megamergersare implementedprices will increaseand servicewill continueto decline, especiallyto Europe.Consumers will havefewer choices.Consolidation will not drive meaningfulimprovements in schedulefrequency or hub operations.Over time the lossof marketcompetition will leadto a steadydeterioration in service,cost efficiency and innovation.

6. ExtremeConsolidation on the NorthAtlantic Could Not HaveHappened Without Direct Government InterferenceWith Open-Marketcompetition

"MarketForces" did not drivethe rapidmovement from healthycompetition and low concentrationto permanentdomination of the Europeanmarket by a Duopolyof collusivegroups and permanent dominationof the UKmarket by a third collusivegroup-it wasdriven by the carriers,themselves, in pursuitof profitsfrom marketpower and anti-competitivepricing. But it couldnever have happened without the full supportof the EuropeanUnion and the USDepartment of Transportation.As noted earlier,the EU'smade an explicitpublic policy decision to abandonits previous focus on the general publicinterest in open-marketIntercontinental competition and to activelyintervene in airline competitionand industrystructure in favorof the interestsof the shareholdersof Air France,Lufthansa and BritishAirways. EU decisions and actionsover the lastfive years have been clearly aligned with its statedpro-"industry consolidation" and pro-"nationalchampions" policies. However, the DOT'Songoing supportfor artificialconsolidation has not beenbased on anystated policies, and hasnot beenthe subject of publiccomment and reviewmuch less Congressional oversight.

DOThas approved, with minimalanalysis or review,every Legacy carrier application to increaseNorth Atlanticmarket concentration in recentyears, including every requested expansion of Luftha nsa/U nited antitrustimmunity to a widergroup of airlines,and the recentmerger of the previouslyindependent Air France/Deltaand NorthwesVKLMalliance. lt isunclear whether these decisions represent gross negligence on the DOT'spart (atotal disinterestin protectingthe publicinterest in healthymarket competition, or a refusalto assignthe requiredresources and expertiseneeded to addressthese issues) or a willful attempt to undermineexisting competition policies in {avorof the interestsof companieslike Delta.At no point in anydecision or analysishas the DOTacknowledged either the clearhistorical evidence of rapidlygrowing consolidationsince 2004 (as shown in the tablein section3), or publiclyacknowledged the possibilitythat extremeconsolidation might threaten consumers, or attemptedto defineany objective analytical frameworkfor evaluatingthe tradeoffsbetween increasing airline concentration, industry competition andefficiency, and consumer welfare.

Horantestimony, House Transportation Committee, l4 May 2008 9 TheDOT issues are illustrated by its recentdecision on Air France'sapplication to mergethe Air France and KLMalliances (Docket OST-2007 -28644). lt rapidlyrubber-stamped the alliancemerger without any scrutinyof mergerclaims and without anyattempt to independentlyanalyze any of the competitive/consumerissues, and would be extremelydangerous to assumeto useit asprecedent in futurecases . The two alliancesthat were "merged"by thisdecision have greater route overlap and would achievehigher concentration in their coremarkets than a mergerbetween United and Americanat Chicagowould achieve,but the DOTfailed to conductanything similar to the seriousmerger/antitrust analysissuch cases would require.

DOTtotallyignored all historicalevidence of rapidlyincreasing US-Europe concentration, and the artificialcauses of thisconcentration, and the specificrisks that concentrationlevels this high could leadto anti-competitivepricing behavior DOTaccepted undocumented carrier claims of consumerbenefits and costefficiencies without any independentobjective analysis or any attemptto explainwhy the allegedgains offset consumer risksfrom reducedcompetition, and n yet DOTrejected evidence of higherprices and other anti-competitivebehavior because it didn't providedefinitive proof of "a substantialreduction in competition" DOTdeliberately ignored the consumerrisks created by high barriersto entry,asserting that "Open Skies"treaty conditions automatically ensured fully contestiblemarket conditions DOTdeliberately understated actual concentration impacts by includingthe separate10 million passengerUS-London market (which KLM and Air Francehave never served) DOTignored the fundamentaleconomics of the DL/AF/NWKLhub-based networks by ignoringthe extremeconcentration of the connectingmarkets that driveUS-EU competition. Aside from its deliberatelyunderstated comparisons of aggregateTransatlantic shares, its only competitive analysis(simple tables that countednonstops) was limitedto country-by-countrynonstop service. Overhalf of all trafficon Air France/KLMtransatlantic flights connect to other citiesbeyond the gateway.The Air France/LufthansaDuopoly will controlalmost 100% of this hugetraffic base, and it isa criticalfactor in Transatlanticcompetition, but the DOTdid not evenacknowledge its existence. DOTdid not considerany evidenceexcept what waspresented by the largeLegacy airlines

Horantestimony, House Transportation Committee, 14 May2008 10 AppendixA

AlmostAll MergersBetween Large Airlines Since Derequlation Have Been Dismal Financial Failures

In almostevery case, airline mergers have failed to generatepositive returns for shareholders,which is to sayprofit improvements(above and beyondwhat the carrierswould haveearned absent the merger)that fullyjustified the financialcosts and risks.Mergers that cannotearn positive returns for shareholders cannotpossibly justify the risks(from reduced competition) imposed on consumers.The rare successes, involvedeither --Major restructuringof hubswhose development had beenartificially blocked before deregulation --VerySmall acquisitions that wereeasily integrated into the parentairline --Mergersimplemented under chapter 11 or bankruptcy-likeconditions Theproposed Delta/Northwest and Un ited/USAirways mergers have none of the characteristicsof any successfulmerger and havemany of the characteristicsof the failedmergers.

-argeAirline Mergers ategory UUeremerger acquisition and implementation costs tullv iustified bv improved profitabilitv? 30:Pan Am/National 1-PostDereg AILURE-NA networklargely liquidated 32:Texas lntl/Continental 1-PostDereg FAILURE-carrierquickly went bankrupt 35:Southwest/Muse 2-Quasi-BK Profitable-cheap acquisitionin lieu of MC bankruptcy 35:People Exp/Frontier 4-Synergy/5copeFAILURE-carrier quickly went bankrupt 36:TWA/Ozark 1-PostDereg rrofitable-RestructuredSTL into a competitivehub 36:Northwest/Repu blic 1-PostDereg >rofitable-RestructuredDTWMSP into competitivehubs 86:American/Aircal 4-Synergy/Scope AILURE-OCnetwork totally liquidated 37:Continenta l/PElNY/FL 1-Synergy/5copeFAILURE-carriersoon bankrupt, FLINY networks liquidated 37:DeltaAl/estern 1-Synergy/5cope FAILURE-WAnetwork largely liquidated 37:Conti nental/Eastern 1-Synergy/ScopeFAILURE-COsoon bankrupt, EA network liquidated 38:U5Air/PSA 4-Synergy/5copeFAfLURE-PSnetwork fargelyliquidated 38:USAir/Piedmont 4-Synergy/5cope AILURE-USsoon bankrupt, Pl partially liquidated 14:5outhwest/Morris l-SmallAcquis >rofitable-easyfit with SWAnetwork/operations )9:American/Reno 4-Synergy/Scope AIIURE-QQ networklargefy liquidated )0: American/TWA 1-Synergy/ScopeFAILURE-TWnetwork largely liquidated )0: United/USAir(plan) 1-Synergy/5cope FAILURE-both carrierswent quickly bankrupt 15:America WesVUSAir 2-Quasi-BK fury StillOut-favorable bankruptcyterms, but struggling Note:2000 United/USAir merger reached regulatory review process but wasnever implemented All Canadianairline mergers during this time frame were also failures

MergerCategories, based on the economicrationale for pursuingthe merger 1-Post Deregulation : integratingroutes and hubsthat had beenartificially constrainedunder CAB regu lations 2-Ouasi-Bankruptcy sale/integ ration of assetsunder chapter 11 protection (or a transact;onin lieuof chapter1 1) where only assets were acquired at highlyfavorable rates and assetsnot requiredpost-merger were not acquired 3-Very5ln_alLAeS_Ut5jtian5:mergers involving very smallfleets, where operationscould be easilyand quicklyintegrated into the parentcompany 4--CostSynergies/Network Scope-mergers (outside of bankruptcy)justified by costsynergies, scale economiesand networkscope synergies. s-Htgh.ly Atrt!:eqlopettwe (no USAexamples in the 1980-2005timeframe) mergers designed to create andexploit market dominance and pricingpower in environmentswith highentry barriers

'14 Horantestimony, House Transportation Committee, May 2008 11