The Pocketbook Truth Of Airline Alliances

If you had to pay $3,400 for a round-trip, economy-class airline ticket between Atlanta and Amsterdam, would you be confident that vigorous trans-Atlantic airline competition is providing you with great value?

I would not.

Atlanta is both the world’s busiest airport and home base for Delta Air Lines (DAL), the world’s leading carrier last year. Amsterdam, a major European hub, is home to the KLM unit of Air France-KLM, which is Delta’s major partner in the SkyTeam global airline alliance.

Delta CEO Richard Anderson met recently with Air France-KLM (AFLYY) executives to discuss which airline would make which cuts to their respective trans-Atlantic routes this fall. By working together to limit capacity during an anticipated slow flying season, the airlines hope to keep seats filled and fares high. This helps explain the $3,431 fare (including taxes and fees) I found on Orbitz last week when I priced a hypothetical flight departing Atlanta on Monday, Oct. 3, and returning Friday, Oct. 7. Delta and KLM are the only airlines offering non-stop service on that route.

When businesses “coordinate” their prices and services, it is usually the companies, not their customers, who benefit. This is why the United States and many other countries have antitrust laws.

Had representatives from Delta and American Airlines attempted such so-called coordination on domestic routes, it would have been a blatant violation. But Delta and Air France-KLM enjoy an antitrust exemption that made the meeting legal. They still compete with other trans-Atlantic providers, such as American and its Oneworld partners or United and its Star Alliance, but Air France-KLM, which is number eight among global airlines and the second-largest in Europe, and Delta can fix routes and prices among themselves without restraint. Delta recently won another exemption with Virgin Australia, allowing those airlines similar privileges in the South Pacific.

Such exemptions, however, may not last. The Obama administration has taken a skeptical stance on antitrust immunity for airline alliances. When it was under Democratic control in 2009, the House passed legislation that would have made all previous grants of immunity expire after three years and would have tightened the standards for future antitrust exemptions. The Senate, however, did not act on the legislation.

More recently, the Justice Department proposed ending antitrust immunity for fare-setting meetings held through the International Air Transport Association (IATA). The Department argued that changes in international air travel have made such price coordination unnecessary and that today’s more powerful international alliances reduce the need for the IATA to get involved in pricing and route determinations.

Airlines, not surprisingly, are fighting to retain their antitrust immunity. Two Washington attorneys who represent the industry, Warren L. Dean and Jeffrey N. Shane (a former official in the Department of Transportation), set out the airlines’ case last year in an article that argued airline alliances “generate important competitive benefits.”

“Put simply, if a combination of resources from different enterprises is necessary to compete effectively in a given market, then allowing the combination to take the most efficient form effectively lowers the barriers to entry into that market,” they wrote.

Dean and Shane raise a good point, which is that national laws severely limit cross-border ownership of airlines, making trans-Atlantic airline mergers all but impossible. If Delta were to merge with Air France-KLM, there would be no need to collude about setting routes and rates. But American law blocks such mergers by prohibiting more than 25 percent foreign ownership for a domestic airline. Many other countries have similar rules. Of course, if aviation law permitted Delta to merge with Air France-KLM, antitrust regulators would still need to sign off on the deal.

Industry lawyers argue that we should look at competition between alliances, or between alliance members and unaffiliated airlines, to find the economic benefits of alliance antitrust exemptions. If my hypothetical October trip had been between Newark, N.J., and Amsterdam, the fare would have been $2,208 on United and its partner Lufthansa, or on Delta and its partner KLM. If we credit the alliance with making Delta and KLM a player at Newark, where United’s Continental unit has a major hub, then maybe the competition is keeping United’s fare down.

But on the same dates as my proposed Atlanta-Amsterdam trip, travelers could fly on Delta or KLM from New York’s John F. Kennedy International to London’s Heathrow for just $1,284. The SkyTeam airlines compete on the JFK-London route with British independents Virgin Atlantic and British Midland International, Star Alliance members United and Lufthansa, and Oneworld’s British Airways. Is it the alliance members or the independents that are keeping the fare that low?

A look at flights from Chicago’s O’Hare airport to Heathrow on the same dates gives us the likely answer. Neither Delta nor Air France-KLM offered a flight on that route on that day. Star Alliance’s United has a major Chicago hub, yet its fare was a comparatively modest $1,500. The key is in the fact that British Midland flies that route at $1,500, while Virgin Atlantic was only a little more, at $1,685. It seems the biggest factor in holding down fares is not the presence of one or more of the old-line, full-fare carriers and their global allies; it is the presence of aggressive, generally independent discount airlines.

The recent negotiations between Delta and Air France-KLM probably focused on who would be allowed to fly the lion’s share of the high-revenue, less-competitive routes to places like Amsterdam, where trans-Atlantic discounters are not a factor, and how much capacity to cut from low-fare, competitive routes to places like Heathrow.

Allowing the partner airlines to “bargain” with one another, as an Air France executive described it, keeps international fares higher than they would be if airlines had to match the prices and performances of their most efficient competition. Absent their alliance, Delta and KLM would likely have to compete with one another on the route that joins their respective home cities. Instead, thanks to the antitrust immunity, Delta can keep its international capacity relatively low and its associated profits high. This gives it more resources to focus on domestic competitors.

One of those competitors is Southwest, whose recent acquisition of AirTran could make it a threat to Delta in the Atlanta hub. Southwest only flies domestic routes, so it cannot collude with competitors. Unlike Delta, it doesn’t have artificially high international route profits to fall back on, putting it at a disadvantage. The international exemption creates an uneven playing field.

Airlines need to recover their costs, including currently high fuel costs, and make a profit. This reality means mergers between domestic airlines are often a logical step, as with Southwest and AirTran, or Delta’s earlier acquisition of Northwest. I generally have no objection. Similarly, it would sometimes make sense for U.S. airlines to formally merge with foreign competitors, if they were not prohibited by law from doing so.

Without such regulations, Delta might already have merged with Air France-KLM, making inter-company coordination unnecessary. This legal roadblock is one of many reasons that large airline alliances like SkyTeam have become so dominant; they allow international airlines to share many of the benefits of merging while observing the laws that keep them separate. They offer customers convenience, increased loyalty benefits, and simpler ticketing. Unfortunately, they also come at the cost of higher fares. The more antitrust exemptions, the higher the fares rise.

If we are going to have separate airlines, we should keep them separate in ways that benefit travelers. We would do that by fostering competition rather than suppressing it. It is time to give the alliances’ antitrust exemptions another look.

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