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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About Larry M. Elkin 564 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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2 Comments on The Pocketbook Truth Of Airline Alliances

  1. Good article with some good points, but maybe the author could do a better job researching facts. BMI does not fly Chicago-London, they most likely show up as code-sharing on UA flight ops (so there goes his little theory about domination in a market place). Little errors like this put the whole creditability of the article (dare I say author) in question.

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