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On airlines, DOJ finally gets a backbone

August 14, 2013: 11:11 AM ET

By blocking the merger between American and US Airways, the government is saying that a tipping point was reached with the last mega merger. It's about time.

By Cyrus Sanati

american-airlines-us-airways-merger-620xaFORTUNE -- The government's unexpected move to block the merger of American Airlines and US Airways is a positive change of tack for the Justice Department, which, for the last decade, has essentially rubber stamped similar combinations to the detriment of the flying public. The unusually harsh tone of the government's brief on the matter suggests that there is little to no chance that this latest mega merger would be allowed to take place without crippling concessions from the airlines that would make the merger unpalatable to either carrier. While both American and US Airways say they will fight the government on this issue, it would be in their best interest to develop standalone plans.

This turnaround couldn't have come soon enough for consumers who have seen fares rise and service collapse as a result of the various airline mega mergers. The government rightly contended that this latest merger would have continued this trend through tacit collusion with other airlines in regards to routes, fees and fares. The airline industry is vital to the U.S. economy and is already subsidized, both directly and indirectly, by the government. Further consolidation would have made it much harder to convince airlines to keep service to secondary cities and small towns that normally wouldn't have access to certain routes or to any air travel whatsoever.

It is rare that the government shocks Wall Street but the Justice Department's move to block the merger plans of American Airlines and US Airways did just that. US Airways stock fell 13% on the news Tuesday as investors ran for the hills. It took several hours for the airlines to counter the government's harsh contentions laid out in its motion to enjoin the merger, suggesting that they too were taken aback.

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This is odd because it is doubtful that the airlines would have even proposed the merger without at least a wink and a nod from government officials giving them the green light. But there has, for some unknown reason, been a change of heart at the USDOJ concerning airline mega mergers. The government's brief, which was issued in tandem with seven state's Attorneys General, including Texas and Arizona where American and US Airways (LCC) are headquartered, respectively, was chock full of quotes from Doug Parker, US Airways' chief executive, and other airline executives noting how airline consolidation has essentially been a positive for industry profit but a bad thing for the U.S. flying public. It focused on the impact the merger could have at Washington's Reagan National airport, noting that the combined carrier would control 69% of the takeoff and landing slots at the airport and over 60% of the nonstop flights. This merger seems to have literally hit too close to home for the government.

There is little hope the airlines can save the merger. They noted in hastily prepared statements that they were going to take the government to court to somehow force this "procompetitive" merger through. But such an endeavor seems futile. The government can clearly demonstrate that past airline mergers have led to reduced service and higher fares and fees for consumers in an industry that is of vital economic importance to the nation.

There are plenty of examples for the government to use when demonstrating how mergers lead to reduced service -- actually, too many. It can turn to how American Airlines decimated TWA's St. Louis hub when it merged with the carrier in 2000 or how Delta Air Lines (DAL) did the same with its hubs in Cincinnati and Memphis following its merger with Northwest Airlines in 2008. But probably the best example the government can use regarding reduced capacity comes courtesy of Doug Parker and his campaign of lies concerning US Airways' once great hub in Pittsburgh. When US Airways merged with America West in 2005, Parker, who would go on to lead the combined airline, said that he did not expect any changes to come to US Airways' operations at Pittsburgh. The government believed him, after all, the airline had already sliced operations at the airport in half in the last few years, going from over 500 flights to 233 flights per day. But after the merger was complete, Parker almost immediately reduced the number of flights in and out of Pittsburgh to 170. Today, US Airways operates only 41 daily flights out of Pittsburgh. International travel in and out of Pittsburgh is now almost nonexistent, forcing residents to fly or drive to a larger city.

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It is no wonder why Pennsylvania's Attorney General's office signed on to the DOJ's case to enjoin the merger. They know all too well that Parker's latest promise that the new American Airlines would keep all its routes is just lip service to get the green light from regulators. Philadelphia, a major US Airways hub, will undoubtedly see international routes cut after the merger given American's much larger international hub in nearby New York. The loss of those flights would downgrade Philadelphia to regional airport status, which would be a profound blow to the city and its prospects of reinventing itself as an international business hub.

The US Airways and American team's only real argument here will be to claim unfairness -- why aren't they allowed to merge when the government signed off on the other airline mega mergers, namely, Delta's merger with Northwest in 2008 and United's merger with Continental in 2010? The government's horror that Reagan National would be dominated by the new American seems hypocritical after they allowed the new United (UAL) to control over 80% of the air traffic at Houston's Bush Intercontinental airport following its merger with Continental. The truth is, that the combination of American and US Airways is no less damaging to competition than the past mega mergers.

But the government can argue that it allowed those other mergers to go through because the composition of the industry was different at the time. If US Airways and American would have tried to merge, say, in 2009, before United and Continental's tie up, then the government's analysis would have been different. By blocking this last of the mega mergers the government is saying that a tipping point was reached with the last mega merger, which makes the US Airways and American merger too much to swallow. In its complaint the DOJ showed how US Airways offers much cheaper fares to customers who connect through their various hubs as opposed to flying direct. This is because they are in direct competition with three other airlines for many of the same routes. The DOJ is concerned that those cheap fares would go away with the merger as American tends to better match prices with other airlines on routes, regardless of how many stops are involved.

American and US Airways will be just fine if this merger is blocked. American has lowered its costs thanks to its recent voluntary trip into bankruptcy while US Airways will continue being the airline of secondary and tertiary U.S. cities. Both will be profitable and can continue making money thanks to tacit and government-approved collusion with the remaining legacy carriers. If either airline wants to grow then they will need to do it the old fashioned way -- buy more jets and fly more routes.

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