United States: Airline Antitrust Investigation: Are The Skies Too Friendly?

Last Updated: November 19 2015
Article by Daniel Schaefer and Erik Lowe

This past summer the Department of Justice opened up an investigation into the domestic airline market to determine if there had been collusion in the decisions to limit the expansion of seat capacity (ergo, to raise ticket prices). In the months that followed, airline passengers around the country filed at least 23 separate class action suits accusing the airlines of conspiring to fix airline ticket prices. After a jurisdictional battle broke out among leading cases, the U.S. Judicial Panel on Multidistrict Litigation consolidated the class actions to the District of the District of Columbia. Unfortunately for the airlines, regardless of the outcome of the DOJ investigation, the multidistrict lawsuit will likely continue.

At this point, it is not exactly clear what prompted the investigation, nor has a cogent theory of collusion emerged. The New York Times initially reported that multiple airline executives may have signaled each other in public addresses and trade association meetings to remain "disciplined" about capacity—industry jargon for limiting flights. Shortly thereafter, Senator Richard Blumenthal of Connecticut called on the DOJ to take more aggressive action, pointing to surging airline profits and perceived higher fares for passengers in spite of falling fuel costs. Senator Chuck Schumer followed, alleging that the airlines were withholding flight information from discount websites in an attempt to control ticket sales. And in recent months, the DOJ has indicated that it is looking into communications between the airlines and their significant investors, presumably under the theory that investors with common ownership served as a conduit through which a collusive outcome was sought.

Whatever the alleged vector, regulators may have a hard time overlooking prior antitrust investigations in this industry. From 2005 to 2011, the DOJ obtained guilty pleas from many airlines and secured nearly $2 billion in fines for an alleged conspiracy to fix cargo fuel surcharges. The current claims fall against that backdrop, and in spite of plummeting fuel costs—savings you'd expect airlines to pass on to customers—inflation-adjusted fares have risen (slightly). In addition, the airlines are now reporting large profits; a remarkable recovery for an industry that lost billions for many years and had several participants file for bankruptcy.

Of course, the fact that the airlines are finally all making profits does not prove anything on its own. In many competitive industries, business decisions on pricing and capacity may be "interdependent." Competitors may have parallel responses when presented with similar market forces. The airlines could be engaging in substantially similar business conduct, whether in terms of setting prices or limiting passenger carrying capacity, simply because they have all decided independently that it is the best strategy. If common investors are involved, it opens up a new-ish theory of antitrust liability that asks whether investors, acting in self-interest to reap higher profits and in response to similar market forces, violate the Sherman Act by influencing their airline investments in similar ways.

Still another twist that might play out is the role of confirmation bias. The DOJ has, for the most part, approved the series of mergers over the past few years that reduced the number of major airlines from eight to four. The most recent of these mergers between American and US Air in late 2013 consolidated more than 80% of the domestic airline seats into only four carriers. The DOJ initially sued to block it, but American and US Air ultimately persuaded the DOJ that the merger would benefit consumers by allowing the joined airlines to create more options for travelers through a comprehensive network of global alliances. Can the DOJ now be tasked with impartially determining whether this market is supporting collusion without calling into question the prudence of its prior decisions?

In addition, some research suggests that the industry is not predisposed to price-fixing. This is the position of Harvard professor Michael Porter, famous for his Five-Forces Analysis assessing the "attractiveness" of a market through five external forces: (1) threat of new entrants; (2) threat of substitute products; (3) buyers with bargaining power; (4) suppliers with bargaining power; and (5) rivalry among existing firms.2 Collusion acts on the fifth force by suppressing inter-firm rivalry.3 As such, price-fixing should be more profitable in industries where forces 1-4 have a relatively benign effect on prices, and factor 5 exerts greater influence.

The Five Forces analysis implies that the airline industry is notoriously unattractive for price-fixing because airline profitability and growth are most heavily influenced by Forces 1-4: there are low barriers to entry, with new startups continually threatening incumbent airlines (force #1); other means to travel are improving (force #2); customers are becoming better informed and can easily discover competitors' prices through online sources (force #3); the two main suppliers of commercial jets are responding to increased international demand, and flying is dependent on fuel, labor, and infrastructure costs, and subject to government control and political influence (force #4). Even meteorological forces, from Icelandic volcanoes to polar vortices, can wreak havoc on airlines profits.4

Porter's work emphasizes an important reality underpinning the potential for collusion in the airline industry; namely, inter-firm rivalry, historically, has not been the main threat to airline profitability. On the other hand, we might be witnessing a new dynamic in the post-merger environment. Although mergers eliminate competition between the firms that merge, they also increase the incentives—and therefore the likelihood—for the remaining firms to collude. If the mergers create an oligopolistic market, it also becomes easier for the remaining participants to consciously monitor, and parallel, their competitors' actions without ever having forged an agreement, a phenomenon known as tacit collusion. The ultimate question for the DOJ is whether the airlines made an agreement. Although the Sherman Act is broad enough to encompass a purely tacit agreement to fix prices, the DOJ usually proves collusion through communications.

At some point, the antitrust regulators at the DOJ must have concluded that the airline mergers it approved were competitively beneficial or at the worst competitively neutral. Yet all merger analysis is predictive and imperfect. Perhaps the DOJ has had a change of heart, or perhaps it just believes an investigation is warranted as a first step. Either way, for companies operating in markets with only a few major participants, it might not be a bad idea to be just a bit less friendly.

Footnotes

1. The ideas expressed herein are my own personal and independent views, and not those of Dickstein Shapiro or its clients.

2. Michael E. Porter, "The Five Competitive Forces That Shape Strategy," Harvard Business Review (Jan. 2008).

3. Robert C. Marshall & Leslie M. Marx, The Economics of Collusion (2012).

4.The Five Competitive Forces That Shape Strategy, An Interview with Michael E. Porter, (June 30, 2008) (here for video).

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