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DEC
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PAN AMERICAN TO UNITED:
THE PACIFIC DIVISION TRANSFER CASE
Franklin M. Fisher
Number 420
May 1986
massachusetts
institute of
technology
50 memorial drive
Cambridge, mass. 02139
4
1986
<PAN AMERICAN TO UNITED:
THE PACIFIC DIVISION TRANSFER CASE
Franklin M. Fisher
Number 420
May 1986
5/26/86
Franklin M. Fisher
Massachusetts Institute of Technology
United Airlines recent acquisition of Pan American's Pacific
Division will greatly increase concentration,
-
Japan service
—
an important market
Price competition will disappear.
ket
combining
its
with high entry barriers.
United will dominate the mar-
use of its computer reservation
biased
by
less
and
by
Ameri-
Without the acqui-
the resulting efficiencies could have been achieved in a
restrictive
way with three carriers competing
efficient service.
narrow
system
own giant domestic feeder system with Pan
can's Tokyo hub, both legacies of regulation.
sition,
especially in U.S.
to
The Department of Transportation took
view of its post-deregulation responsibilities in
ving the acquisition.
provide
a
very
appro-
DEC 3
1986
f
Franklin M. Fisher
Massachusetts Institute of Technology
success
The
substitution
of
competition
substitution
in
turn
particularly
in
the
deregulation
airline
of
direct
for
requires serious
transition
the
on
That
regulation.
enforcement,
antitrust
a
free
danger
that
regulated
from a
Without such enforcement,
environment.
depends
there is
a
to
airlines
that
were specially favored during the regulatory
will
able
to combine and parlay those
be
advantages
era
into
an
avoidance of market discipline.
April,
In
United
1985,
Airlines and Pan
announced an agreement whereby United would acquire
Airways
American's International Pacific Division.
American
$750
million,
craft and other assets.
while Pan American was to
along with
and 401(h)
408
to
air-
The two airlines applied to
Department of Transportation for approval pursuant
amended,
tive
transfer
An agreement involving employment of Pan
American employees was also reached.
tions
Pan
United was to pay Pan
its underlying Pacific route authority,
United
the
World
American
of the Federal Aviation Act
of
sec-
to
1958,
as
and, after an evidentiary hearing before an Administra-
Law Judge (who,
however,
wrote no opinion).
Secretary of
Transportation Elizabeth Dole approved the transaction at the end
of October.
The
One,
issues involved in the proceeding fell into two
parts.
with which this paper will not be concerned, had to do with
.
the various labor provisions of the agreement.
of this paper,
subject
dealt with the possible effects
nautics Board (CAB)
(DOT)
,
and this was the first
The competitive issues were
major case to come before it.
in testimony offered by the two applicants,
partment
and by American,
of Justice,
Airlines.
I
was
the
of
the task of dealing with that issue devolved
,
on the Department of Transportation
sidered
the
With the demise of the Civil Aero-
on competition.
acquisition
The second,
a
Eastern,
witness for Northwest,
con-
De-
by the
and
and this
Northwest
paper
is
largely based on my testimony.
Merger and acquisition cases are remarkable even among antitrust cases for the extent to which they tend to focus on
issues
of market definition and the measurement of concentration.
focus is an unfortunate one.
While market definition and concen-
measurement are not irrelevant,
tration
they at best provide
guide to the competitive issues involved.
crude
That
a
In particular,
market definition is only a way of organizing the data, while too
little is known about oligopoly behavior for measures of
tration such as the Hirschman-Herf indahl Index (HHI)
concen-
to give more
than a very rough indication of the likelihood of non-competitive
Consideration of such matters is entirely appropriate
behavior.
as
a
screening device,
Guidelines.
will
center
serious
as in the Department of Justice's Merger
The danger in actual proceedings is that discussion
on such threshold issues to the exclusion
and detailed analysis.
of
This is particularly likely
more
in
the case of the HHI where the natural desire of attorneys to find
a
bright line leads a numerical index to be taken over-seriously
.
The EM£lii£^QiyisiQn^ll£&nsl3£^£&SS was no exception. Indeed,
the applicants,
correctly foreseeing that the Department of Jus-
(and possibly others)
tice
presentations
on
were ready with obviously pre-prepared rebuttal
HHIs,
involving
would rely heavily
testimony directed solely at the question of whether anything can
be
concluded from examination of raw HHI statistics in
airline "markets".
tional
As a result,
Secretary Dole's opinion,
cially,
interna-
the debate and,
espe-
was misdirected, giving rela-
tively little attention to the interesting and substantive compe-
titive issues.
market definition and concentration
Nevertheless,
ment are important threshold issues to discuss,
and
measurebegin with
I
them.
anti-trust
Market definition is only the starting point for
defining
analysis,
analysis
market
will
the universe of discourse within which
take place.
Hence,
to be useful,
definition must include all those
'
noncompetitive behavior in the proposed market.
can
proposed
products,
firms,
and
constraints
that are likely to provide substantial
services
a
that
Such constraints
come either through substitution in demand or through
ready
substitution in supply (which shades over into ease of entry)
In
gers,
previous cases involving post-deregulation airline
the
CAB
wisely
declined to look only
on
at
2
mer-
concentration
statistics constructed for narrowly defined markets consisting of
individual
possibility
city
pairs.
The CAB reasoned
correctly
that
the
of entry by other carriers into serving a particular
wider market definition was
city
pair meant that
even
though it was not always clear just what that wider defini-
tion should be.
a
called
3
market
SMSl^iQ^'QA^lsl&B^TXMnsfSl^QMSM presents no such
The
for,
concentration
the message of the
definition
problems.
statistics
(whatever that is worth)
First,
any
reasonable market definition.
tant)
,
is
essentially the same
Second (and far more
for
impor-
air transportation in the Pacific does not take place in a
deregulated environment, and problems of entry are severe indeed.
Table
travel
shows that the largest segment of U.S. -Far East
1
is
between
mainland and the
the U.S.
Far
East.
Hawaii-Far East and Guam-Far East segments predominantly
of low-fare,
Japan-originating tour group travel.
segments (as opposed to Japan-mainland travel)
posed
primarily
reign
flag carriers.
tings.
Trip
[TABLES
travel
this?
for example,
rouadd
1
So far as the U.S.
I
concentrate
AND
2
market
definition
4
HERE]
be interested in a narrower
is concerned,
fo-
U.S. -Far
non-stop
In what follows,
on Mainland U.S. -Far East air travel.
than
com-
hours to what would otherwise be a
4
5200 mile, 10 hour non-stop trip.
one
to be
suggestion reinforced by the
a
routings via Honolulu to Japan,
approximately 1000 miles and
Should
shows
This suggests treating Mainland
that most of the passengers involved prefer
fact
2
of foreign nationals travelling largely by
East travel as a separate market,
The
consist
Table
these
air
part of Mainland-Far
the answer is negative.
East
Surveys of
air
U.S.
resident air travelers going to the Far East show that only about
32
percent of them live in one of the gateway
Mew York, San Francisco, and Seattle).
Los Angeles,
adjusting
cities
(Chicago,
5
Even after
for the fact that travelers residing near but not in a
gateway city also use that city's airport as their home
it
considerably more than half of all
is clear that
travelling
dents
to
the Far East do not begin
airport,
U.S.
resi-
end
their
and
Such travellers are likely to be indifferent
travel at gateways.
as to which gateway they pass through, making their choice on the
basis of schedule convenience and price.
Similarly, many passen-
gers originating in the Orient are unlikely to have strong prefeas to the choice of an American gateway through which
rences
or end their visits.
begin
definition
involving
They
narrow.
also
These facts suggest that
to
market
a
only single American cities would
be
too
competed
show that Pan American and United
with each other before the acquisition despite the fact that they
served different gateways.
A
similar
statement does not apply to
concentrating on particular Asian cities,
for
lar,
reasons
of geography,
market
definitions
In particu-
however.
the importance of Japan
as
a
tourist attraction, and the overwhelming importance of its economy in that of Asia,
play
a
the Japanese airports,
particularly
Tokyo,
vital special role in trans-Pacific travel.
Indeed, not only does more than half of trans-Pacific travel
originate
or terminate in Japan
(Table
remaining traffic passes through Tokyo.
1)
,
but also much of the
While it is possible to
compete for such traffic using other hubs (Seoul,
the
for
example),
fact that such a large part of the traffic stops,
lays over
,
or originates in Tokyo necessarily places the use of such
natives at
the
a
disadvantage.
In terms of demand substitutability
of those alternatives places only
availability
alter-
weak
con-
stemming from supply substitutability are
also
a
straint on the pricing of Japan-U.S mainland travel.
Constraints
relatively weak, for there are serious barriers to entry into the
provision of U.S. -Japan air transportation.
air transportation mergers,
domestic
deregulation makes for
dealing with
a
Unlike the case
where ease of entry
Bermuda-1
barrier
of
deregulated environment.
a
type bilateral agreement
conduct show,
Indeed,
neither U.S.
formidable
a
As over thirty years
freely
or Japanese carriers can
Japan
the last several years,
in
signed in 1952, is
presenting
to entry into U.S. -Japan service.
enter.
after
wider market definition, we are not here
The U.S. -Japan Civil Aviation Agreement,
a
in
favored
has
scrapping
the existing route description negotiated in the
agreement
in favor of an agreement v;hich,
1952
changes,
among other
would limit or do away with the existing valuable "beyond" rights
carriers to carry traffic beyond Tokyo).
(the right of U.S.
agreement of April 30,
permit
provide
a
1985,
The
which amends the 1952 agreement to
somewhat limited increase in Japan-U.S. service does not
a
corresponding increase in beyond rights
Indeed,
the
Japanese resisted the transfer of Pan American's beyond rights to
United,
asking
for
concessions from United
States,
and
only
backing down under heavy pressure from the U.S. government.
In
addition
to the reluctance of the
Japanese
to
permit
that can provide full-fledged competition,
entry
limitations
severe
on the use of Tokyo's
similar problems at Osaka,
and environmental factors,
airport
(and
Japan's secondary international faci-
(A
airlines serving Narita may toge-
only 270 movements per day during
provide
1985-86
and limits on terminal parking stands
As a consequence,
and gates.
hour permitted between 6:00 A.M.
There
movements
winter
are
of
Ope-
with only 26 movements per
and 8:00 P.M.,
fewer from 8:00
and none at all between 11:00 P.M. and 6:00
to 11:00 P.M.,
A.M..
the
takeoff and landing constitute two movements.).
rations per hour are also restricted,
P.M.
Narita
These include operational restrictions, political, legal,
lity).
ther
there are also
further
constraints on the total
in consecutive three hour periods.
number
Particularly
cause flights to or from the United States must use certain
of
betime
periods to enable passengers to make sensible connections without
arriving or departing at ungodly hours of the night,
period
constraints
As
one.
a
these time-
daily
are far more binding than the overall
result,
there is no serious prospect for a sizeable
expansion of operations in the near future.
These barriers are high, but they will become even higher as
a
result of the acquisition.
give the post-acquisition United an unfair
that
will
over
existing
strain
sitioned
The same factors described
competitors will even more certainly act
further entry.
United itself was the airline
to overcome the existing barriers;
later
advantage
to
re-
best
po-
it is hard to envi-
sion any other airline entering in a major way after the acquisition.
The presence of such barriers to entry and, indeed, the fact
Japan-U.S.
that
important
Mainland traffic can be taken to constitute
separate
market
is
reflected in the
United-Pan American transaction itself.
price
The principal
being acquired by United from Pan American are
assets
of
an
the
tangible
aircraft,
Indeed, a news report
but these are obsolescent and inefficient.
o
about the President of United states:
"Mr. Ferris of United has conceded that the transaction
Mr.
poses aircraft problems.
Ferris says that ^we're not
overjoyed about the airplanes United is getting, particular."
ly the L-lOll's
.
What
for
.
.
•
is paying three quarters of a billion
United
is rather Pan American's route system and rights.
dollars
part
In
because United already serves Seoul and Hong Kong, this means the
valuable rights to carry traffic beyond Tokyo.
paid
being
associated
merely reflects the scarcity rents
those rights or whether
assessment
Whether the price
(as I believe)
it also includes
United
that Japan-U.S.
Mainland air transportation is
Certainly,
to consider.
a
it is clear
sensible market
no sensible analysis of the effects of
pos-
acquisition on competition in trans-Pacific travel can
sibly
fail
to
's
from
of the supra-competitive profits to be achieved
the avoidance of price competition in serving Japan,
the
with
pay primary
attention
to
Japan-U.S.
Mainland
service.
Whether
travel
one defines the market as all Mainland-Far East air
or restricts attention to Japan,
drawn
about concentration are the same.
quite
concentrated
the conclusions
The market is
to
be
already
and that the acquisition will increase
that
,
concentration significantly.
Table
shows pre-acquisition market shares for
3
overly-broad U.S.
same.
In
the
Mainland-Far East market and the narrower U.S.
Mainland-Japan market.
the
both
In either case,
the general conclusion is
terms of the Herf indahl-Hirschman
concentration in the provision of U.S.
Index
(HHI)
Mainland-Far East service
will
go from 1782 before the acquisition to 2052 after
U.S.
Mainland-Japan service,
In
it.
the HHI will go from 2542 to 2812.
Either case would certainly cause concern in terms of the Justice
Merger
Department's
Guidelines.
9
In either
case
already
an
highly concentrated market will become significantly more concenThat
trated.
conclusion
is reinforced by the
that,
fact
as
discussed in the Appendix, the non-Japanese foreign flag carriers
are unlikely to be able to expand their shares of U.S. -Japan
air
Hence the
service to take advantage of supra-competitive prices.
HHI which counts those shares understates the effective degree of
concentration
and the increase that will be caused by the acqui-
sition.
[TABLE
As already remarked,
perly
treated
problems.
tacit
provide
3
HERE]
however, concentration statistics proonly a general
indication
of
possible
We believe that oligopolistic self-restraint (or less
forms of collusion)
are more likely when numbers are small
and concentration high, but we totally lack any precise theory as
to the concentration levels involved.
HHI
Accordingly,
statistics may be suitable for guidelines but
reliance on
cannot
avoid
the necessity for further, detailed analysis.
principal reason for concern is,
The
of course,
fear
the
that
the increase in concentration brought about by the acquisi-
tion
will
lead to an avoidance
international
no longer are)
price
wish
domestic fares
(as
It is interesting that the answer
of
affirmative,
the Japanese government to
despite
regulate.
particularly interesting to note that United has been
active
Since
the question naturally arises of whether there is
,
the case of Pacific air travel is
obvious
competition.
air fares are heavily regulated
any competition to be avoided.
in
of
It
is
especially
such competition as it has attempted to expand
in
the
using
its Seattle gateway.
The
first form that such price competition
takes
involves
the combination of a trans-Pacific and an internal U.S.
journey.
While
the fare between Japan and a U.S.
gateway city is subject
to international tariff filing requirements,
U.S.
As a result,
is not.
a U.S.
airline, particularly United
with its immense domestic route system,
price
the fare within the
can effectively cut
offered to a Japanese (or other Asian) visitor by offering
extremely low prices on the segment of the trip that takes
within the U.S.,
gers
the
place
Such price cutting even applies to some passen-
travelling only to U.S.
gateways.
A passenger travelling
from Tokyo to New York, for example, could take advantage of such
price cuts by travelling via Seattle instead of directly.
When
1983,
its
United
first entered the U.S. -Japan market
it offered "Visit U.S.A."
on-line
passengers,
(VUSA)
fares,
April
available only to
enabling them to fly on
10
in
its
domestic
In so doing, United did not merely follow
systerr for a flat fee.
it offered a pass that significantly
the
competition,
the
VUSA fares already being offered by other
(responding to
the CAB
a
undercut
airlines.
After
complaint by JAL) declared VUSA fares to
be international fares subject to Japanese tariff filing require-
United introduced a different price cut
ments.
passengers.
on-line
for its
In November 1983 it, began offering so-called YROPAC
involving low "add-ons" for the domestic portion of trans-
fares
When, in May 1985, DOT (again respon-
Pacific travel on United.
to a complaint by JAL)
ding
filed
international tariffs or be discontinued.
in
ready with a third version.
must
held that these fares also
United
be
was
It introduced so-called COMPO fares
allowing
international
segments
for a low add-on price
passengers to fly up
domestic
four
to
(two hundred dollars for
travel
within
the western United States)
rently
has arrangements with certain Orient travel agencies per-
.
In addition.
United
appa-
mitting them not to remit the COMPO fare add-on collected.
The second form of price competition involves travel agents.
Airlines
regularly
agents.
Since
such
compete on the commissions
paid
business,
agents book the lion's share of
particularly for international travel,
travel
to
such competition is quite
important.
Here again United is particularly well placed.
control
the Apollo computer reservations
below)
of
enables
it
efficiently to monitor
system
and
(discussed
reward
bookings in terms of its own share of those bookings.
Its
agents'
United has
actively competed on price using this technique.
Of course, price competition in commissions to travel agents
need not always result in lower prices to travellers.
11
Whether it
so depends on the state of competition among travel
does
At least in large cities, however, one would expect
themselves.
commissions to be passed on in some
increased
agents
either
form,
as
lower prices or as improved service.
In
least one segment of the market,
clear
it is
that
commissions to travel agents do result in lower prices to
higher
the
at
travelling public.
This is the so-called
"ethnic"
market
segment where, for example, American travellers of Chinese origin
purchase tickets in Chinese neighborhoods.
fic,
In serving such traf-
it is common for airlines to sell through "consolidators"
brokers
major
These consolidators
who sell many tickets.
given substantial "commission overrides" which are partly
—
are
passed
on by them to their own customers such as travel agencies located
in ethnic neighborhoods.
Those agencies in turn pass on part of
commissions to individuals in those neighborhoods who mar-
their
ket the tickets to the travelling public.
This system of
competition in the ethnic market segment in the U.S.
more
price
has an even
active parallel abroad where airline tickets can
regularly
be bought at a discount on the streets of Hong Kong or Taipei.
before
Thus,
competition.
In
the acquisition,
particular,
there was substantial price
United,
which had
a
foothold
such
serving Japan and was particularly well placed to engage in
competition
flights
others.
was very active in doing so.
between
It fought to fill its
Seattle and Japan and to attract
from
traffic
It also invested in a competing hub at Seoul and fought
to attract traffic there.
have
in
eventually
permitted
Whether such price competition
United to overcome the
12
would
barriers
to
into Japan is
entry
a
close question,
and
I
discuss
later.
it
What is certain, however, is that the acquisition removed much of
the
motive
for engaging in it.
With Pan American's Tokyo
other Pacific service added to its immense domestic route
with
(and
below)
,
Apollo computer
its
United can expect to attract
without competing on price.
Angeles-Tokyo
and
increase
would
reservations
a
Pan
system
discussed
system
large share of the traffic
Indeed, United forecast that its Los
San Francisco-Tokyo
over
and
on-board
American's
by
average
and
14.9%
fares
13.3%,
respectively.
At
the same time.
Pan American was taken out of the fight.
Its Pacific Division was profitable and,
the
shortly before
indeed,
acquisition Pan American had announced and
published
dules for a major expansion of its Pacific service.
sche-
The acquisi-
tion ended that.
Thus,
there
when
appears
one looks behind the concentration
statistics,
ample reason for concern over the effect
of
the
acquisition on competition.
There is more to the matter than this, however.
doubt
that the post-acquisition United will be
titor than the pre-acquisition Pan American.
stronger compe-
In particular,
provide single-line service between interior points in
will
United
with
a
There is no
States and points beyond Tokyo
a
—
something Pan
very poor domestic route system did not
do
it
the
American
effectively.
This will be a benefit to the travelling public.
Will the provision of that benefit more than offset the loss
13
of price competition?
In this connection,
it is noteworthy that
the
acquisition was opposed by Northwest Airlines,
U.S.
flag carrier in the Pacific as well as by Eastern and Ameri-
can
Airlines,
competitors
V7here
suspect
that
competition.
oppose
a
merger,
If one looks no further,
routes.
ordinarily
one is
they fear a net increase,
Pacific
not a net
led
to
decrease
in
this suggests that compe-
by single-line service will be worth more to the
tition
ling
of which hoped to acquire
both
largest
the
travel-
public than the price competition that would have continued
in the absence of the acquisition.
In fact,
such a conclusion is quite superficial.
for believing that the public and
reasons
will both suffer as
competitors
result of the acquisition.
is booked through travel agents.
Far
the
Since the middle
1970s,
agent bookings have been predominantly made by the use
tavel
computer
provide
seat
's
far the largest part of travel to
By
^^^k^SQllQ^
East
a
United
There are
reservations
systems (CRSs)
Such systems
.
up-to-date schedule information,
availability
at different fare
only
not
they also inform as to
levels,
airline computers to book reservations,
of
communicate
with
print tickets, and faci-
litate land arrangements.
With one relatively minor exception,
airlines,
system,
and
the two airlines with the largest domestic
American and United,
of their systems
all CRSs are owned
(named,
by
route
have by far the largest placements
respectively, "Sabre" and "Apollo") with
agents.
This is not an accident.
In responding to a travel agent's
inquiry, not all possible flights and routings can be given equal
14
prominence in the computer display.
possibilities
Generally, there are so many
they cannot all be displayed
that
once,
at
and
is a natural tendency for agents to choose from the alter-
there
natives
on
the first screen presented and even from
line or two on that screen.
importance
to
13
first
the
It is thus a matter of considerable
airlines how the software
involved
chooses
the
order in which flights are displayed, and there is a great incen-
Indeed,
tive for an airline CRS vendor to favor its own flights.
the
money
make
to be made from so doing is large enough to
it
profitable for an airline to offer its CRS to travel agents below
cost or even to pay them for taking it.
Both
United
and American were quick to take
opportunity,
this
was happening,
(still pending)
of
biased
After it became plain that
this produced two private
antitrust
suits
and an investigation by the Deparment of Justice.
investigation
That
advantage
first providing relatively openly
at
displays favoring their own flights.
this
14
in
turn led to proceedings before
the
CAB
which, in the fall of 1984, adopted the suggestion of the Justice
Department and began regulating the way in which CRS displays are
determined.
I
use the phrase "began regulating" deliberately,
lation in this area is likely to be
a
for regu-
never-ending task with
vendors always one step ahead of the regulators.
the
For example, in
its initial regulations, the CAB required that the primary screen
displayed
United
be "unbiased" but permitted
a
biased secondary screen.
and American took full advantage of this
loophole,
providing incentives to travel agencies to lock in the
15
even
secondary
screen so that individual agents had to begin with it rather than
the
unbiased "primary" one.
That practice was abandoned
after
Congressional hearings in March 1985.
more subtle example involves trans-Pacific travel
A second,
United's
directly.
Apollo system (unlike other CRSs) does
connecting flights where the carrier involved has no autho-
list
rity to carry merely local traffic.
agents
This means that Apollo-using
to Osaka
booking passengers travelling from the U.S.
Northwest
in Tokyo.
or
connection
Okinawa cannot discover that there is an easy on-line
on
not
Instead they find connections to
JAL.
Not surprisingly, many of those connections involve United trans-
Pacific flights even though the usual considerations of passenger
on-line
convenience used in the Apollo algorithm would place the
connection first. 15
Northwest
There are many other examples
of
the anticompetitive use of Apollo in the Pacific.
examples
Such
are only the tip of the
potential
iceberg.
regu-
They represent abuses already located but not yet cured by
illustrate the enormous difficulty
(indeed,
the
impossibility) of curing the CRS problem through regulation.
The
They
lation.
algorithms
complex
so
(necessarily)
that the effort to regulate is likely to lead
and continual series of hearings with regulation
so
ways
and the opportunities for misuse of them in subtle
varied
endless
used to determine display order are
to
an
always
struggling to catch up. 17
So
far
as
trans-Pacific service
is
concerned,
willingness to use Apollo to divert traffic from its
is
competitors
limited directly to passengers booking in the United
That is not the end of the story,
16
however,
United's
States.
for travel agents in
8
Japan also use
a
biased CRS, the JAL controlled JALCOM III.
system,
not subject to U.S.
showing
only JAL flights.
That
regulation, provides a first screen
It
is
conceivable that United
could
trade JAL special status on Apollo in return for favorable treat-
ment
JALCOM III
on
—
an arrangement not available to
current American trans-Pacific competitors.
already
been
hansa.)
In
United
similar deal
(A
struck in the Atlantic between American and
this way.
United could extend its
biased
's
has
Luftuse
of
traffic through the provision
of
Apollo to involve Japan-originating traffic.
Obviously,
diversion
of
biased or incomplete information is destructive of competition on
Moreover,
merits.
the
even if regulation keeps
moving target,
perpetually
catching
the harm will be done.
its
Because
of
existing competition, operating margins are thin on trans-Pacific
diverted
so that relatively little traffic needs to be
flights,
to United for other airlines to find such service unprofitable.
Without
a
trans-Pacific service while pursuing
does
United
problem.
not
high-fare policy
a
is
position
to be able to use Apollo to attain a commanding
likely
in
resolution of the difficult CRS
1
merely reflect the additional benefits of its
that
on-line
service.
Even apart from the
^-i^S'ii^^SiiPXtrXJJe^L^a^sy^pf^Eeaai^iifiD^
CRS
problem,
potential
service
Those
the
however,
are reasons to believe
there
benefits of the acquisition in
will not,
reasons
eventual
in the long run,
providing
be passed on to
that
single-line
consumers.
have to do with the impact of the acquisition
structure
of the
17
market
for
the
trans-Pacific
on
air
.
travel
As
result of half a century of airline
a
both
and Pan American possessed certain advantages over
United
when deregulation began.
airlines
system
the United States,
in
favored U.S.
single
other
United had the largest route
while
Pan
American,
often
the
flag airline, had a large Pacific system, including
beyond-Tokyo rights.
a
regulation,
airline,
Had those advantages both been possessed by
airline would doubtless
that
totally
have
dominated Pacific air travel.
That domination did not occur,
west in particular
not shared.
—
Before the acquisition. United had excellent domes-
develop its Pacific routes.
an
It v/as striving
expanded from nothing in pre-deregulation days,
the acquisition of National Airlines.
provided partly by JAL,
largely
flag carriers to a limited extent
service
through
Competition in the Pacific
Japanese
the airline of choice for
nationals but without any internal U.S.
of all, by Northwest.
to
Pan American, on the other hand, had
excellent hub at Tokyo but very poor domestic feeder
was
North-
could compete because those advantages were
service but poor service beyond Tokyo.
tic
—
and other airlines
routes, by other foreign
(see the Appendix)
,
and,
most
Northwest, in particular, had moved in the
post-deregulation period to build its hub at Tokyo and expand its
domestic
system,
but,
by
1985 had not come close to having
domestic feeder service that matched United
a
's.
Had the acquisition not been approved. United would have had
to
continue to fight to expand its Asian service.
time.
Northwest
At the
would have expanded its domestic route
If both airlines had been successful,
18
same
system.
the result in five to
ten
time would have been competition by two powerful
years
carriers
providing on-line service from points inside the United States to
many points in Asia.
without
Further,
the acquisition,
Pan American would have
had to do something else with its Pacific Division.
mentioned,
Division was profitable,
that
already
As
and Pan American
announced plans for expansion of service in the Pacific,
already
active
so one possibility would have been for it to remain as an
competitor,
run
long
striving for greater efficiency.
as a major player,
To succeed in the
it would have had to
its domestic operations.
expand
had
continue
have
it could
Alternatively,
some or all of the Division to another domestic carrier
sold
carriers.
Unless
that carrier were American Airlines
tion
of the Pacific Division by whom would present many
same
problems
as acquisition by United)
,
such
a
to
or
(acquisithe
of
sale would
be
pro-competitive.
Thus,
run
had the acquisition not taken place, the likely long-
result would have involved at least two and
probably
three
American flag carriers providing on-line service on both sides of
the Pacific and competing to do so.
That competition would have
resulted in the benefits of superior on-line service being passed
on
to
the travelling public rather than being retained
airlines in the form of higher prices.
tion would have continued as United,
by
the
Certainly, price competiPan American, and Northwest
all fought to gain adequate systems on both sides of the Pacific.
The
acquisition changed that picture drastically.
It
re-
moved Pan American as an active force and, at one stroke, allowed
19
to inherit not only its own legacy of regulation but also
United
that of Pan American.
it
much
likely that Northwest
less
receive
could
previously noted,
sufficient
on-line
to grow internally into a second full
traffic
As
This gives it an immense headstart, making
carrier.
it does not take much diversion of traffic
on Pacific routes to turn profit into loss.
Similarly, U.S. flag carriers that did not provide U.S. -Asia
before the acquisition are unlikely to
service
constraints
competitive
April
United.
The
agreement
frequency of service and hence the capacity
the
of
Furthermore, the new U. S. carriers will only have rights
1986.
not beyond.
Tokyo,
19
Had the acquisition not been
approved,
the
new carriers would have fought to expand their service,
the
U.S.
exchange
that
might well have pressed for beyond rights (perhaps
for parallel concessions to
United
rights at
from
a
has
carriers)
however,
and
and
in
Now
.
beyond
the pressure of competition
the new carriers who lack such advantages is likely
approved
the
Japanese
acquired Pan American's Tokyo hub
single stroke,
relatively low.
is
the
newly able to provide trans-Pacific service starting in
carriers
to
post-acquisition
1985 amendment to the U.S. -Japan bilateral
30,
limits
on the
serious
impose
to
be
The Japanese government, having just reluctantly
the transfer of Pan American's beyond rights to
likely strongly to resist granting new ones.
new carriers to grow gradually at
best,
United
This will force
sinking
resources
into rent-seeking activity and perceiving that United can use its
CRS
and superior on-line service to discipline them at any time.
Can
competition
be preserved in
the
Pacific?
The
most
likely source of such competition remains Northwest, but here the
20
acquisition
As already discussed.
consequences.
advantages
too
are
been
The alternative
Northwest would itself seek
that
United
continue
Pacific,
the
competing
providing
a
merger partner as a means
Northwest announcing
A major reason for that merger is Republic's fleet of
It
non-merger means.
Airlines.
short-haul
If the
a
feeder system,
by
Northwest-Republic meger is consummated
and Northwest is able to redeploy the acquired aircraft,
person-
and other facilities greatly to expand its route structure,
nel,
there is at least
effectively
the
in
would take several years for Northwest to acquire
crucial to the development of
such a fleet,
of
That oc-
1986 that it had arranged to acquire Republic
aircraft.
very
(predicted in my testimony) was
curred as this paper was being written,
January
would
it
acquiring a substantial domestic feed system.
quickly
of
post-acquisition
's
Had it attempted to do so,
forced to retrench in
limited service.
chain
(and predicted)
great for Northwest to
internal growth.
through
have
set off a predictable
has
a
chance that Northwest can continue to compete
in the Pacific.
Northwest-Republic
What other effects on
acquisition
may or may not
competition
have
is
a
matter beyond the scope of this paper.
Such matters are not outside the scope of the Department
Transportation, however.
of
Indeed, one would expect the Department
to take a broad view of transportation policy. Quite the contrary
was
of
the case,
with the Department taking a very fragmented view
its responsibilities.
merely
That fragmented view was evident
not
in DOT's refusal to take seriously the prospect that
the
21
.
.
acquisition would lead to further mergers but, more surprisingly,
in
the way in which it dealt
rather,
(or,
failed to deal) with
the question of United's post-acquisition advantages.
DOT appears never to have seriously considered the
cular,
tion
In parti-
whether the efficiencies achievable by the
of
ques-
acquisition
could also be achieved in a way less likely to be destructive
of
competition
the first of United's post-acquisition
discussed above,
As
advantages
is the possession and use of the Apollo
CRS
Given
fact that the CRS problem remains under
review
the
litigation)
,
expanding
its
one
might
have
consequences in
expected DOT to
a
major way.
hesitate
This was
system.
(and
before
not
the
case, Secretary Dole's opinion brushing aside the matter with the
comment
that it was premature to conclude that the existing
CRS
rules are inadequate.
The
Department took
In
a
the
substantial financial commitment in order to
so doing,
nouncement
similarly narrow view of
larger
It accepted Pan American's contention that the airline
picture.
required
a
expand.
it passed over Pan American's pre-acquisition
of increased service.
21
an-
Even if that conclusion were
correct, however, it would not follow that the acquisition should
have
been approved.
The Department failed to consider
whether
the
required financial commitment could have been obtained in
way
less
destructive
of competition
(sale to
an
airline
a
not
already competing in the Pacific, for example)
The
question
similar treatment.
of
United's ability to expand
was
given
a
The Department recognized the entry barriers
22
involved and concluded that United would not be able to
so that substitution of a strong United for a weak
unaided,
thein
Pan American would increase competition.
In one sense,
had
United
this is
a
close call.
Before the acquisition.
the willingness of the Japanese government to
—
rights
Tokyo
and its service into
beyond rights,
no
22
was
To an extent, therefore, further expansion was subject
limited.
to
overcome
further
grant
something it would certainly not do easily.
There are, however, three reasons for thinking that approval
the acquisition was not necessary for such expansion and that
of
the same ends could have been achieved in a less restrictive way.
of all U.
First,
S.
airlines, United was probably the best siIndeed, it had already begun development
tuated to bypass Japan.
an alternative hub at Seoul.
of
By approving the
acquisition,
removed the incentive for that development which would
DOT
have
provided at least some competition to America-Japan service.
the history of U.
Second,
reflects
tion
slow.
The
involved
-Japan negotiations over avia-
although the progress has
expansion of Northwest in the Pacific,
been
often
for example,
continual pressure by the American government for
ther rights.
sition,
progress,
S.
it
fur-
Had the American government not approved the acqui-
could have made further rights for United its
priority in negotiations with Japan.
If,
first
indeed, it turned out
that Pan American had to retrench, there would have been a strong
argument for gradual,
to United.
a
in
piecemeal transfer of unused beyond rights
Moreover, a fully pro-competitive policy
would offer
Japanese carrier the right to carry passengers beyond
gateways
exchange for rights beyond Tokyo for United (and other U.
23
S.
—
carriers)
flag
government
an offer that the Japanese
would
certainly have to think about.
rights for United would have to
have
DOT could itself
have
United could provide increased trans-Pacific
ser-
while
Third,
beyond
been the subject of further negotiations,
that
assured
The agreement of April,
vice.
up
1985 provided for the addition of
three additional routes for American
to
providing
carriers
Depart-
It was totally in the control of the
service to Japan.
Transportation to assure that United received
ment
of
more)
of those routes.
one
(or
This would have ensured that United kept
fighting to fill its trans-Pacific planes and would have enhanced
the
argument
that
required
additional beyond rights were
for
efficient service.
DOT did not do this.
ensuring that the U,
thereby
would
routes
have
acquisition
United,
expansion.
In
cursory
that
Instead it approved the
on
flag carriers awarded the
to deal with the
immensely
a
new
post-
powerful
discouraging them from more than
so doing,
connection
S.
acquisition,
limited
it failed to make more than the
between the decision on the acquisition
the new routes,
stating only that the
result
of
most
and
any
by United in the Japan route case "cannot be predic-
application
ted here."^^
This
is
considering
a
very blinkered view of DOT's
airline mergers.
responsibility
It made sense temporarily to give
DOT the post-deregulation responsibility for approval of
mergers
in
airline
DOT only because that department can take an overview of
transportation
policy.
Without that,
24
it would have been
more
immediately to entrust such responsibility directly
sensible
the
courts
matters)
trust
the
But
.
consideration
particular
means.
refused
of
a
in
anti-
primary point of such an overview must be
whether the efficiencies
promised
transaction can be achieved through less
by
a
restrictive
In the P^sifif^Diyi^iPE 1l^n§i^X^£MS^^ the Department of
Transportation
and
perhaps to those agencies more skilled
(or
to
simply
failed
to^
consider
to step outside the confines of the
such
questions.
instant
proceeding
consider even closely related matters plainly under its
control.
In so refusing,
lities.
That
is
a
It
own
it failed to live up to its responsibi-
cause for concern however one
thinks
2M£iilQ^Qi^i§lQB^TXMDS£sx^£^SM should have been decided.
25
the
presence of the secondary Asian foregin
The
carriers
flag
(China Airlines, Korean Air, C.A.A.C, Thai Airv/ays International,
Singapore Airlines, and Phillipine Airlines)
for
is
already accounted
the concentration statistice given in the
in
statistics
show
a
high degree
of
concentration
Those
text.
substantially
Such statistice, moreover, under-
increased by the acquisition.
whose
the importance of the secondary Asian flag carriers
state
ability to impose constraints on the behavior of the major market
Those secondary carriers are
is severely limited.
participants
unlikely to expand much beyond the position they now occupy.
Secondary Asian flag carriers have substantial advantages in
their own countries.
serving
countries
those
carriers
are more likely to fly on
than on foreign ones.
passengers
from
Japan
passengers
All else equal,
(A
their
from
national
own
similar statement holds
or the United
for
National
States.)
flag
carriers enjoy the benefits of greater visibility at home, established
relationships with local organizations,
intra-country
traffic.
They
also enjoy the
and control over
benefits
the
of
active governmental support that can take the form of restrictive
regulation
of competitors,
capital and operating subsidies,
or
informal pressure on nationals to use their own flag carrier.
On
the other hand,
such carriers have much less of
sence outside their own countries.
As a result,
a
pre-
much of the U.
S.-Asia air traffic served by such carriers is made up of passengers originating in their home countries.
It is far from
clear
that they can expand much beyond this.
In
many
instances,
the level of traffic on the
26
secondary
Asian flag carriers reflects explicit agreements on capacity
Through various agreements,
price.
service
vide
many of these carriers pro-
(especially between Tokyo and other Asian
under either capacity or pooling agreements.
cities)
A capacity
agree-
airplane size, and other aspects
ment controls flight frequency,
In a pooling agreement,
of service.
and
the pooling carriers agree
as to the sharing of revenues derived from the joint operation of
an air routs.
They also agree to restrict capacity.
Many of the
secondary Asian flag carriers have pooling or capacity agreements
Those agreements serve to protect the positions of the
with JAL.
participating
carriers
and help them to maintain
control
over
lucrative traffic between their home countries. 23
immense importance of U.S. -Japan traffic in Pacific air
The
travel would force any secondary Asian flag carrier aspiring to a
significant
truly
through
Japan
role
in the broader market
to the U.S..
enjoy fifth-freedom rights
of
those
carrier
rights.
would
presently
While such carriers
in carrying passengers
it is hard to envisage much expansion
An aggressive expansion attempt
doubtless be resisted by the Japanese
if a secondary Asian flag carrier were to
doubtful
Moreover,
expanded
obtain
Certainly,
it is
from
that it could also obtain the beyond-Tokyo rights
nations
such
needed to establish an efficient
carriers
hub
at
Tokyo.
could not provide service within
27
a
government
in carrying passengers between Japan and the U.S.,
rights
other
such
by
and might even jeopardize existing pooling agreements.
even
do
(the right to carry passengers between
two countries both foreign to the carrier)
through Tokyo to the U.S.,
rights
seek
to
the
United States.
Such
carriers would thus,
find it extremely
in any event,
difficult
to expand and play a major role in
They
continue to lack both hubs at Tokyo and U.S.
v^ill
the
post-acqusition United that has both.
unlikely to play
travel.
domestic
Thus handicapped, they will now have to contend
feeder systems.
with
U.S. -Asia
a
They
major pro-competitive role in the
sition world.
28
are
thus
post-acqui-
,
paper is largely based on my testimony on
*This
Airlines Inc.
Northwest
in the
of
2S£lii£^^iylSlQn^Tl^n§iSI^£M^S
Department of Transportation Docket 43065,
are to this case unless otherwise specified.
1985.
I
All references
am indebted to J.
George Hall, Kevin Neels, Sheldon L. Pine, Barry S.
Campion,
W.
behalf
Spector, Peter Ward, and especially Ronald D. Eastman and William
Kutzke for assistance and discussion but retain responsibility
A.
for
The views expressed are my own and not
error.
necessarily
those of Northwest Airlines.
1.
Exhibit JA-RT-2, Rebuttal testimony of Dennis W. Carlton,
William M. Landes, and Sam Peltzman.
2.
For
a
definition,
IS£I
detailed discussion of economic analysis and market
see P.M.
(Cambridge,
MA:
Fisher,
J.J.
McGowan, and J.E. Greenwood
MIT Press), 1983, Chapter 3. In effect, the
Department of Justice now takes this view of market definition as
a
summary of constraints.
ter,
Vol.
minimal
49,
1984,
Its l^sZQSX^Sii-l^MlinSM
26,284)
define
a
(Federal Regis-
"market" in terms as the
collection of firms that could sustain
a
price
rise
of
stated size for a given period of time.
3.
the
D.
Aviation
S.
Sibley, S. B. Jollie, gi^^I "Antitrust Policy in
Industry,"
Washington:
£iyli^^xeD^JJii£^^BfiS£^ ^
1982, pp. 109-113.
3.
traffic
The
is
conclusions
included.
are
no different if
Hawaii-Far East service
concentrated.
29
Hawaii-Far
is
also
East
quite
For example, U.S. Travel and Tourism Administration "Sur-
4.
of International Air Travelers,
vey
December,
pp. yOSOS4-l - YOSOS4-6.
1983,
yield consistent results.
to
In-Flight Survey," OctoberOther similar surveys
Surveys of residence are more
likely
be accurate on the question of how much travel originates
terminates
in
gateway city than are direct ticketing
travelers to the Far East buy separate
many
since
a
or
counts,
tickets
for
travel between their residence and a gateway city.
It
5.
traffic
United's
non-negligible
portion
of
through Seattle to Japan originates at one
of
even the case that
is
the two California gateways.
a
See Exhibit DOJ-R-1, Rebuttal Tes-
timony of Gloria J. Hurdle, Table R-2.
6.
In January 1986,
Pan American provided non-stop service
between Tokyo and Los Angeles, New York, and San Francisco, while
United had non-stop flights between Tokyo and Seattle.
Northwest
provided non-stop service between Tokyo and all five gateways and
Japan
Air
gateway
stop
Lines
(JAL)
had such flights between Tokyo and
except Chicago.
every
non-
Other foreign flag carriers flew
between Tokyo and the two California
cities.
were
There
somewhat different patterns .for other Asian destinations (but, as
seen in Table
1
and discussed below, Japan-U.S. traffic is by far
the most important piece of U.S-Asia air travel).
7.
8.
W^ll^S^LSM^^^mxn&l
,
April 29, 1985, p.
The Guidelines characterize
trated" if the HHI is at least 1800.
that
produces
a
a
6.
concen-
market as "highly
They suggest that
"highly concentrated" market will
a
merger
usually
be
challenged if it results in an increase in the HHI of at least 50
points.
The increase involved here (on either definition)
30
is
270
points.
For a somewhat more extended discussion of what follows,
9.
see Exhibit NW-T-780,
"Pacific Pricing."
Exhibit NW-R-734.
10.
11. For an estimate of the way the public values single-line
service in the context of
a
domestic merger case,
ton, W.M. Landes, and R.A. Posner
A
Mergers:
Case
(1980), pp. 65-83.
to
that
suppose
Study,"
,
see D.W. Carl-
"Benefits and Costs of Airline
B^ii^JpyxD^l^pi
SQQnQml£3
,
Vol.
At least in the short run, there is no reason
United will be more
cost-efficient
than
it plans to continue to use the same obsolescent
American;
11
Pan
air-
craft.
almost
first
American Airlines study in December 1981 found that
An
12.
of all sales made on its CRS
92%
screen
(Sabre)
came
first
line.
and more than 53% from the
from
(U.
the
S.
Department of Justice, "Comments and Proposed Rules," Civil Aeronautics Board, Docket 41686 (1983), p. 81.)
13.
In one case. United offered to recompense a travel agent
converting to its CRS (Apollo) with $500,000 cash, a 10% override
on all transportation sold on Apollo,
of
and five years of free use
the system including absorption by United of all telecommuni-
cations line charges.
("Statement of Northwest Airlines, Inc.,"
Committee on Commerce,
Science and Transportation,
on Aviation,
1985,
p.
Hearings,
Subcommittee
Computer Reservation Systems,
March 19,
64.)
14. The loss in passenger convenience involved here is large
as
anyone
who looks at the schedules involved
31
or
has
changed
.
terminals at Narita will quickly realize.
15. See Exhibit NW-T-765.
16.
numerous
recent
A
report
of the Department of
examples of complaints about
]/^iiPfl^Si:Si^Ei^lD^i}^i£^
f
bias
1985, pp. 33-40)
Justice
cites
{i^<85^EfiPfiXi^e£^ii)^
and states
(p.
39):
Whether a specific algorithm
violates the antibias rule can be a difficult and highly fact-bound
issue.
The issue would not be adequately resolved by more rules,
however.
It can only be addressed on a case-by-case basis.
.
.
.
17. For example. Northwest's profit margin in the Pacific in
Pan American's was 7.5%.
1984 was only 5.8% of revenues.
bit N^V-R-18)
.
(Exhi-
Such low margins imply that much of the price paid
by United to Pan American is for future supra-competitive profits
rather
than for the scarcity rents involved in competitive
ser-
vice to Japan.
18.
Similarly,
a
new Japanese carrier will not be able
to
acquire a U.S. feeder system.
19.
Eln^l^QElnlQn^sn^^Qi^sx
pp.
,
50-51.
QslniQD^&B^^Ql^MI is equally terse on this subject
20. lln^l^QsiBlQB^^n^^Qx^SI
,
pp.
21. lin^l^QslnlQn^Mn^^Qx^si
r
p.
22.
23.
Zln^l^QelnlQB^MB^^Qx^SI
See Exhibit NW-T-790.
32
,
p.
3
5-36.
39.
38.
The
2'^ai^iizs
(p. 35)
.
TABLE
Number of Passengers
1
(Thousands)
on Scheduled Service
between the U.S. and the Far East, 1984
Bs^nM^n/M^
TPi^2
Total
6
,372
2
,128
551
3
,693
Japan
4
,253
1
,516
498
2
,239
557
526
352
330
140
182
102
1
99
70
35
55
Hong Kong
Korea
Taiwan
Phillipines
India
Singapore
P.R.C.
Thailand
Pakistan
Malaysia
EQBQlUla
9
1
Source: Northwest Airlines
a.
91
182
—
Qi^sm
4
15
33
—
MsiulSD^
371
423
246
115
140
44
70
35
9
1
(from INS Form 92)
Including Okinawa (total of eight thousand passengers).
TABLE
Number of Passengers
2
(Thousands)
on Scheduled and Charter
Service between the U.S. and Japan
Japan
Between
4,404
Guam
Percent
521
Honolulu
Percent
1,631
Mainland
Percent
2,252
Source:
a.
1984
Foreign
U.S.
Foreign
1,357
3,047
2,122
2,282
31
69
48
52
43
478
215
9
91
41
306
59
I
Total
Percent
,
1
U.S.
228
1,403
86
611
37
1,020
14
1,086
1,166
1,296
48
52
58
956
42
63
Northwest Airlines (from DOT U^S^^In^MI.n^^lQBMl^hl£.
Including Okinawa.
TABLE
1984 Market Shares
(Per Cents)
3
in Trans-Pacific Air Travel^
ShMi^A<^Mlnl^n^-l&£^^M§^
£M^£is£
BMxsA^Minl^n§z2^p^n
Northwest
27.5
31.3
JAL
21.9
33.5
Pan American
18.5
19.3
Korean Air
9.3
0.0
United
7.3
7.0
China Airlines
6.8
1.4
Singapore Airlines
2.9
3.1
Thai International
Airways
2.2
1.9
CAAC
1.6
Phillipine Airlines
1.3
1.4
Varig
0.6
1.0
1782
2542
HHI
a.
Market
Immigration
and Naturalization Service
shares are for total number of passengers
figures
each
Source:
on total passengers carried by U.S.
gateway
were allocated to
Northwest,
United using ER586 service segment data.
flag
Pan
(INS).
carried.
INS
carriers
via
American,
and
953 073
W
Date Due
FES 2
1990
"on
to 2
^26 '§0
;^Y 1
EG ^S
\c
^S Q
Lib-26-67
3
TDflO
DD4 ^E^ B3