**BEFORE THE DEPARTMENT OF TRANSPORTATION**  **WASHINGTON, D.C.**

-------------------------------------------- Joint Application of: : : AMERICAN AIRLINES, INC. : BRITISH AIRWAYS PLC : FINNAIR OYJ : IBERIA LÍNEAS AÉREAS DE ESPAÑA, S.A. : DOT-OST-2008-0252 ROYAL JORDANIAN AIRLINES : : under 49 U.S.C. §§ 41308 and 41309 for : approval of and antitrust immunity for : alliance agreements :

-------------------------------------------- **[PUBLIC] JOINT APPLICANTS’ ANSWER TO THE DEPARTMENT OF JUSTICE’S MOTION FOR LEAVE AND COMMENTS**  Communications with respect to this document should be sent to: **For American Airlines : For British Airways**  **: F**  **or Iberia :**  WILLIAM K. RIS, JR. Senior Vice President – Government Affairs American Airlines, Inc. 1101 17th Street, N.W. Washington, DC 20036

VIRASB VAHIDI Senior Vice President – Planning American Airlines, Inc. P.O. Box 619616, MD 5628 DFW Airport, TX 75261

KENJI HASHIMOTO Vice President – Strategic Alliances American Airlines, Inc. P.O. Box 619616, MD 5635 DFW Airport, TX 75261

CARL B. NELSON, JR. Associate General Counsel American Airlines, Inc. 1101 17th Street, N.W. Washington, DC 20036

R. BRUCE WARK Associate General Counsel JEFFREY A. OGAR Senior Attorney American Airlines, Inc. P.O. Box 619616, MD 5675 DFW Airport, TX 75261 (817) 967-3478 jeff.ogar@aa.com TOM KING Executive Vice President - External Relations British Airways Plc Rue de la Science B-1040 Brussels, Belgium

PAUL C. JASINSKI General Counsel, Americas JAMES B. BLANEY Senior Counsel, Americas British Airways Plc 75-20 Astoria Boulevard Jackson Heights, NY 11370 (347) 418-4250 paul.jasinski@ba.com

DARYL A. LIBOW Sullivan & Cromwell LLP 1701 Pennsylvania Ave., N.W. Washington, DC 20006 (202) 956-7500 libowd@sullcrom.com

DON H. HAINBACH Garofalo Goerlich Hainbach PC 1200 New Hampshire Ave., N.W. Washington, DC 20036 (202) 776-3970 dhainbach@ggh-airlaw.com ELVIRA HERRERO Senior Vice President - Int’l Relations & Alliances Iberia Líneas Aéreas de España, S.A. Velazquez, 130 28006 Madrid, Spain

WILLIAM KARAS CAROL GOSAIN Steptoe & Johnson LLP 1330 Connecticut Ave., N.W. Washington, DC 20036 (202) 429-6223 wkaras@steptoe.com

**For Finnair :**  SAMI SARELIUS Vice President & General Counsel Finnair Oyj Tietotie 11 A FI-01053, Finland +358 (9) 818-4070 sami.sarelius@finnair.fi **For Royal Jordanian :**  MICHAEL J. HOLLAND Condon & Forsyth LLP 7 Times Square New York, NY 10036 (212) 490-9100 mholland@condonlaw.com

January 11, 2010**TABLE OF CONTENTS**

INTRODUCTION ...................................................... 2

I. DOJ HAS FAILED TO MEET ITS BURDEN OF PROVING THAT THE PROPOSED ALLIANCE WOULD HARM COMPETITION ................ 11 A. DOJ Has The Burden Of Proving The Proposed Alliance Would Harm Competition ........................... 11 B. DOJ Has Failed To Meet Its Burden Of Proving Competitive Harm ........................................... 12 1. Connecting Service Imposes An Effective Constraint On O&Ds With Nonstop Flights .......... 12 2. The Proposed Alliance Will Not Create Six “Highly Concentrated Markets” ................ 14

a. New York-London ................................ 15 b. Chicago-London ................................ 17

c. Boston-London ................................ 18

d. Miami-London ................................ 19 e. Dallas/Fort Worth-London ..................... 19

f. Miami-Madrid ................................ 20 3. DOJ Fails To Prove That Significant Fare Increases Would Result From The Proposed Alliance ................................ 21 a. DOJ’s Fare Study – Even If Correct – Would Reliably Predict Harm On Just One City-Pair, Not Six ...................................... 21 b. DOJ’s Comments Fail To Recognize The Fundamental Difference Between A Change In Capacity And A Change In The Number Of Competitors ................................ 22 c. DOJ’s Description Of Yield Management Strategy Is Fundamentally Flawed ..................... 23- ii –

**CONFIDENTIAL VERSION** d. DOJ’s Arguments Regarding New Entry Ignore Reality ................................ 25 i. There Is No Hub Barrier To Entry .......... 25 ii. Heathrow Slots Have Not Proven To Be A Barrier To Entry ..................... 26 iii. DOJ’s Attempt To Dismiss The 19 New U.S.-Heathrow Frequencies Only Proves The Competitiveness Of London Routes ..... 28 4. DOJ Fails To Effectively Rebut Compass/ Lexecon’s Findings ................................ 30

II. THE DEPARTMENT HAS CONSISTENTLY HELD THAT ANTITRUST IMMUNITY IS REQUIRED TO ACHIEVE THE FULL PUBLIC BENEFITS OF ALLIANCE INTEGRATION ........................................... 32 A. DOJ’s Claims Regarding Network Benefits Are Fundamentally Wrong ...................................... 33 1. DOJ Misuses American’s Forecasting Data .......... 33 2. The Department Has Rejected DOJ’s Arguments Regarding SkyTeam’s Three-Coupon Itineraries ..... 35 3. DOJ’s Study Of Alliance Fares Is Deeply Flawed ..... 36 B. DOJ’s Claims Regarding New Nonstop Service Were Previously Rejected ...................................... 38 C. The Department Does Not Share DOJ’s Lack of Concern Regarding Interalliance Competition ..................... 39 D. DOJ’s Speculation That The Joint Applicants Would Move Forward Without Full Immunity Has No Basis In Fact ..... 43

III. DOJ’S PROPOSED REMEDIES ARE BOTH UNNECESSARY AND UNWORKABLE ..... 45

A. Carve-Outs ................................................. 45 1. Impact On Capacity ................................ 46 2. Impact On Yield Management ........................... 47 3. Impact On Scheduling ................................ 50

B. Slot Divestitures ...................................... 51

CONCLUSION ........................................................... 52**BEFORE THE DEPARTMENT OF TRANSPORTATION**  **WASHINGTON, D.C.**

-------------------------------------------- Joint Application of: : : AMERICAN AIRLINES, INC. : BRITISH AIRWAYS PLC : FINNAIR OYJ : IBERIA LÍNEAS AÉREAS DE ESPAÑA, S.A. : DOT-OST-2008-0252 ROYAL JORDANIAN AIRLINES : : under 49 U.S.C. §§ 41308 and 41309 for : approval of and antitrust immunity for : alliance agreements :

--------------------------------------------

**[PUBLIC] JOINT APPLICANTS’ ANSWER TO THE DEPARTMENT OF JUSTICE’S MOTION FOR LEAVE AND COMMENTS**  Pursuant to Order 2009-12-16, the Joint Applicants submit their answer to the Department of Justice’s comments. 1 DOJ’s comments add no new evidence to the record, and the arguments it advances have already been rebutted by the Joint Applicants in this docket and rejected by the Department in the Star II docket (DOT-OST-2008-0234). As the Joint Applicants have demonstrated, the proposed alliance is necessary to create interalliance competition with the already deeply integrated Star and SkyTeam alliances, and U.S.-EU Open Skies has facilitated new entry at Heathrow that will prevent any competitive harm on overlap routes. The Department should proceed to issue an Order to Show Cause approving the Joint Application without further delay. 2

1 DOJ filed its comments nearly seven months after the Department’s comment period, and nearly two months after the statutory deadline for a final decision in this case (October 31) had passed.

2 The Department has asked whether the Joint Applicants “would object to a limited public disclosure by the Department of aggregate market shares . . . from the MIDT data set that was submitted” (Order 2009-12-16, p. 2). We have no objection to the results of analyses performed using that data being included in the public record. However, the raw data files should continue to receive confidential treatment.- 2 –

**PUBLIC VERSION**

**INTRODUCTION** The Joint Applicants initiated this proceeding in August 2008, hoping to achieve regulatory equity with the much larger and more integrated Star and SkyTeam alliances. The Department deemed the record complete in March 2009, after the Joint Applicants provided an unprecedented level of data and documents supporting the proposed alliance. After having 17 months to review the application, and full access to the most extensive record in the history of antitrust immunity proceedings, DOJ has failed to demonstrate that the proposed alliance would harm competition.

**► DOJ HAS FAILED TO PROVE HARM TO COMPETITION**  DOJ has not met the burden of proof under 49 U.S.C. § 41309(c)(2). The Department has already rejected many of DOJ’s arguments regarding the relevant market and the nature of international airline competition. For example, DOJ persists in excluding connecting service from the relevant market, despite the fact that as recently as July 2009 the Department hadrejected that argument. Likewise, DOJ attempts to use the HerfindahlHirschman Index (“HHI”) standards from its Horizontal Merger Guidelines despite the fact that leading economists and academics have long recognized that the DOJ’s HHI merger thresholds (as opposed to comparisons of relative HHI) do not work in the context of certain industries. Air transportation is one such industry. In reality, the six overlap routes cited by DOJ are some of the most competitive across the Atlantic – with just one 2-to-1 overlap that is less concentrated than comparable routes in the Star I and SkyTeam II alliances to which DOJ did not object.- 3 –

**PUBLIC VERSION** DOJ also restates the fare study it introduced last year in the Star

II docket, and adds a response to the criticism that Compass/Lexecon submitted on September 8, 2009. DOJ’s rebuttal of Compass/Lexecon suffers from the same basic problem that undermined DOJ’s original fare study – failure to control for the necessary variables. Yet even if DOJ’s fare study were accepted on its face, it provides no statistically significant evidence sufficient to meet DOJ’s burden of proving potential harm on any route other than Dallas/Fort Worth-London (a small local O&D that enjoys its current level of service precisely because of the alliance between American and British Airways). DOJ even includes a 5-to-4 route – New York-London – that is one of the most competitive in the world, justifying its argument by dismissing competition from the world’s largest airline (Delta, which has a larger presence at JFK than American) and New York’s largest hub carrier (Continental, which controls 80% of the slots at Newark). DOJ also persists in the myth that entry at Heathrow by new and existing competitors is not possible. Despite the fact that the secondary market and intra-alliance transfers have led to 48 daily slot-pairs changing hands at Heathrow over the past two years, DOJ argues that new entrants could only obtain slots by regulatory fiat. In 2001, DOJ expressed doubts that intra-alliance transfers would occur – an argument proven wrong by both Star and SkyTeam. In 2001, DOJ pointed to the fact that Virgin had only been able to obtain three daily slot-pairs since 1996 as evidence that the secondary market does not work. Today, Virgin leases three daily slot-pairs to Aer Lingus because it cannot fully utilize its Heathrow slot holdings. DOJ discounts new entry by five carriers that occurred on the first day of U.S.-EU Open Skies because most had previously flown their routes to Gatwick, but the issue is whether Heathrow slots can be obtained, not why

.- 4 –

**PUBLIC VERSION** Moreover, DOJ – which has always argued that Heathrow and Gatwick are separate relevant markets – cannot have it both ways. If Gatwick is not a substitute for Heathrow, then the shifts of service are new entry in the relevant market. If, on the other hand, the shifts from Gatwick are not viewed as new entry, that can only be because the two airports are in the

same relevant market. Given that slots at Gatwick are even easier to obtain on the secondary market than Heathrow slots, there would be no need for remedies at all if the two airports are in fact substitutes. In reality, there is no evidence that the proposed alliance would harm consumers on the nonstop overlap routes. New York-London is highly competitive and consumers will still have four strong nonstop options in addition to the potential for new entry on a route with the largest local traffic base across the Atlantic. Chicago-London will still have three competing options, including the Star Alliance’s hub-to-hub operation. Boston-London will still have two competing options, with potential new entry by both Star (US Airways) and SkyTeam (Delta), each with larger Boston operations than American and a history of operating the route from Boston to Gatwick. Miami-London is predominantly flown by leisure passengers, and will have more competition at Heathrow after the alliance is approved today than it did in 2001 when DOJ found no need for a remedy on the route. Dallas/Fort Worth-London is an extremely small local O&D, and those customers will benefit from the added capacity that a fully integrated joint venture will facilitate. Finally, Miami-Madrid is a small and predominantly leisure O&D city-pair that will have nonstop competition from SkyTeam (Air Europa) and which has no slot barriers to entry at all. DOJ has failed to meet its burden, and as such the proposed alliance should be approved.- 5 –

**PUBLIC VERSION ►**  **DOJ HAS FAILED TO REBUT THE JOINT APPLICANTS’ SHOWING OF PUBLIC BENEFITS**  Even if DOJ had met its burden of proving competitive harm, the Joint Applicants have provided more evidence of consumer benefits than has any other alliance in prior proceedings. DOJ claims that the Joint Applicants “downplay” their incentive to cooperate absent antitrust immunity, ignoring

the fact that **one** world remains the least integrated of the branded alliances precisely because the legal risk of antitrust litigation and the commercial risk of diversion has kept American and British Airways from cooperating at the same level as United/Lufthansa, Delta/Air France, or Northwest/KLM. In an attempt to rebut the plain fact that **one** world is the least integrated of the three global alliances, DOJ cites **one** world’s website as though it contradicts the alliance’s lack of full behind/beyond codesharing, and the transatlantic frequent flyer gap. DOJ misuses data from American’s IFS forecasting model which American provided in response to a Civil Investigative Demand but cautioned DOJ against using in a manner it was “not designed for.” DOJ also selectively cites the results of the IFS forecast. DOJ points to the IFS data as showing limited benefits on behind/beyond routes (despite the fact that the data pull assumed unchanged schedules, while the Joint Applicants will retime their entire networks to maximize connectivity). Nonetheless, the IFS model predicted lower fares on the nonstop overlap routes – demonstrating that even if the model is to be credited, it shows improved efficiency and no harm to competition.- 6 –

**PUBLIC VERSION** The Compass/Lexecon results that DOJ does not challenge are by themselves sufficient to support approval of the proposed alliance. DOJ’s criticisms of Compass/Lexecon’s other results are without merit. For example, DOJ also attacked some of the conclusions in Compass/Lexecon’s fare study, pointing instead to DOJ’s own findings that antitrust immunity does not lead to lower fares on connecting itineraries. However, DOJ’s study fails to control for the actual marketing carrier – a control that is necessary in this case in order to obtain an accurate result. As Compass/Lexecon explains in Exhibit 1, DOJ’s counter-intuitive results disappear once individual carrier identities are controlled for in the regressions. Both Compass/Lexecon and The Brattle Group demonstrate that DOJ’s study of connecting fares reaches the wrong results because of incorrect methodology. When done properly, both groups of economists find that codesharing and antitrust immunity lead to lower fares than traditional

interline connections. 3 In addition, DOJ denies that new nonstop service will be a public benefit of the proposed alliance, claiming that such service does not depend on antitrust immunity. Yet that ignores the fact that American only launched Dallas/Fort Worth-Madrid service – an extremely thin local route – in anticipation of the proposed alliance. Although the launch was planned solely by American, absent antitrust immunity with its transatlantic partners the route lacks long-term viability. **[REDACTED]**

3 Moreover, DOJ’s entire study is based on historically inaccurate definitions of immunized, codeshare, and interline itineraries. For example, DOJ would define PIT-(CO)-EWR-(CO*/VS)-LHR as an interline itinerary, even though all segments are sold under the CO code as a part of the Continental/Virgin Atlantic codeshare alliance. Conversely, it appears that DOJ would define AUS-(AA)-DFW-(BA)-LHR as a codeshare flight simply because the two airlines are a part of oneworld – ignoring the fact that the itinerary is sold with two marketing carrier codes.- 7 –

**PUBLIC VERSION [REDACTED]**  Moreover, the Department has already held against DOJ on this point, having determined new nonstop service to be a public benefit in Star I (DOT-OST-2005-22922). Likewise, the Department has rejected DOJ’s arguments regarding interalliance competition. It is disappointing that DOJ continues to dismiss the importance of competition between the three branded global alliances as “overstate[d].” While DOJ makes vague claims about interviews with corporate travel managers, and cites internal documents out of context, the reality is that consumers are increasingly demanding an alliance product. This fact has been consistently found by the Department in prior proceedings, and confirmed both in the data (the Compass/Lexecon study) and in the marketplace (Star’s and SkyTeam’s increasing market shares on behind and beyond routes). In citing a 2002 study of alliances conducted by

**one** world, DOJ disregards the fact that the study was being referenced in the context of a 2008 follow-up which found interalliance competition to be increasingly important, and concluded that **one** world had fallen behind because it had not aggressively marketed its alliance brand to the same extent as the more integrated Star and SkyTeam.- 8 –

**PUBLIC VERSION ►**  **DOJ’S SUGGESTED REMEDIES ARE INAPPROPRIATE IN THIS CASE** DOJ suggests two types of remedies for the Department to consider – slot divestitures and carve-outs. Yet DOJ fails to explain why slot remedies are necessary given the existence of a secondary market that regularly facilitates new entry on U.S.-UK and other long-haul routes. The most likely new entrants – Virgin, Star and SkyTeam – have ample access to slots, and Virgin is even leasing surplus Heathrow slots for short-haul flights. Divesting slots without requiring compensation would be nothing more than a value transfer from the smallest alliance to its larger competitors. Worse yet, DOJ suggests that a slot remedy might not be earmarked to one of the six routes DOJ’s comments identify, meaning that the “remedy” for competition on Boston-London could be to give Heathrow slots to Delta for additional Detroit service (where it faces no nonstop competition). Alternatively, DOJ endorses the use of carve-out remedies, but fails to demonstrate why they are necessary, or how a fully integrated joint venture can operate effectively with carve-outs in place. Unlike the limited carve-outs in other cases (such as American/Lan Chile/Lan Peru , DOTOST-2004-19964), DOJ proposes, as one alternative, full carve-outs on nonstop overlap routes, not simply ones limited to non-discounted unrestricted economy and premium fares. In any event, DOJ itself calls the evidence on the usefulness of carve-outs “inconclusive” in 2001, and has provided no new evidence to explain why they should be imposed on a fullyintegrated joint venture today. The Department rejected the use of carveouts in a fully integrated joint venture in Star II and SkyTeam II , and

should do the same in this case.- 9 –

**PUBLIC VERSION** Carve-outs would negatively impact the Joint Applicants’ incentive to increase capacity on hub-to-hub routes – precisely the opposite of the desired result. In an effort to rebut the Joint Applicants’ evidence that a metal neutral joint venture will lead to an increase capacity on hub-to-hub routes, DOJ argues that the Joint Applicants would already prefer allocating aircraft to short-haul and out-of-scope long-haul flying. However, DOJ ignores two simple yet important facts. First, the majority of transatlantic flights will be operated with wide-body aircraft, while the majority of short-haul flights are operated with narrow-body equipment. Thus British Airways would not choose between allocating a Boeing 747 to JFK-London and London-Paris. Second, since the JBA’s revenue sharing payments to each carrier will be based on capacity, opting to cede JBA flying to other partners would reduce the carrier’s share of all JBA revenue. While DOJ suggests that carve-outs do not impact capacity growth in immunized alliances, the facts show that Delta/Air France grew on routes without carve-outs after receiving ATI (up to 29%), and reduced capacity on routes with carve-outs (up to 12%) (Exhibit 3).- 10 –

**PUBLIC VERSION** DOJ also denies that carve-outs would result in inefficient yield management. While DOJ uses terms like “fare class mapping,” its argument demonstrates a lack of understanding about the issue. DOJ presents a hypothetical that compares yield management decisions on a behind-gateway domestic segment (Atlanta-Miami), rather than the transatlantic segment that would be subject to a carve-out. Even if the hypothetical were relevant, it oversimplifies the analysis by ignoring network revenue contribution and the actual revenue sharing provisions of the JBA. Thus DOJ mistakenly believes that American would prefer selling a seat to a local Atlanta-Miami passenger (which would generate $ **XXXX** in revenue) than to a passenger connecting on to Heathrow (which would generate $ **XXXX** in revenue even after the revenue share). The proper analysis was accepted by the Department in Star II , and applies with equal force here (Order 2009-7-10, pp. 19-20). Finally, DOJ denies that carve-outs would result in sub-optimal scheduling on routes with multiple frequencies. However, the evidence DOJ cites supports the Joint Applicants’ argument. Prior to the immunized American/Swiss revenue sharing agreement on JFK-Zurich, both airlines operated JFK departures in the peak 1700 departure hour. With revenue sharing, American moved its departure to the 2100 hour, creating more connecting opportunities and greater overall revenue for the joint venture. When Lufthansa acquired Swiss, thus terminating the revenue share, American returned to a 1700 hour departure. DOJ cites Swiss’ subsequent decision to launch its own 2100 departure as evidence that revenue sharing was unnecessary, but ignores the fact that by operating both frequencies Swiss integrated its operations and internalized the pro-competitive efficiencies for Swiss that the American/Swiss joint venture had previously achieved.- 11 –

**PUBLIC VERSION I. DOJ HAS FAILED TO MEET ITS BURDEN OF PROVING THAT THE PROPOSED**  **ALLIANCE WOULD HARM COMPETITION** It is unfortunate that DOJ’s focus in alliance proceedings continues to be limited to competition in nonstop overlap O&D city-pairs. Alliances have been a tool for U.S. airlines to create international growth opportunities with their partners and to provide better service with the potential for lower prices for consumers. The connecting O&Ds that alliances serve may be individually small, but collectively account for the majority of transatlantic traffic. The passengers served and revenue generated by U.S. carriers from their international operations is essential to their maintenance of strong domestic networks at their hubs. Scores of small communities would be at risk of seeing service reduced – or eliminated – if onboard international traffic flows (DPIJ) were to significantly

decline. **A. DOJ Has The Burden Of Proving The Proposed Alliance Would Harm Competition**  DOJ claims that “[t]he burden is on Applicants to justify their need for authority to engage in conduct that will likely restrict competition” (p. 7). But this is an inaccurate description of the process set out in 49 U.S.C. § 41309 for adjudicating applications for antitrust immunity. DOJ cites to subsection (b) of the statute (p. 7 n.26), but omits any mention of subsection (c) regarding the burden of proof: “In a proceeding before the [Department] applying standards under subsection (b)(1) of this section, a party opposing an agreement, request, modification, or cancellation has the burden of proving that it substantially reduces or eliminates competition and that less anticompetitive alternatives are available

. The party defending the agreement, request, modification, or cancellation has the burden of proving the transportation need or public benefits” (49 U.S.C. § 41309(c)(2), emphasis added).- 12 –

**PUBLIC VERSION** This provision of 49 U.S.C. § 41309 could not be clearer – DOJ bears the burden of proving both: (a) a reduction in competition; and (b) the existence of less anticompetitive alternatives. DOJ avoids any mention of

this subsection because it has failed to make a case for either element. Rather, DOJ’s comments rely entirely on arguments that the Department has previously rejected in Star II and other dockets (See , e.g. , Order 2009-7- 10, DOT-OST-2008-0234, 7/10/09, pp. 14, 16-17). **B. DOJ Has Failed To Meet Its Burden Of Proving Competitive Harm 1. Connecting Service Imposes An Effective Constraint On O&Ds**  **With Nonstop Flights** DOJ argues that “[i]n transatlantic routes covered by the Joint Application, nonstop service is a separate product from connect service,” claiming that “[a] variety of evidence supports this conclusion” (p. 9). DOJ made this same argument in the Star II docket (DOJ Comments, DOT-OST2008-0234, 6/26/09, p. 49), where the Department rejected the notion that connecting service does not discipline nonstop pricing: “We thus are not persuaded to limit our analysis to nonstop service, given that connecting services can discipline prices on nonstop routes for a significant percentage of nonstop passengers. As American points out, ‘DOJ’s claim that connecting itineraries do not compete with nonstop flights is directly contradicted by empirical evidence’” (Order 2009-7-10, p. 17). Moreover, the Department found that had DOJ included a broader sample of markets in its study, it would have shown that “over one-third of the passengers in [transatlantic] markets used connecting service” (Order 2009- 7-10, p. 17).- 13 –

**PUBLIC VERSION** DOJ argues that “empirical analyses show that the number of nonstop carriers competing in a market has a significant impact on the average fares paid by consumers” (p. 9, citing Appendix A). But this does not prove that connecting carriers do not also have an impact on average fares. In fact, there are numerous examples of connecting fares impacting nonstop prices on transatlantic routes for both premium and economy traffic:

 **Premium Traffic:** On April 19, 2008, United reduced first and business class fares by between $200 and $400 on connecting London itineraries to/from Boston, Dallas/Fort Worth, Miami and New York. American matched each of these fare actions three days later, despite having nonstop service on these routes.

 **Economy Traffic:** On November 12, 2008, United reduced sale fares in economy class on connecting London itineraries to/from Dallas/Fort Worth, Miami, Phoenix and Seattle, as well as Madrid to/from Miami and New York. The nonstop carriers matched these fare actions within nine days. DOJ also cites the Joint Applicants’ “internal models” (referred to as “quality of service index” or “QSI” modeling) as “commonly assum[ing] that an airline’s share of travel between cities will be higher if it offers nonstop service than if it offers connecting service” (p. 9). But these models are used for forecasting domestic routes where the time penalty for connecting service is far more significant than it is for long-haul transatlantic routes. Moreover, the fact that a nonstop carrier would obtain a higher share of O&D traffic is hardly evidence that connecting service is not a meaningful alternative for nonstop service. The issue is substitutability – not merely preference. Given these facts (along with the reasons American previously cited in both this docket and Star II ), there is no basis for departing from the precedent set less than six months ago in

Order 2009-7-10.- 14 –

**PUBLIC VERSION 2. The Proposed Alliance Will Not Create Six “Highly**  **Concentrated Markets”** DOJ claims that six O&D city-pairs 4 will become “highly concentrated” once the proposed alliance is approved: New York-London, Chicago-London, Boston-London, Miami-London, Dallas/Fort Worth-London, and Miami-Madrid (p.11). DOJ uses the Herfindahl-Hirschman Index (“HHI”) to define these citypairs as being “highly concentrated” under DOJ’s Horizontal Merger

Guidelines , but ignores the fact that even the most competitive O&D citypairs exceed the threshold HHI of 1,800 without any grants of antitrust immunity. 5 Given questions about using HHI as anything other than a measure

of relative concentration in international air transportation cases, it is not surprising that DOJ did not cite to the HHI merger thresholds in other cases where it submitted comments (such as Star II and the U.S.-UK Alliance

Case ). Moreover, DOJ’s merger thresholds are meant to “provide only the starting point for” analysis” (DOJ/FTC Horizontal Merger Guidelines , § 2.0). Thus DOJ provides no reason for the Department to depart from its long-held

view that measures of HHI like concentration are “not conclusive” in the airline industry because most individual city pairs have “high levels of concentration” (Order 96-5-12, DOT-OST-1996-1116, 5/9/96, p. 18).

4 In previous comments, the Joint Applicants have disputed DOJ’s undue reliance on nonstop O&D city-pairs as the relevant market in alliance cases, and we incorporate those here by reference. See , e.g. , Joint Applicants’ Supplemental Comments, 9/8/09, p. 13; see also AA Response, DOT-OST-2008- 0234, 7/6/09, pp. 10-11.

5 In fact, the average HHI on a U.S. city-pair is approximately 4,000. See , e.g. , Dresner, Win and Windle (1996).- 15 –

**PUBLIC VERSION** For example, New York-Paris (about which DOJ expressed no concern when SkyTeam sought antitrust immunity in 2000, 2004 or 2007) has a non-ATI HHI of approximately 1,900, which nearly doubles (to approximately 3,400) with ATI for SkyTeam. Nor did DOJ express any concern with antitrust immunity on the New York-Frankfurt route when United and Lufthansa first sought immunity in 1996, despite an HHI of nearly 7,000. In fact, a city-pair with five competitors, each having just 20% of the traffic, would have an HHI of 2,000, even though such a route is extremely competitive in context of the airline industry (which is consistent with DOJ’s own fare study, which showed no harm on 5-to-4 routes). Thus, while HHI may be useful for comparing relative changes in concentration on a city-pair or in broader network markets, the use of DOJ’s HHI thresholds as a litmus test in the airline industry would prohibit almost any transaction. In reality, there are no competitive concerns on any of the six city-pairs DOJ has discussed,

as demonstrated below.

**a. New York-London** New York-London is one of the world’s most competitive aviation corridors (notwithstanding DOJ’s attempt to paint it as “highly concentrated” by using the HHI index). It is served by five differentcarriers offering daily nonstop service, and has historically attracted nonhub point-to-point entry by Fifth Freedom operators (such as Air India and Kuwait Airways) and low-cost carriers (such as Eos, MaxJet and Silverjet). DOJ’s own fare study shows that there are no competition concerns on O&D city-pairs going from five competitors to four (Appendix A).- 16 –

**PUBLIC VERSION** Moreover, Star has true alliance hubs on both ends of the route (Continental at Newark, bmi at Heathrow), and SkyTeam’s Delta has a significant JFK operation (with 34% of the slots) and intends to turn New York into one of its major hubs as well through acquisition of US Airways’ LaGuardia slot holdings. By comparison, **one** world’s New York presence is smaller than either Star (with more than 80% of Newark slots) or SkyTeam, as American has just 18% of JFK slots (and the rest of **one** world holds a de

minimis number). There is no basis for DOJ or the Department to conclude

that **one** world would have any potential market power in New York. DOJ claims that Continental lags “far behind” with just “4%” of nonstop business traffic between New York and London, citing MIDT data from the last three quarters of 2008 (p. 13 n.39). 6 DOJ concludes that “[t]his deficit is likely due to the fact that neither Delta nor Continental offers as many flights as the others, particularly at times business passengers prefer” (p. 13). 7 However, DOJ’s speculation is incorrect, as Continental’s premium MIDT booking share for 2008 was 6% - equal to its share of premium seats. 8 Moreover, the Joint Applicants have already

demonstrated that both Continental and Delta have New York-Heathrow arrivals

6 DOJ’s argument is undermined by its own comments from 2001, in which it held that “three or four flights” could sustain New York-London service – ata time when American offered seven daily nonstops (DOJ Comments, DOT-OST2001-11029, 12/17/01, p. 44). Today, American is down to just five nonstops in the summer, and four in the winter. Thus, it is difficult to see how Delta or Continental lacks the size to compete effectively on the route.

7 In fact, BA puts just 66% of its JFK-Heathrow flights in DOJ’s peak departure window (1800-2200). That is the same as Continental (66%), and less than Delta (100%). Just 60% of American’s and Virgin’s flights depart between 1800 and 2200.

8 By comparison, both American and British Airways had lower premium booking shares (50% and 16%) than premium seat shares (52% and 17%).- 17 –

**PUBLIC VERSION** in two of the four peak hours, compared to just three each for British Airways, Virgin and American (Joint Applicants’ Consolidated Reply, 5/28/09, pp. 32-33). 9 In addition, Continental benefits from its codeshare agreement with Virgin, which adds to Star’s pattern of service. 10 In any event, Continental’s premium booking share is largely a function of the aircraft it chooses to operate (including two narrow-body 757s with just 16 premium seats). **b. Chicago-London** DOJ argues that on Chicago-London, the proposed alliance “would reduce the number of nonstop competitors from three to two for part of the year and from four to three for the other part,” noting that Virgin “only offers seasonal service” (pp. 12-13). Yet Virgin’s service has not historically been seasonal, and if competitive conditions warrant its return to the route in winter 2010-11, Virgin has both the slots and the aircraft to do so. 11 Even in the brief period after 2007 when Virgin returned to Chicago (before the global economic crisis led it to withdraw temporarily), it was able toregain a 13.4% share of local O&D bookings (Joint Application, Exhibit JA27).

9 While DOJ focuses on the number of frequencies offered by the Joint Applicants, it ignores the fact that there is little competitive advantage gained from wingtip flying. For example, AA 100 arrives at LHR from JFK at 0625 and AA 104 arrives at 0655. BA 112 arrives from JFK at 0625, while BA 184 arrives at 0650. DOJ provides no evidence proving that multiple arrivals in the same hour create a frequency advantage on long-haul flights, or that adding American’s incremental flights to the British Airways service creates any additional barrier to entry. Thus even if DOJ were correct that British Airways currently has a frequency advantage, there is no evidence that it would be enhanced by adding American’s schedule.

10 Inexplicably, DOJ does not include the Continental/Virgin alliance as a “codeshare.” See infra , p. 36.

11 Virgin’s decision was driven by an overall cost-cutting program resulting from a reduction in demand worldwide. See Kevin Done, Virgin Atlantic to Cut Flights and Jobs , Financial Times, 7/2/09). Moreover, both American and British Airways also reduced their frequencies on this route.- 18 –

**PUBLIC VERSION** Even if the proposed alliance were to raise fares, resulting in unmet demand for Chicago-London service, both United and Virgin could increase their capacity by upgauging aircraft. Virgin could shift from an Airbus A340 to a Boeing 747, while United could use Boeing 747 equipment (374 seats) rather than the much smaller Boeing 767 (183 seats) it flies today (Joint Applicants’ Consolidated Reply, 5/28/09, pp. 52-53). Clearly, both new entry and capacity expansion are possible on the route, calling into question why DOJ has included Chicago-London as a city-pair of concern.

**c. Boston-London** DOJ notes that American and British Airways are two of the three nonstop competitors on this route (p. 12). Yet DOJ ignores the fact that both Delta and US Airways have a larger Boston presence than American and have historically served the route, and could choose to re-enter if warranted by the competitive conditions. In 2001, DOJ itself stated that both carriers “have significant operations at Boston, and hence they have the type of ‘presence’ that would give them the incentive and ability to attract corporate business to LHR services” (DOJ Comments, DOT-OST-2001- 11029, 12/17/01, p. 44). Both Delta (the world’s largest airline) and US Airways (a member of Star) have access to Heathrow slots through intra-alliance transfer or the secondary market. Accordingly, these two potential new entrants have boththe ability as well as the incentive to discipline prices on the BostonLondon route. Lufthansa itself could also enter the route, having acquired bmi (and its Heathrow slots). Lufthansa has an equity stake in (and a codeshare agreement with) JetBlue, which has 60 daily departures from Boston to large U.S. markets, allowing Lufthansa to connect traffic through Boston

as well.- 19 –

**PUBLIC VERSION d. Miami-London**  DOJ states that American and British Airways are two of the three nonstop competitors on this route (p. 12). Yet in 2001, DOJ pointed outthat “[b]usiness traffic is a relatively smaller percentage of this leisureoriented market . . .” (DOJ Comments, DOT-OST-2001-11029, 12/17/01, pp. 31- 32). At that time, DOJ argued against a slot remedy for Miami-London, finding that any anticompetitive effects would be offset by new entry (Id

. at 31, 45). Since then, Virgin has shifted its Miami service from Gatwick to Heathrow, and now has a 27% booking share of local Miami-London traffic. Thus it is difficult to see how DOJ could argue for a remedy on this route today, which is more competitive now than it was eight years ago. DOJ viewed bmi as a viable new entrant in 2001, with “both the endpoint presence and the LHR facilities needed to make it a plausible entry candidate” (Id . at 45). With Lufthansa’s acquisition of bmi in 2009, DOJ’s findings are even more compelling today. Moreover, connecting service is used by 14% O&D passengers between Miami and London. In fact, American’s top connecting O&D itinerary using its JFK-Heathrow service is Miami-London – even though American operates nonstop Miami-Heathrow service of its own. There is simply no basis for DOJ to conclude that the proposed alliance would have market power on this route. **e. Dallas/Fort Worth-London** DOJ notes that American and British Airways operate the only nonstop service (p. 12). However, today more than 20% of the local O&D traffic on the route opts for connecting service – including 14% of premium passengers (2008 CAA Survey). Capacity on this route is set for flow traffic, as only 20% of onboard passengers on the route are traveling on the local O&D (Joint Applicants’ Consolidated Reply, 5/28/09, p. 39).- 20 –

**PUBLIC VERSION**Moreover, DOJ’s concern for O&D passengers on the Dallas/Fort WorthLondon route is inconsistent with its silence regarding the antitrust immunity granted to Star and SkyTeam on two-to-one routes like Atlanta-Paris (82% SkyTeam share) and Detroit-Amsterdam (89% SkyTeam share) (Joint Application, 8/14/08, p. 55). As the Department held in Star II , “[t]hepotential serious anticompetitive effects of reducing competition on [hubto-hub] routes may be offset to some extent if the affected city pairs are served by competing carriers on a nonstop or connecting basis (Order 2009-4- 5, DOT-OST-2008-0234, 4/5/09, p. 10, emphasis added).

**f. Miami-Madrid** DOJ claims that the Joint Applicants “currently offer the only daily nonstop service” between Miami and Madrid (p. 12, emphasis added). This statement ignores the entry of Air Europa – a SkyTeam member – on the route beginning in March 2010. Air Europa’s initial five weekly flights are scheduled to expand to daily service in June 2010. DOJ also disregards other important characteristics of the route. Miami-Madrid is overwhelmingly (approximately 82%) a leisure route. Approximately 21% of the O&D traffic opts for an itinerary other than the nonstop, which disciplines pricing. Moreover, the nonstop flight primarily accommodates flow traffic, as less than 25% of onboard traffic is local O&D. In addition, Star Alliance member Spanair could enter the route based on the strength of its Madrid hub. There is no evidence that slots are a barrier to entry on either end of the route, as Miami is not a slot controlled airport, and Madrid has available slots during the transatlantic arrival window (a fact DOJ concedes) (p. 18 n.51). There is no legitimate

reason for DOJ to have included Miami-Madrid as a route of concern.- 21 –

**PUBLIC VERSION 3. DOJ Fails To Prove That Significant Fare Increases Would**  **Result From The Proposed Alliance a. DOJ’s Fare Study – Even If Correct – Would Reliably**  **Predict Harm On Just One City-Pair, Not Six** DOJ cites its fare study for the proposition that on a 2-to-1 route ATI would lead to a 15% fare increase, while on a 3-to-2 route fares would increase by 6.6% (pp. 14-15). While a reduction from three to two alliance competitors across an entire network would certainly be significant enough to merit concern (which would become the case if the proposed alliance were not approved), DOJ’s concerns are limited to handful of routes rather than the broader and more relevant context of network competition. In any event, DOJ admits that its 3-to-2 city-pair findings are not statistically significant, and does not even try to argue that competitive harm would result if there are three or more post-transaction competitors (Appendix A, Table 1). Accordingly, even if DOJ’s fare study were

accurate, 12 it would still potentially satisfy DOJ’s burden of proof on just a single route – Dallas/Fort Worth-London – not the six it has chosen to include. The Department’s Star II decision reflects this fact as well (Order 2009-7-10, DOT-OST-2008-0234, 7/10/09, p. 18, holding that “we will not impose carve outs in markets [with no joint venture] that only shift from four to three, or from three to two, nonstop competitors, as we are not convinced that these pose a substantial reduction in competition”).

12 Compass/Lexecon’s response to DOJ’s Appendix B is attached as Exhibit 1.- 22 –

**PUBLIC VERSION** For example, in order to include New York-London in its analysis, DOJ is forced to simply ignore the very existence of Delta and Continental in order to artificially transform New York-London into a three-to-two route. In other words, even though the route will still have four nonstop competitors with two or more daily operations, DOJ ignores half of them, including the world’s largest airline and New York’s largest hub carrier. DOJ applied no such filter to discount the presence of competitors with multiple nonstop operations in its fare study, and has no basis for ignoring

Delta and Continental in order to reach its desired conclusion. **b. DOJ’s Comments Fail To Recognize The Fundamental Difference Between A Change In Capacity And A Change**  **In The Number Of Competitors** DOJ argues that The Brattle Group also found “that the number of nonstop competitors . . . does directly influence price” (p. 15 n.43). DOJ claims that “[t]he data showed that, all else equal , fares on routes served only by carriers in an antitrust immunized alliance are 15% higher than on routes served by two independent non-stop carriers” (Appendix B, pp. 1-2, emphasis added). Yet all else is not equal. The fare reductions resulting from the Joint Applicants’ new entry on transatlantic routes into SkyTeam hubs like Amsterdam or Frankfurt will be caused by increased capacity – not simply a numerical increase the in the number of competitors. Since there is no evidence that the Joint Applicants would have any incentive to reduce their capacity on any of the six routes (to the contrary, history has proven that alliances increase capacity even on hub-to-hub routes where they face no nonstop competition), DOJ has taken Brattle’s findings entirely out of

context.- 23 –

**PUBLIC VERSION c. DOJ’s Description Of Yield Management Strategy Is**  **Fundamentally Flawed** The Joint Applicants have already demonstrated that they will have “no ability or incentive to raise local fares” given their plans to increase – not reduce – capacity (Joint Applicants’ Supplemental Comments, 9/8/09, pp. 4-6). DOJ’s response is to state that the Joint Applicants have “highly sophisticated computer systems that . . . seek to maximize yield on eachflight, and one way to maximize yield is to restrict capacity [on] hub-tohub routes where they face little competition” (pp. 16-17). However, the Compass/Lexecon study examined the precise issue of whether ATI leads to fare increases on local nonstop overlap routes, finding that as an empirical matter it does not (Exhibit 1). DOJ does not address the declaration submitted by Don Casey, American’s Vice President for Revenue Management, in which he explained the conflict between increasing network capacity (and overall profitability) and simultaneously trying to raise local fares: “If AA were to constrict capacity in order to gain pricing power against local passengers, it would simultaneously diminish the quality of its product and the inventory that it has available to sell to the far more numerous connecting passengers. A network carrier cannot have it both ways – if it reduces flying on a route, it must withdraw large chunks of capacity that serve not only as inventory for local passengers but also as trunk capacity for connecting passengers on many more routes. Given that margins in the airline industry are notoriously thin (and all too often negative), the loss of even one or two passengers can determine whether a flight generates a loss or profit. Shrinking critical trunk capacity in order to earn supra-competitive fares from a relatively small subset of passengers is simply not a viable long-term strategy for network carriers. A carrier like AA must offer service that is attractive to both local and connecting passengers” (Casey Declaration, 9/8/09, pp. 5-6).- 24 –

**PUBLIC VERSION** Mr. Casey has more than two decades of experience working in the airline industry and is in charge of the “highly sophisticated” yield management systems that American operates. DOJ also fails to consider the impact that a strategy of artificially closing local transatlantic inventory to raise yield would have on load factor. Likewise, DOJ has no appreciation for the fact that it is RASM 13 that drives a flight’s profitability. As local fares increase, demand will decrease; thus, if load factor declines, an increase in yield 14 can nonetheless result in a decrease in both RASM and profitability. Thus, unless an airline could replace the lost local traffic with connecting traffic of a yield sufficient to offset the revenue losses, DOJ’s hypothetical yield management strategy would be unprofitable. Yet if unmet high-value demand existed on those connecting itineraries, the alliance would likely seek to accommodate it in addition to its local pricing strategy. This explains why the integrated alliance will increase capacity as a direct result of their improved network product.

13 RASM is revenue per available seat mile – which is driven downward by spoiled empty seats.

14 Yield is revenue per revenue passenger mile, which is unaffected by load factor.- 25 –

**PUBLIC VERSION d. DOJ’s Arguments Regarding New Entry Ignore Reality**  **i. There Is No Hub Barrier To Entry** DOJ argues that new entry on Chicago-London, Dallas/Fort Worth-London, Miami-London and Miami-Madrid is unlikely because the Joint Applicants “would have hubs at both ends, a competitive advantage no new entrant can match” (p. 17). But in 2001, DOJ maintained that having a hub at either endpoint was sufficient for a carrier to be considered a likely potential entrant, sometimes even “consider[ing] that carrier already in the market” (DOJ Comments, DOT-OST-2001-11029, 12/17/01, p. 43). In 2005, DOJ’s Deputy Assistant Attorney General overseeing airline competition confirmed this (J. Bruce McDonald, Remarks at the Regional Airline Association President’s Council Meeting: Antitrust for Airlines , 11/3/05). DOJ provides no evidence to explain its contrary conclusion here. Indeed, the validity of DOJ’s newly theorized entry barrier is contradicted by Air Europa’s launch of new nonstop Miami-Madrid service, which will have hub support at only one end (Madrid). On Chicago-London, DOJ ignores the fact that Star has hubs on both ends of the route, meaning that United could easily add capacity. On Miami-London, Virgin has been able to launch and sustain service with a hub at the Heathrow end, demonstrating that Star (with an even larger Heathrow hub) can do the same. Finally, Dallas/Fort Worth-London has eight seats for every one local booking (a ratio sure to increase after the proposed alliance has been approved), calling into question why there would be any need for new entry in any event (Joint Applicants’ Supplemental Comments, 9/8/09, p. 5).- 26 –

**PUBLIC VERSION ii. Heathrow Slots Have Not Proven To Be A Barrier To**  **Entry** DOJ argues that “[e]ntry is unlikely because slots at Heathrow – the most attractive London airport for a potential entrant – are difficult to obtain” (p. 18). 15 DOJ thus chooses to ignore the evidence of an effective secondary market that has been submitted in the docket, and instead focuses almost exclusively on the lack of “pool” slots (pp. 21-22; but see Joint Applicants’ Reply To Virgin Answer, 9/28/09, Appendices A-C). DOJ quotes Heathrow’s slot coordinator as saying that new entrants must “accept commercially sub-optimal timings” (p. 21, citing ACL Response, 1/28/09, p. 2). DOJ – like Virgin – is selectively quoting from the ACL Response by omitting key parts of the sentence: “Although past experience (e.g., with Open Skies) indicates that the secondary slot market is capable of facilitating determined new entry, it is ACL’s experience that new entrant airlines still need to be flexible about the timing of slots and accept commercially suboptimal timings” (ACL Response, 1/28/09, p. 2, emphasis added on omitted text).

15 DOJ claims that “[a]ggregating London airports” does not “alter the entry analysis” (p. 11 n.35). Yet this defies logic – Gatwick slots are certainly available on the secondary market; in fact, for every shift of service from Heathrow to Gatwick, a slot pair at the latter was either released into the pool, sold to a different airline, or reallocated onto another route. The Joint Applicants have shown that the two airports are in the same relevant market regardless of perceived preferences (See , e.g. , Joint Application, Exhibit JA-26), and DOJ has provided no empirical analysis to rebut that. Given the fact that DOJ – not the Joint Applicants – bears the burden of proving the relevant market, the Department should consider the potential for new entry at Gatwick in its analysis.- 27 –

**PUBLIC VERSION** While new entrants must be flexible (as is the case at any slot controlled airport), the secondary market does work and new entry is taking place. ACL stated that “slots for competitor services may be found within the incumbent carriers’ slot portfolios, from alliance partners, or from the secondary market more generally” (Id .). Also omitted from DOJ’s filing is the most important sentence from the ACL response: “The level of service that new entrants could expect to achieve in the next two seasons at Heathrow and Gatwick is primarily a function of market demand” (Id ., p. 1). At the moment, it is a buyer’s market for Heathrow slots. Since U.S.- EU Open Skies took effect, 48 daily Heathrow slot pairs have changed hands through intra-alliance trading and the secondary market, including 29 sales and leases for Winter 2008 and beyond – many for peak hour arrivals (Joint Applicants’ Reply To Virgin Answer, 9/28/09, Appendices A-C). Among other things:

 Virgin Atlantic has leased out three Heathrow slots that could be used for transatlantic flights to Aer Lingus (which uses them for short-haul flights to Ireland). Virgin also withdrew service from the JFK-Heathrow route and reassigned those slots to launch additional service to Hong Kong.

 **[REDACTED]**

 **[REDACTED]**- 28 –

**PUBLIC VERSION** DOJ’s comments largely repeat its 2001 arguments on Heathrow access, which cited Virgin’s inability to obtain more than three daily Heathrow slot pairs between 1996 and 2001 as evidence that the secondary market is not a practical source of new entry (DOJ Comments, DOT-OST-2001-11029, 12/17/01, p. 38). But by ignoring recent developments, DOJ overlooks the fact that Virgin has acquired so many Heathrow slots that it now leases them to other carriers. Likewise, DOJ argued in 2001 that the lack of revenue sharing among alliances made it unlikely that intra-alliance transfers would take place (Id . at 40) – yet revenue sharing now exists within both Star and SkyTeam, and intra-alliance transfers are commonplace. **iii. DOJ’s Attempt To Dismiss The 19 New U.S.-Heathrow Frequencies Only Proves The Competitiveness Of**  **London Routes** DOJ admits that “[d]uring the first open-skies season in the summer of 2008, there were 19 more daily flight frequencies between the U.S. and Heathrow than in the summer of 2007,” with slots coming “from a variety of sources” (pp. 21-22). Yet DOJ tries to dismiss the significance of this new entry by arguing that it “merely involve[d] carriers that shifted service involving their hubs” (p. 22). DOJ notes the two exceptions – Northwest on Seattle-Heathrow and Air France on Los Angeles-Heathrow – but argues that “each airline abandoned its new route after less than a year,” and thus that “there are no examples of truly new entry into Heathrow” (Id .).- 29 –

**PUBLIC VERSION** However, the relevant question is not why a new entrant obtained a

slot – it is whether the slot could be obtained. The fact that 17 of the 19 slot pairs used to launch new Heathrow service were Gatwick shifts (and that the two new routes failed) is not evidence that Heathrow slots are impossible to obtain – to the contrary, five new entrants found slots for more than a dozen new flights immediately after U.S.-EU Open Skies took

effect. 16 Rather, the facts DOJ cites are merely evidence that Heathrow is not the gold mine that many incorrectly speculated it would be. ACL called the initial rush to acquire Heathrow slots an “exuberant market” in 2008 and noted that “it is probable that slot values have fallen back from [those] high levels” (ACL Response, 1/28/09, p. 1). Northwest and Air France failed on their new routes because they likely misjudged consumer demand and the mythical “Heathrow premium” that did not even exist under Bermuda II. Given the competitiveness of London routes and the lack of unmet demand for U.S.- London travel, it only makes sense that capacity remained largely steady,

while service shifted from Gatwick to Heathrow.

16 In 2001, DOJ sought a remedy of nine daily slot-pairs, arguing that they would not be available in the secondary market (DOJ Comments, DOT-OST-2001- 11029, 12/17/01, pp. 37-38, 49-50). Given the fact that more than nine were purchased, leased or traded within a relatively short period of time by new entrants, it is difficult to see how DOJ can seek any remedy in this case at all.- 30 –

**PUBLIC VERSION** DOJ cannot continue to have it both ways by suggesting that Gatwick is

not in the same relevant market as Heathrow and arguing that switches from Gatwick to Heathrow are “not truly new entry” (p. 22). Nor can it claim that “[a]ggregating London airports” does not “alter the entry analysis” (p. 11 n.35). If Gatwick and Heathrow are in the same relevant market, then slot availability at Gatwick must be considered. It is indisputable that Gatwick slots are available on the secondary market; in fact, for every shift of service to Heathrow a slot pair was released into the pool, sold to another airline, or reallocated onto another route. In sum, DOJ has fallen far short of proving that new entry is unlikely

on the six routes it has identified. If a transaction were to create market power – resulting in a reduction in supply, and higher fares in turn – demand for new entry would be created. Given the availability of Heathrow slots in the secondary market – and the fact that incumbents like Virgin are leasing their slots to short-haul carriers (like Aer Lingus) to protect them from loss under the IATA slot usage rules – if there were demand for more capacity on a route, a new entrant would meet that new demand. **4. DOJ Fails To Effectively Rebut Compass/Lexecon’s Findings** DOJ’s Appendix B attempts to rebut Compass/Lexecon’s findings, which directly contradict the findings that DOJ presented in the Star II docket. In response, Compass/Lexecon notes that “what is most striking about the DOJ Response is the number of topics on which it ignores, agrees with, or fails to provide any econometric analysis to respond to fundamental points that we made in our initial affidavit” (Exhibit 1, p. 2). DOJ focuses primarily upon “implementation issues” which have “no effect on any of the conclusions” in Compass/Lexecon’s initial affidavit (Id ., at p. 3). As Compass/Lexecon concludes:- 31 –

**PUBLIC VERSION** “In essence, DOJ continues to confound pricing differences across carriers with the relevant competitive effects of ATI, and consequently continues to to draw incorrect conclusions about ATI effects” (Id .). There are four key facts about which DOJ either agrees with or fails to rebut Compass/Lexecon:

 That the question of whether ATI does or does not lead to higher nonstop fares is a separate, empirically testable question, distinct from the effect of the number of carriers on the route;

 That Compass/Lexecon provides a cross-sectional alternative analysis that renders moot DOJ’s criticism of the route fixed effects methodology;

 That consumer preference for ATI service reveals itself in consumer choices in the O&D Survey; and

 That carve-outs result in higher fares and lower non-price benefits on connecting itineraries in an ATI alliance. As Compass/Lexecon notes, “[s]imply combining the conclusions from the studies listed above . . . demonstrates the pro-competitive nature of ATI and the harm from carve-outs” (Id . at p. 6). With DOJ having failed to satisfy its burden of proof, the Department should approve the proposed alliance without further delay.- 32 –

**PUBLIC VERSION II. THE DEPARTMENT HAS CONSISTENTLY HELD THAT ANTITRUST IMMUNITY IS**  **REQUIRED TO ACHIEVE THE FULL PUBLIC BENEFITS OF ALLIANCE INTEGRATION** Even if DOJ had met its burden of proving competitive harm, the Joint Applicants have demonstrated that their proposed alliance will generate significant public benefits. DOJ claims that the Joint Applicants “assign undue weight” to these public benefits, and that they “downplay their incentives to cooperate absent immunity” (p. 22). DOJ further argues that the Joint Applicants “do not distinguish between the formation of an alliance and the granting of antitrust immunity” (Appendix B, p. 4). But DOJ could not be more wrong. The bilateral alliances between American, British Airways and Iberia were formed separately in 1992 and 1997.

**one** world itself was created in 1999 as a brand, but effective integration has not been possible. What DOJ fails to appreciate is the fact that antitrust immunity is necessary to eliminate the diversion risks that stand in the way of true network integration, which cannot occur based on a patchwork of codesharing and reciprocal frequent flyer arrangements that create only limited consumer benefits. DOJ’s view that antitrust immunity is not required ignores the fact that these alliances are necessary for international network expansion because of the legal restrictions on ownership and control of airlines in the U.S. and EU. These restrictions prevent international airlines from merging, and immunized alliances are intended to provide the network extension that mergers would create.- 33 –

**PUBLIC VERSION A. DOJ’s Claims Regarding Network Benefits Are Fundamentally Wrong**  **1. DOJ Misuses American’s Forecasting Data** According to DOJ, “American’s modeling suggests that very few gainsfrom new codesharing will result from passengers carried between small (nongateway) cities in the U.S. and small (non-gateway) cities in Europe” (p. 23). As evidence, DOJ cites American’s response to Specification 7 of its Civil Investigative Demand, which required American to perform an analysis using its Integrated Forecasting System (“IFS”). But the fact is that Specification 7 was fundamentally flawed, and forced American to use a tool for a purpose for which it is ill-suited and not intended – making the results completely unreliable as evidence in this proceeding. Specification 7 required American to assume existing schedules for the before and after cases. This means that the network connectivity could not be optimized – by definition understating the benefits of the proposed alliance. Moreover, American cautioned DOJ that “IFS forecasting models are a planning tool (and thus not designed for precise or accurate measurements)” (AA Response to CID 25295, 3/13/09, p. 1). American added that “[i]t is important to remember that IFS is a tool – its output is used as a part of – not a substitute for – the planning process” (Id . at 2). Yet despite being advised that the output from Specification 7 would have little or no probative value, DOJ cites the results as though they were dispositive on the issue (rather than simply a basis for further analysis).- 34 –

**PUBLIC VERSION** Even if the response to Specification 7 did have probative value, it undermines rather than supports DOJ’s argument when considered in its entirety. DOJ has selectively cited from American’s response in a manner that creates a misleading impression of the record. Specifically, while DOJ claims the IFS model predicts that “only about **XXX** % of the total additional passengers” are on behind/beyond routes served by alliances (p. 23), DOJ

omits the fact that IFS also predicted lower fares on nonstop overlaps: “While it is important to recognize that IFS forecasting models are a planning tool (and thus not designed for precise or accurate measurements), its application as requested by the CID suggests that the proposed alliance will be more efficient in carrying traffic but will not harm competition

. The estimated increases in passengers and revenue are generally lower for nonstop overlaps and greatest for flow markets where the proposed alliance will create the most value for consumers. At the same time, there is no evidence that the proposed alliance would create market power in the nonstop overlaps, as the forecast does not predict reductions of capacity with significant increases in price, or new traffic paying significantly higher average fares. In short, the model predicts no harm to consumers in the overlap markets and substantial benefit in the flow markets currently dominated by the Star/SkyTeam duopoly .” (AA Response to CID 25295, 3/13/09, pp. 1-2, emphasis added). DOJ cannot have it both ways – if DOJ chooses to rely on the IFS model to discount the public benefits, it must also accept the model’s showing of no harm to competition. 17

17 Despite being highly favorable to the proposed alliance, the Joint Applicants have never cited them to the Department precisely because they lack any probative value.- 35 –

**PUBLIC VERSION 2. The Department Has Rejected DOJ’s Arguments Regarding**  **SkyTeam’s Three-Coupon Itineraries** DOJ argues that enhancing connectivity on behind/beyond itineraries which involve three segments generates “little incremental value” for consumers (p. 24). As evidence, DOJ cites MIDT data for SkyTeam’s network, which shows “only 7% of all SkyTeam marketed tickets involve three segments of travel” (p. 24). Yet the Department approved SkyTeam’s joint venture, even though SkyTeam II presented overlapping immunized networks: “We have considered the arguments of each side. Circumstances have changed significantly since the SkyTeam I case . . . . At that time, we noted that the applicants had not reached any detailed agreements to align the conflicting economic incentives that inevitably occur when forming an alliance that combines overlapping networks. The absence of such agreements, we believed, impeded the realization of consumer benefits. In contrast, the Joint Applicants now supply a detailed joint venture agreement that integrates international operations to such an extent as to suggest metal neutrality and seamless travel across one joint network. The proposed alliance is likely to result in the introduction of new capacity and greater availability of discount fares across the entire joint network – benefits that we tentatively find to be substantial in the circumstances of this case . . . . The aligned economic incentives in the 4-way JV increase the likelihood that the new public benefits will be realized, over and above what is possible under the two existing alliances. Antitrust immunity is well suited to enable carriers to achieve mergerlike efficiencies and deliver benefits that would not otherwise be possible” (Order 2008-4-17, DOT-OST-2007-28644, 4/17/08, p. 15) DOJ’s arguments are inconsistent with the Department’s precedent, and should be rejected on that basis.- 36 –

**PUBLIC VERSION 3. DOJ’s Study Of Alliance Fares Is Deeply Flawed**  DOJ’s study of alliance fares for connecting passengers appears to be based on a fundamental misunderstanding of what makes an itinerary online, codeshare, ATI, or interline: “A ticket is an online ticket if all of the coupons in the ticket are operated and marketed by a single airline. An ATI ticket is a ticket that lists two or more airlines as operating or marketing carriers and all of the airlines are immunized members of the same alliance (SkyTeam, Star, or oneworld). A code-share ticket is a ticket that lists two or more airlines, and all listed airlines are members of the same alliance (SkyTeam, Star, or oneworld), but at least one of the airlines is not an immunized alliance member. Lastly, a ticket is an interline ticket if it lists two or more carriers that are not members of the same alliance. These interline tickets encompass traditional interline tickets as well as tickets that derived from bilateral code-share arrangements between airlines not in alliances or in different alliances” (DOJ Comments, Appendix B, p. 20 n.12). While DOJ correctly defines an online itinerary, its definitions of codeshare, ATI and interline tickets are simply wrong.

 **Codeshare:** A codeshare itinerary is one in which each segment is marketed by a single carrier, but there is more than one operating carrier. Thus DOJ’s definition misses the mark in two ways. First, it includes any itinerary “that lists two or more airlines” (Id .), irrespective of whether there is a single marketing carrier. Thus AUS-(AA)-DFW-(BA)-LHR would be incorrectly defined as a codeshare under DOJ’s definition. Second, DOJ’s definition is limited to tickets on which “all listed airlines are members of the same alliance (SkyTeam, Star, or **one** world).” However, there are many codeshare agreements that exist outside the scope of one of the three globally branded alliances. For example, Continental and Virgin have an extensive codesharing alliance, even though Virgin is not in a branded alliance. Yet DOJ’s definition would exclude PIT- (CO)-EWR-(CO*/VS)-LHR from the definition of a codeshare.- 37 –

**PUBLIC VERSION**  **ATI:** An ATI itinerary is either a codeshare or interline itinerary where there is more than one operating carrier, but all operating carriers have antitrust immunity with one another. DOJ’s definition lumps ATI codeshare and ATI interline together, even though fare construction for the two may be different. For example, DOJ would treat IAD-(UA)-FRA-(LH)-IAD the same as IAD-(UA)-FRA-(UA*/LH)-IAD, even though the former would be a combination of United and Lufthansa fares, while the latter would be sold under a single United fare.

 **Interline:** An interline itinerary is any itinerary with more than one marketing carrier sold either under a single carrier’s fare (typically the carrier with the longest segment) or as a combination of local O&D fares. The interline nature of an itinerary exists regardless of whether the carriers are immunized or in an alliance. This could be further broken down into IATA Interline and Special Prorate Agreement (“SPA”) Interline – and the latter divided further still into SPA/ATI Interline and SPA/No ATI Interline, as each of these has a different competitive dynamic. Yet DOJ defines“interline” to include “tickets that derived from bilateral codeshare arrangements between airlines not in alliances” (Id .). Thus the PIT-(CO)-EWR-(CO*/VS)-LHR itinerary – even though it is a codeshare sold under a single marketing code – is defined as “interline” by DOJ. Given that, as shown above, DOJ rests its case on erroneous definitions of basic airline industry terms like “codeshare” and “interline,” the Department should give no weight to DOJ’s conclusions. DOJ’s study of connecting fares for **one** world is further flawed in a number of ways. As The Brattle Group found: 18

“DOJ is even less careful when it draws conclusions regarding the relative price differences between **one** world online and codeshare fares because many of the routes that DOJ relies on for this comparison cannot (by definition) be served by online service. Asmentioned previously, DOJ’s data contains behindbeyond routes that are not served by online service.However, since these routes can be served by codeshare service, their inclusion affects the magnitude of the coefficient estimated for DOJ’s code-share variable. An appropriate analysis that compares online fares to code-share fares should be constrained to routes where online service exists” (Exhibit 2).

18 DOJ’s study is also flawed because it is based on the limited American/Finnair and American/Brussels Airlines alliances (Exhibit B). Brussels Airlines has never been a member of **one** world, and in fact is slated to join Star now that it has been acquired by Lufthansa.- 38 –

**PUBLIC VERSION** The Brattle Group modified DOJ’s model to address its methodological flaws, and found decidedly different results. Brattle found that **one** world

carriers’ individual online fares are lower than the **one** world codeshare fares, suggesting that the alliance is “unable to achieve the fare coordination for connecting passengers through codesharing that can be attained under more ‘unified control,’ such as single-carrier online service” (Id .). When an additional modification – looking at operating carriers only – is added, the fare decreases are deeper, ranging between 7.2% and 7.4%. Thus it is only DOJ’s methodology – not the fare data – that leads to the incorrect conclusion that non-immunized codesharing creates optimal consumer benefits. **B. DOJ’s Claims Regarding New Nonstop Service Were Previously Rejected**  DOJ dismisses the potential for new nonstop transatlantic service as a public benefit, arguing that such service “does not depend on the immunized status of the alliance” (p. 25 n.73). As evidence, DOJ cites the fact that American has “considered” flying to **[REDACTED]** “in the recent past” (Id .). But the real point is that American has not launched such service – largely because it lacks integrated European partners that can help market and support the flights.

**[REDACTED]**- 39 –

**PUBLIC VERSION** DOJ also cites American’s arguments in the Star I case that “simple codesharing and non-immunized joint marketing will support new nonstop service . . .” (Id .). However, American’s arguments failed to carry the day, as the Department approved nine-way antitrust immunity for Star in that case (Order 2006-12-17, DOT-OST-2005-22922), finding that: “The Joint Applicants claim that their proposed alliance will produced numerous public benefits beyond new online service. They cite as potential public benefits . . . expansion of nonstop international service . . . . We tentatively find, in the particular facts and circumstances of this case, that these are substantial benefits offered by Star to the traveling public” (Id . at 18). Arguments that the Department has already rejected in other proceedings can hardly be viewed as persuasive. **C. The Department Does Not Share DOJ’s Lack of Concern Regarding Interalliance Competition**  DOJ claims that the Joint Applicants “overstate the importance of interalliance competition to consumers” (p. 27). As evidence, DOJ points to

the **one** world website, which “proclaims that it is already the preferred alliance, citing to the advanced level of cooperation among its members and the travel industry awards captured by the alliance” (p. 27). The fact that the quality of **one** world’s carriers has allowed it to survive in the face of the network integration being implemented by Star and SkyTeam is not evidence that the proposed alliance would not increase competition and generate public benefits. As the two other alliances implement their transatlantic joint ventures, absent antitrust immunity **one** world will continue to fall behind – notwithstanding promotional statements contained on a marketing website.- 40 –

**PUBLIC VERSION** DOJ also claims that “few, if any, corporate travel managers whom DOJ interviewed have stated a desire for increased interalliance competition” (p. 27). Yet no corporate customers opposed the application. To the contrary, when American surveyed its 40 largest corporate customers, **XXX** % called having a single alliance contract “very important,” and **XXX** % said it was at least “somewhat important.” **[REDACTED]** said they would seek to renegotiate their contracts immediately upon the JBA’s implementation, while just **XXX** % sought to maintain the status quo. Moreover, the Joint Applicants’ survey of corporate customers is consistent with the broad and unprecedented support the Joint Application has received from government officials, corporations, small businesses and community organizations. Likewise, the Joint Applicants commissioned independent firm Ipsos Mori to conduct a survey of their top corporate customers on each of the Heathrow overlap routes. This survey shows that **XXX** % of corporate customers supported the proposed alliance, while just **XXX** % opposed it. This survey found that only **XXX** of **XXX** corporate accounts considered a single alliance contract unimportant – while **XXX** % of customers with alliance deals and **XXX** % of customers without alliance deals said they found value in the ability to negotiate a single contract for an entire network of alliance travel.- 41 –

**PUBLIC VERSION** DOJ cites an American document which it presents as showing that

consumers “ **[REDACTED]** ” (p. 27 n.81, citing AA-DOT-0007977- 48034). Once again, DOJ is taking a document out of context. Although the

document itself is from **XXXX** , the language DOJ quotes reflects a **XXXX** study (AA-DOT-0007984). The **XXXX** document goes on to question “ [ **REDACTED]** ” citing the “ **[REDACTED]** ” as having “ **[REDACTED]** ” (AA-DOT-0007985). In other words, the **XXXX** document DOJ quotes specifically

notes that **[REDACTED]**

. Nor does DOJ quote the **XXXX** document’s conclusion regarding the impact

of **one** world’s decision **[REDACTED]** to

:

**[REDACTED]**

Accordingly, the document DOJ cites is hardly evidence that **[REDACTED]** . In fact, it indicates the opposite – **[REDACTED]**

.- 42 –

**PUBLIC VERSION** Another document taken completely out of context is AA-DOT-0007981, which DOJ quotes as “

19 **[REDACTED]** ” (p. 28 n.84). Yet that **[REDACTED]** . The Joint Applicants remain concerned about private treble damage antitrust litigation – however frivolous – in the absence of an

immunized alliance. **[REDACTED]** , it would not prevent litigious competitors (like Virgin) from seeking to disrupt pro-competitive alliance network competition in the courts. In addition, the JBA participants have diversion concerns about joint corporate dealing in the absence of a revenue sharing

agreement. The Department has never agreed with DOJ’s dismissal of the value antitrust immunity brings to consumers, holding that “[a]lliances compete with each other based on connecting services, seeking to minimize connecting times and to provide greater scheduling and other ‘alliance’ productfeatures to attract passengers to their networks” (Order 2009-7-10, DOT-OST2008-0234, p. 17). Likewise, the Department has allocated routes in limited entry markets in order to ensure more effective interalliance competition (See , e.g. , Order 2005-2-14, DOT-OST-2004-19077, p. 19).

19 **[REDACTED]**- 43 –

**PUBLIC VERSION D. DOJ’s Speculation That The Joint Applicants Would Move Forward**  **Without Full Immunity Has No Basis In Fact** DOJ also speculates that absent antitrust immunity the Joint Applicants “likely would engage in some sort of cooperation that would provide nearly identical benefits to consumers as those likely to result from the” proposed alliance (p. 28). DOJ claims that the American/British Airways alliance has “evolved substantially” since the failure to obtain antitrust immunity in 2001 (p. 29). As support, DOJ quotes an American document stating that “ **[REDACTED]**

” and that “ **[REDACTED]** ” (p. 29, citing AA-DOT-0003658). Like those described above, this document is also taken out of context. On the very same page, American notes that “ [ **REDACTED]** ” (AA-DOT-003658). While it is certainly true that American and British Airways have tried to find ways to expand their cooperation without antitrust immunity, it is far from optimal. The

document still **[REDACTED]** (AA-DOT-0003661), and expresses concerns that **[REDACTED]**

.- 44 –

**PUBLIC VERSION** While American and British Airways have engaged in some behind/beyond codesharing, it is not comprehensive. The important issue in this proceeding is not what the Joint Applicants have accomplished despite their lack of antitrust immunity – it is what they can achieve only if the proposed alliance is approved and immunized. The Brattle Group has quantified the additional consumer benefits from more integrated codesharing – using a study authored by one of DOJ’s own economists – and found nearly $100 million in annual consumer benefits. DOJ does not address the other gaps in the non-immunized alliance, such as the lack of transatlantic codesharing, fully reciprocal frequent flyer programs, combinable fares, or joint corporate dealing. Just because American, British Airways and Iberia have been able to survive by implementing incremental cooperation without immunity does not mean consumers would not enjoy significant additional consumer benefits from a fully integrated joint venture capable of competing with those the Department has approved and immunized for Star and SkyTeam. DOJ has failed to rebut the Joint Applicants’ evidence of public benefits, and the Department should approve the proposed alliance.- 45 –

**PUBLIC VERSION III. DOJ’S PROPOSED REMEDIES ARE BOTH UNNECESSARY AND UNWORKABLE** 

**A. Carve-Outs** DOJ asserts that carve-outs “are relatively easy to administer and preserve the incentives of the current market participants to compete” (p. 31). Yet carve-outs have significant administrative costs. Mr. Casey’s

declaration shows that a second real-time database would be needed to balance competing yield management priorities created by a carve-out (Casey Affidavit, 9/8/09, ¶ 31). Additionally, there is still no evidence that carve-outs are necessary or effective. In 2001, DOJ called the evidence on carve-outs “inconclusive” (DOJ Comments, DOT-OST-2001-11029, 12/17/01, p. 51). Eight years later, DOJ has submitted no new studies or evidence on this issue. While American does not dispute that carve-outs on full-fare traffic might be workable in the absence of an integrated network, DOJ ignores the shift – required by the Department in SkyTeam II – toward metal neutrality, which would be severely undermined by carve-outs. According to DOJ, the issue is whether carve-outs “destroy [] Applicants’ incentives to” work together (p. 32). But the question is not whether carve-outs are a complete bar to coordination – it is the cost they impose on consumers by reducing the efficiencies the JBA will generate. As the Department has repeatedly held, carve-outs would stifle the efficiencies generated by metal neutral joint ventures (See Order 2009-7-10, p. 12; Order 2008-4-17, DOT-OST-2007-28644, p. 10). DOJ’s unsupported belief is hardly enough to meet the statutory burden of proof in 49 U.S.C. § 41309(c)(2).- 46 –

**PUBLIC VERSION 1. Impact On Capacity** 

DOJ asserts that carve-outs would not reduce the incentives of an alliance to increase capacity on hub-to-hub routes. DOJ claims the Joint Applicants “would not have identical interests because they remain separate

entities that do not share revenues on domestic travel or international travel involving parts of the world not covered by the joint venture” (p. 32). DOJ’s arguments reveal a fundamental misunderstanding of both operational reality and the Joint Business Agreement. The majority of the Joint Applicants’ transatlantic flights are operated with wide-body aircraft, such as the Boeing 777. In contrast, the majority of the Joint Applicants’ domestic/intra-EU flying is operated with narrow-body aircraft, such as the Boeing MD-80. Moreover, even where wide-body aircraft are used for domestic routes, that is generally done during times the aircraft would not be operating on international routes, and/or to reposition the aircraft for their next international segment. The fact that the Joint Applicants do not share revenue on domestic/intra-EU O&D traffic has no relevance to the capacity that would be allocated for flights within the JBA’s scope. DOJ also ignores the fact that the Joint Applicants’ revenue sharing formula is based on the capacity each of them operates within the JBA. Thus if one carrier were to forego a transatlantic flight in favor of a route outside the JBA’s scope, it would lose the revenue not just from the foregone flight, but also a share of all the revenue generated by the JBA. The language cited by DOJ regarding the JBA’s governing principles about how- 47 –

**PUBLIC VERSION** “ **[REDACTED** ] ” (p. 32 n.92, citing AA-DOT-0008559) concerns revenue management, not capacity planning, and thus proves nothing. 20 DOJ does not rebut the fact that by carving out local traffic from the JBA, the Joint Applicants would have less incentive to optimize capacity on the route, unlike, for example, Northwest/KLM on routes like Detroit-Amsterdam (where it faces no nonstop competition, has no carve-outs, yet still operates nearly quadruple the number of seats per local passenger than American and British Airways do on Dallas/Fort Worth-London). **2. Impact On Yield Management** DOJ claims that carve-outs would not create inefficient yield management incentives in a metal neutral joint venture. However, the example DOJ sets forth is both irrelevant and inaccurate. As DOJ puts it: “Suppose, for example, that American is considering how to allocate a seat on an Atlanta-Miami flight after the alliance is approved. American could give the seat to a local passenger on Atlanta-Miami, to a connecting passenger traveling Atlanta-Miami-Buenos Aires, or to an Atlanta-Miami-London passenger (whose fare it would share with British Airways). In the first two cases, American keeps all the revenue because these American routes are outside the alliance. If American evaluated the seats based on what it would earn on that seat given its agreements, it could easily rank the alliance passenger last because most of the revenue from the transatlantic leg is shared, whereas American keeps 100% of the revenue otherwise” (p. 33).

20 If anything, the fact that each carrier will continue to manage the inventory on its own flights proves the case made in subsection 2, below, regarding yield management. Because each carrier would have both the incentive and the ability to allocate more seats for local traffic (which would be excluded from the revenue share), and less for connecting traffic (which is what drives capacity on the hub-to-hub routes), carve-outs would lead to a sub-optimal competitive result.- 48 –

**PUBLIC VERSION** DOJ has raised an irrelevant hypothetical. The issue with carve-outs is not the yield management of a domestic segment (such as Atlanta-Miami), but of the transatlantic segment (such as Miami-London). The carve-out would apply to local traffic on the Miami-London route in DOJ’s example, and it is on that route that the carve-out would cause inefficient yield management incentives. However, the transatlantic city-pair is not a part of DOJ’s hypothetical. Rather, DOJ focuses on three Atlanta based itineraries - none of which would be impacted by a carve-out. Thus it is unclear how DOJ’s example is in any way related to the issue of carve-outs on transatlantic segments. In any event, DOJ’s hypothetical is simplistic and inaccurate. The three city-pairs cited are Atlanta-Miami, Atlanta-London and Atlanta-Buenos Aires (Id .). DOJ speculates that American “could easily rank the alliance passenger last because most of the revenue from the transatlantic leg is shared, whereas American keeps 100% of the revenue otherwise” (Id .). But it is difficult to see why American would prefer selling the last seat on Atlanta-Miami to a local premium passenger, rather than a connecting passenger to London:

**Itinerary J Fare Segment Prorate 2**  **1 AA Revenue**  **2 2** 

**ATL-MIA** $910 ATL-MIA $910 $ **XXXXX ATL-MIA-LHR**  $6,407 ATL-MIA $759 MIA-LHR $5,648 $ **XXXXX**

21 Assumes straight-rate prorate based on cost-weighted miles.

22 **[REDACTED]**- 49 –

**PUBLIC VERSION** DOJ’s analysis fails to account for the added network revenue associated with an international long-haul passenger, and ignores the inherent complexities in maximizing network revenue as opposed to yield on a single seat. Obviously, yield management involves balancing the ATL-MIA, MIA-LHR and hundreds of other segments so as to create itineraries that generate the maximum overall revenue. DOJ is correct in asserting that American would keep all of the revenue from Atlanta-Buenos Aires (which is out of the scope of the JBA),but only a portion of the revenue from Atlanta-London. However, the carveout issue impacts capacity on Miami-Heathrow, not Atlanta-Miami. The Joint Applicants have already demonstrated that the carve-outs would result in inefficient yield management on the carved-out routes (AA Supplemental Comments, 9/8/09, p. 14; AA Response to DOJ Comments, DOT-OST-2008-0234, 7/6/09, DOT-OST-2008-0234, p. 12), and the Department has agreed:

“American adds that carve outs can alter the financial incentives of the operating carrier, leading it to place more emphasis on capturing gateway-to-gateway passengers to the detriment of flow passengers (gateway-to-beyond or behind-to-gateway) . . . . We have consistently found that where an integrated ‘metal-neutral’ joint venture is present, carve outs inhibit the realization of efficiencies and thereby the consumer benefits resulting from those efficiencies” (Order 2009-7-10, pp. 19-20). It would be manifestly inequitable for the Department not to apply its recent precedent in the Star II docket to this proceeding.- 50 –

**PUBLIC VERSION** DOJ’s proposed solution to the problem carve-outs would create is fare class mapping – the linking of booking classes between carriers (p. 33). DOJ calls fare class mapping a “simple expedient” – but there is nothing simple about applying it in the real world (p. 33). Fare class mapping is necessary on codesharing itineraries in order to ensure that a marketing carrier’s fares being applied on a different operating carrier’s flights

will not result in revenue dilution. 23 The example cited by American in

Star II and the Joint Applicants in this proceeding has nothing to do with codesharing – it involves individual yield management decisions on itineraries marketed and operated by a single carrier. The Joint Applicants fail to see how fare class mapping solves or even addresses the inefficient yield management incentives that carve-outs would create. DOJ’s argument is simply irrelevant. **3. Impact On Scheduling** DOJ claims that the Joint Applicants “fail to acknowledge that competing carriers offer flights at about the same time because that is the time of peak demand from local passengers,” speculating that “[p]assengers benefit from having competing options at the time of day they prefer to fly” (p. 35). But DOJ cites nothing to support this statement beyond its own speculation, and ignores the fact that local passengers also benefit from having options as to the time of day they fly. The Department recognized

this fact in Star II , holding that “[i]ncreased cooperation and fare combinability mean more schedule (time-of-day) options for businesspassengers and others who use connecting service” (Order 2009-7-10, DOT-OST2008-0234, p. 17).

23 For example, if Carrier A filed a low value fare, and applied it to a flight operated by Carrier B, it would need to map to a low value fare class in order to allow Carrier B to efficiently yield manage its flight.- 51 –

**PUBLIC VERSION** DOJ dismisses American’s experience with Swiss because “Swiss independently added a 9 p.m. flight at JFK to accommodate late evening demand from passengers seeking to connect through Zurich” (p. 35). While DOJ asserts that this “call[s] into question the claim that revenue sharing on the local traffic was necessary for the addition of the later JFK flight,” DOJ does not even attempt to challenge the fact that the profitability of American’s flight was reduced by shifting it to a 2100 departure. Moreover, DOJ’s entire premise is undermined by the fact that after terminating its alliance with American, Swiss was operating both the early and late JFK-Zurich departures. Obviously “revenue sharing” is not necessary when a single carrier operates both flights.

**B. Slot Divestitures** DOJ also suggests that the Department “could require Applicants to divest slots to encourage new entry” (p. 30). DOJ fails to acknowledge the fact that Heathrow slots are available for purchase and/or lease today – Star has placed Heathrow slots up for sale, SkyTeam has shifted slots away from U.S. service and put them to use on short-haul flights from Heathrow toParis and Amsterdam, and Virgin is leasing slots to Aer Lingus for shorthaul use. Virtually every potential new entrant in the marketplace has access to slots today, making a slot remedy entirely unnecessary. The only way a slot remedy could work – assuming it were necessary to begin with – would be if the use of the divested slots were restricted to the routes where competitive harm is alleged. But unless the Department allowed the Joint Applicants to sell divested slots to the highest bidder, a slot remedy would do nothing but effectuate a value transfer from **one** world to its larger competitors.- 52 –

**PUBLIC VERSION CONCLUSION**  The Joint Application will generate significant public benefits, and will not harm competition. On the benefits side, **one** world is currently the smallest branded alliance, and absent meaningful integration it will become increasingly marginalized as a competitive alternative to the larger and stronger Star and SkyTeam alliances. As for potential competitive harm, the overlap routes are some of the most competitive across the Atlantic, and the most likely to attract new entry. DOJ has failed to meet its burden of proof regarding harm, or to rebut the comprehensive evidence of public benefits satisfying the Department’s SkyTeam II and Star II precedents. The proposed alliance should be approved and immunized without further delay. Respectfully submitted,

CARL B. NELSON, JR. PAUL C. JASINSKI Associate General Counsel General Counsel, Americas R. BRUCE WARK JAMES B. BLANEY Associate General Counsel Senior Counsel, Americas JEFFREY A. OGAR British Airways plc Senior Attorney American Airlines, Inc. DARYL A. LIBOW Sullivan & Cromwell LLP ROGER W. FONES DON H. HAINBACH Morrison & Foerster LLP Garafalo Goerlich Hainbach PC ANDREW B. STEINBERG Attorneys for British Airways Jones Day Attorneys for American Airlines

WILLIAM KARAS SAMI SARELIUS CAROL GOSAIN Vice President & General Counsel Steptoe & Johnson LLP Finnair Oyj Attorneys for Iberia

MICHAEL J. HOLLAND Condon & Forsyth LLP Attorneys for Royal Jordanian January 11, 2010

# EXHIBIT 1

### 1 

# Competitive Effects of Airline Antitrust Immunity: Response of Robert Willig, Mark Israel, and Bryan Keating

I. Introduction 1. On June 26, 2009, the Department of Ju stice (“DOJ”) submitted comments on the Department of Transportation’s Show Cause Order regarding the Star Alliance, which included econometric studies that purported to ma ke two points. First, DOJ claimed that its evidence showed that “a reduction in th e number of competing airlines offering nonstop transatlantic service may result in larg e, statistically significant price increases,” 1 which the DOJ asserted (without evidence) also implied that granting antitrust immunity (“ATI”) to two or more carriers providing non-stop service on the same route would lead to large increases in non-stop fares. Second, DOJ claimed that its evidence showed that, on average, connecting fares charged by allia nces with antitrust immunity (“ATI”) are higher than connecting fares charged by non-immunized alliance members. 2 Notably, DOJ did not present (and still has not presented) any econometric analysis of the effect of ATI on the service quality that an alliance can o ffer, nor of the effect on fares or service quality of carving particular routes out from immunity.

2. On September 8, 2009, we filed an Affidavit in the current docket, in which we made a number of points that together demonstrated that DOJ’s econometric findings should not be relied upon for the formulation and s upport of policy towards airline alliances. 3 First, with regard to the effect of ATI on non-stop fares, we demonstrated that if one focuses on the relevant question – whether, given a partic ular number of carriers on a route, granting antitrust immunity to two or more carriers leads to higher fares – uses data from more than a single quarter (to which DOJ needlessl y limited analysis in its June 26 and its

1 Comments of the Department of Justice on the Show Cause Order, Public Version, Docket OST2008-0234, June 26, 2009, p. 47 (“DOJ Star Comments”). 2 DOJ Star Comments, p. 49. 3 Joint Applicants’ Motion for Leave to File and Supplemental Comments, Public Version, Docket DOT-OST-2008-0252, September 8, 2009, Exhibit 1 (“Affidavit”).

### 2 December 21 comments) 4 and includes standard sufficient controls for the myriad factors that lead to different fares for different routes, there is no econometric evidence that antitrust immunity leads to any increase in fares on non-stop overlap routes. Second, with regard to the effect of ATI on connec ting traffic, we showed that as long as one includes standard controls, particularly for the identity of the marketing carrier(s) setting prices for the ticket, the policy important r esult that has generally been found in the literature – that ATI itineraries have lower fares than code-share itineraries – is restored. Third, we moved beyond the topics addressed by DOJ and showed that consumers receive substantial non-price benefits from ATI service, as, on average, they prefer ATI service to code-share (or interline) service, with the extent of this preference equivalent to that for a substantial fare reduction. Finally , we demonstrated that carving-out particular segments from immunity diminishes or eliminates both the price and quality benefits from ATI for the connecting itineraries that flow over a carved-out segment. When considered together with the results dem onstrating the lack of harm from ATI on nonstop routes, these carve-out results demonstrate that carve-outs are not only unnecessary to hold fares down, but also harm consumer s by vitiating the fare and quality-of-service benefits that connecting passe ngers receive from full ATI.

3. On December 21, 2009, DOJ presented comments in the current docket that included an Appendix B containing DOJ’s response to our affidavit. 5 In this reply affidavit, we demonstrate that nothing in DOJ’s response in any way changes or diminishes any of the conclusions from our original affidavit. As detailed below, what is most striking about the DOJ response is the number of topics on which it ignores, agrees with, or fails to provide any econometric analysis to rebut the fundamental points that we made in our initial affidavit. Indeed, the econometric results of ours to which DOJ offers no substantive response are sufficient, on their own, to demonstrate the benefits from ATI and the harm from carve-outs. Where DOJ does offer responses to our findings, they largely take the form of detailed “imple mentation issues” regarding our econometric

4 DOJ Star Comments, pp. 24-25 and Appendix B; Comments of the Department of Justice, December 21, 2009, Public Version, Docket DOT-OST-2008-025 2, p. 14 and Append ix A (“DOJ oneworld Comments”). While DOJ did perform some analysis of panel data (as well as a cross-sectional analysis based on the full year of 2008) in response to our Affida vit, it continues to rely on its cross-sectional results based on just the third quarter of 2008 as the main results for its oneworld comments. 5 DOJ oneworld Comments, Appendix B.

### 3 models. 6 Some of the implementation issues that DOJ raises are invalid as criticisms, while others are potentially valid points in r esponse to which we have adjusted certain details of our methodology, but they all share one common feature – regardless of whether they are considered one at a time or in combination, they have, at most, a small effect on our results and no effect on any of the conclusions from our affidavit . Instead, as we demonstrate below, on those topics about which DOJ claims to have refuted our results (price effects of ATI on non-stop r outes and the difference between ATI and codeshare fares for connecting traffic), the source of the difference between their findings and ours remains the same as it has been thr oughout this proceeding – DOJ’s failure to include important and standard controls for the identity of the carriers setting the fares under analysis. In essence, DOJ continues to confound pricing differences across carriers with the relevant competitive effects of AT I, and consequently continues to draw incorrect conclusions about ATI effects. 

### II. Despite DOJ’s Response, All of the Conclusions from Our Original Affidavit Still Hold 4. In this section we discuss the three basic re asons why DOJ’s response affects none of the conclusions from our affidavit:

 There are numerous fundamental topics on whic h DOJ agrees with, ignores, or offers no substantive rebuttal to the point s we made in our Affidavit;

 Whether they are considered one at a time or in combination, the various implementation issues raised by DOJ rega rding our affidavit (which it generally refers to as “errors” or “mistakes” ev en though most reflect intentional and appropriate choices made when analyzing the data) have, at most, a small effect on our results and no effect on any of our conclusions;

 The difference between our results and DOJ’s results (on the effect of ATI on nonstop and connecting fares) rest entirely on DOJ’s inappropriate omission of “carrier fixed effects” to control for the identity of the marketing carrier(s) setting prices. As a result, DOJ confounds pricing differenc es across carriers with the relevant competitive effects of ATI, and consequen tly draws incorrect conclusions about ATI effects.

6 While DOJ generally refers to these as “errors” or “mistakes,” most of the implementation issues that DOJ raises reflect intentional and appropriate choices that we made in analyzing the data.

### 4 We leave the detailed tables of econometric r esults supporting these points to Section III, focusing here on the main results from that anal ysis and their clear implications regarding the pro-competitive effects of ATI and the harm from carve-outs. A. Topics on which DOJ agrees with, ignores, or offers no substantive rebuttal to our evidence 5. As noted above, there are at least four topics about which DOJ agrees with, ignores, or offers no substantive rebuttal to our evidence. First, DOJ now appears to agree with a fundamental premise of our initial affidavit – that the question of whether ATI does or does not lead to higher non-stop fares on overlap routes is a separate empirically testable question, distinct from the question of the effects on fares of the number of carriers on the route. In particular, while DOJ con tinues to assert (contrary to the real-world business experience that the parties detail in their filings) 7 that ATI will either not lead to higher capacity on hub-to-hub routes or, even if capacity expands, this will not lead to lower fares for local traffic, it now acknowledges that the question of ATI’s effect on non-stop fares “can be tested empirically” in a setting that controls for the number of carriers and includes an additional ATI variable. 8 While the DOJ setup is superficially different from ours (in particular, treating carriers in an ATI alliance as a single carrier when counting the carriers serving a route, whereas we count the number of separate carriers whatever the immunity relationship between them), we show below (Sections III-A and III-B) that the choice between setups does not matter: With proper controls in place, the DOJ setup provides affirmative support for our findings that granting ATI is not the same as an actual reduction in the number of carriers, with no empirical evidence that higher fares result from ATI.

6. Second, while DOJ spends substa ntial time asserting that it is not appropriate (for reasons we refute below) to study non-stop fares usi ng panel-data analysis (in which one focuses “entirely on changes over time in the number of competitors on a route” by including “route fixed effects”), 9 this discussion ignores the fact that our affidavit also presented an alternative “cross-sectional” analysis that confirmed the lack of ATI effects on non-stop

7 Joint Applicants’ Motion for Leave to File and Supplemental Comments, Public Version, Docket DOT-OST-2008-0252, September 8, 2009, pp. 4-6 and Exhibit 2. 8 DOJ oneworld Comments, Appendix B, p. 5. 9 Id, pp. 7-8.

### 5 fares. 10 Hence, the source of the differences between our and DOJ’s results cannot be the use of panel vs. cross-sectional economet ric methods. Moreover, in Section III-A, below, we show that our cross-sectional resu lts continue to hold after adjusting for the implementation issues raised by DOJ (in its discussion of our panel analysis) that may also apply to our cross-sectional analysis. As such, the source of the difference in results must come from the fact that we use additi onal data (from Q1:2005-Q4:2008) in contrast to DOJ’s needlessly limited focus on a shorte r time period (Q3:2008 or full-year 2008 in Table 2 of Appendix B to its December 21 Comme nts) and/or that we include additional controls for factors other than the number of carriers that cause fares to vary across routes. With these additional data and contro ls in place, DOJ’s preferred cross-sectional methods confirm the lack of an ATI effect on non-stop fares.

7. Third, DOJ offers no analysis of the bene fits to connecting traffic from the quality advantages resulting from ATI service. Our affidavit quantified the size of these benefits based on consumers’ revealed preference for ATI over code-share and interline flights, holding fares constant. In response to th is, DOJ offers only misguided and inaccurate reasoning to assert that the size of this consum er preference (which is revealed by actual consumer choices in the data) is not “plausible .” In Section III-C, below, we explain why DOJ’s logic is faulty and show that even highly conservative measures of the size of the consumer preference for ATI service imply la rge ATI benefits, which – given the lack of evidence for harm from ATI on non-stop routes – demonstrate the pro-competitive impact of ATI even if one were (inco rrectly) to assume that ATI does not lower connecting fares.

8. Finally, DOJ offers no analysis to refute our finding that carving certain segments out from ATI leads to higher fares and lower non-price benefits on otherwise ATI connecting itineraries that make use of a carved-out segment. Instead, DOJ asserts incorrectly that this result arises from “cherry picking the data.” 11 DOJ does not explain precisely what it means by this comment, but cherry picking implies that we searched through the itineraries in the data to find a set of ATI itineraries with higher fares or lower quality than other ATI itineraries, and then, based on this search, built our hypothesis test around itineraries we knew had higher fares (or lower be nefits). This is completely untrue.

10 See Table 5 of our original Affidavit and the surrounding discussion. Throughout this reply we refer to analyses that do not use r oute fixed effects as “cross-sectional” because they rely on cross-route comparisons of the number of carriers and fares, together with changes over time within routes. 11 DOJ oneworld Comments, Appendix B, p. 31.

### 6 Questions regarding the effects of imposing carve -outs are at the very heart of the issues in these proceedings, and far-from searching th e data for a set of high-fare/low-quality itineraries, we implemented the most obvious test of the effect of carve-outs, by asking whether the presence of a carved-out segmen t on a connecting itinerary vitiates the price and/or quality benefits from ATI. We found that, in fact, itineraries using carved-out segments have higher fares and lower quality than other ATI itineraries, as predicted by the carriers in this proceeding based on their business experience. 12 Standard tests for “statistical significance” – that fully account for the number of itineraries in the data that use carved-out segments and thus whether we have cut the data “exceedingly finely” 13 – show that these results are statistically signifi cant, meaning that there is less than a onein-twenty chance that the results would have occurred at random in the absence of a true effect from carve-outs. 14 Thus, we followed the entirely standard statistical procedure of setting up an obvious hypothesis to test a nd testing it. The resulting finding is clear statistical support for the harmful effects of car ve-outs. In contrast, DOJ offers nothing to explain or refute our finding other than a ge neral statement that we should have included more controls for other segment characteristics, 15 without suggesting a single important control let alone showing that such controls would change our results. In Section III-D, below, we do add such a control – a set of fixed effects for the “midpoint” airport(s) that the connecting itinerary flows through – and show that our results are unaffected by this change.

9. Simply combining the conclusions from the studies listed above – our cross-sectional study of non-stop fares, our study of the quality benefits of ATI, and our studies of the harm from carve-outs – demonstrates the pr o-competitive impact of ATI and the harm from carve-outs. In particular, using DOJ’s preferred cross-sectional framework with the inclusion of additional data and controls demonstrates the lack of empirical support for

12 Joint Applicants’ Motion for Leave to File and Supplemental Comments, Public Version, Docket DOT-OST-2008-0252, September 8, 2009, § II. 13 DOJ oneworld Comments, Appendix B, p. 31. 14 Of course this one-in-twenty requirement means that if one searched enoug h itineraries, thus truly “cherry picking” the data (as DOJ appears to have done in choosing to add dummies for itineraries involving Chicago-Munich and San Francisco-Frankfur t, with no explanation for these choices, in its alternative analysis in footnote 23 of Appendix B of the DOJ oneworld Comments), one should expect to find some that pass the test for significance “at random” with no real underlying effect. In other words, if one searches enough, one can find outliers in the data. But this has nothing to do with what we did in directly testing the effect of ca rve-outs, using entirely standard an d accepted statistical techniques. 15 DOJ oneworld Comments, Appendix B, p. 31.

### 7 higher non-stop fares due to the provision of antitrust immunity. This lack of harm contrasts with the facts that ATI does positivel y benefit consumers via higher quality, and that these quality effects are substantiall y negated when carve-outs are imposed. Nevertheless, in the following sections, we also go on to refute DOJ’s criticisms regarding those of our studies that it does address in a substantive way – our panel analysis of the effect of ATI on non-stop fares and our analysis of the effect of ATI on connecting fares.

B. Lack of substantive effect on our results from “implementation issues” raised by DOJ 10. DOJ raises a number of “implementation issues” wi th regard to our panel analysis of nonstop fares and with regard to our analysis of connecting fares. Starting with the panel analysis of non-stop fares, we note that, while these implementation issues include a mix of valid and invalid points, they have, at mo st, a small effect on our results and no effect on any of our conclusions, regardless of whet her the issues are considered one at a time or in combination. In particular:

 DOJ asserts (with no cited evidence or analys is) that there are not enough entry/exit events to estimate fare effects using a panel analysis. 16 However, we see no basis for this assertion, as many “event studies” in ot her contexts are based on only a single event whose effect can be compared to other observations (here, routes) not experiencing the event. In any case, the “st andard errors” of the regression estimates fully and correctly reflect the amount of ava ilable variation, and as shown in Section III-A and III-B, below, this variation is suffici ent to affirmatively reject the claim that ATI leads to higher non-stop fares.

 DOJ claims that our results are influenced by route-quarters in the data for which the only carriers are foreign, so that the limite d number of tickets in the DB1B data (on which we and DOJ rely) make the measured average prices unreliable. 17 This means that, for those routes, the left hand side variable in our regression – a function of average fare – will be “noisy” with a high variance (since the variance of the average fare is inversely related to the number of observations used to compute that average). However, as a matter of basic econometrics, a high-variance left-hand-side variable

16 DOJ oneworld Comments, Appendix B, p. 8. 17 Id, pp. 9-10.

### 8 in no way biases our results. 18 However, a valid implication is that because the average fare for some route-quarter combinations (in our regression and in DOJ’s) is based on a sample of more tickets than the average fare in other route-quarters (whether due to the foreign carrier issue or simple variation in sample size), the variance of our left-hand-side variable is not the same across routes, meaning that there is “heteroskedasticity” in the data. An econometrically appropriate reaction to such heteroskedasticity is to weight the regressions by the number of observations used to compute the average fare for each r oute–quarter (that is, to put more weight on observations with lower variance in the av erage fare). We do so below, and this modification to our estimation technique has no effect on any of our conclusions.

 DOJ claims that our panel results are partic ularly sensitive to the use of a cutoff of 61 or more flights per quarter for a carrier to be counted as serving a route. 19 As we show in Section III-B below, our results are robust across a wide range of possible cutoffs, including some in which we require a relatively large change in a carrier’s number of operations in order to count the change as an entry or exit.

 DOJ claims that our panel results are influe nced because entry/exit events, or changes in ATI status, may occur mid-quarter, while we assign a fixed number of carriers and a fixed ATI status to the route for the full quarter. As it is described in the DOJ Response, this criticism appears to reflect a misunderstanding of how panel analysis with fixed effects works. 20 This method does not just compare the quarter immediately before and immediately followi ng a change in the number of carriers or a change in their ATI status, but rather compares all quarters on a given route with, for example, two active carriers to all quarters on the route with other numbers of active carriers, or all quarters with multip le ATI carriers on the route to all quarters without multiple ATI carriers. As such, th e particular quarter in which the change occurs has relatively little impact on the results. To demonstrate this, we present results in Section III-B, below, that drop the quarters surrounding a change in carrier count or ATI status (for which the DOJ criticism would imply that our carrier count may be wrong). Our conclusions are unaffected.

18 See Jeffrey M. Wooldridge (2002), Econometric Analysis of Cross Section and Panel Data, The MIT Press, § 4.4.1. 19 DOJ oneworld Comments, Appendix B, pp. 10-12. 20 Id, p. 13.

### 9  Finally, DOJ correctly points out two issues with the data used in our affidavit. First, because of DOJ’s transcription error, we did not have an accurate list of the 65 routes that DOJ used in its June 26 comments. 21 Second, for Quarters 2-4 of 2005, we mistakenly excluded some routes from our dataset. 22 We correct our data for both of these issues below, and none of our conclusions is affected. 23

11. Similarly, DOJ raises a number of “implementation issues” with regard to our analysis of connecting fares. 24 Again, regardless of whether they are considered one at a time or in combination, these issues have, at most, a small effect on our results and no effect on any of our conclusions. In particular:

 DOJ clarifies that the study of connecti ng fares described in its June 26 Comments included a fixed effect for each route-year combination (rather than separate fixed effects for each route and each year). 25 This was not clear to us when we wrote our affidavit, and we thought we were following DOJ in using separate route and year fixed effects. In Section III-C, below, we switch to route-year fixed effects, with no change to any of our conclusions. 26

 DOJ suggests that our results should be ba sed on data that include only those ATI and code-share tickets marketed by members of a single immune alliance, rather than data on all ATI and code-share tic kets across all marketing carriers. 27 This is a valid point, so we provide results in Section III-D, below, based on data that include only

21 Id, fn. 1. 22 Id, p. 15. 23 Note that we do not change the market shares that we use as controls for the mix of carriers reflected in the average price, despite DOJ’s discussion of these shares on pp. 15-16. This is because, contrary to DOJ’s claim, we were not trying to measur e the actual market shares on the route. Rather, as discussed more fully below, these controls were desi gned to capture the mix of carriers setting the prices observed in the DB1B data (that both we and DOJ rely on), in order to account for differences in their price setting practices. As such, our market shares – based on the mix of tickets in the DB1B data – are the appropriate variables to use as controls in a regressi on explaining the average fa re observed in the data. 24 We note that, as described in the parties’ comments, the definitions DOJ uses for “ATI,” “codeshare”, and “interline” itineraries do not follow standard industry usage. Nevertheless, we continue to adopt them in our analysis in order to show that, even using DOJ’s definitions, ATI fares are lower than codeshare fares as long as proper controls are included in the analysis. 25 DOJ oneworld Comments, Appendix B, pp. 21-22. 26 Note that, as DOJ points out, route-year fixed effects soak up all route-year variation, so other controls – such as the HHI for the route-year – cannot be included. This also means that our new model, using route-year fixed effects, addr esses any concerns DOJ had about our HHI variable, as raised on p. 29 of its comments. 27 DOJ oneworld Comments, Appendix B, pp. 27-28.

### 10 tickets for which all marketing carriers ar e in the same immune alliance. These results imply no change in our conclusions. 28

 DOJ argues that code-share tickets should be defined to include only alliance codeshare tickets (meaning tickets where all marketing and operating carriers are in the same alliance, but some do not have antitrus t immunity), not code-share tickets that reflect bilateral or other “non-a lliance” code share relationships. 29 While we believe that both types of code-share tickets ar e informative about the difference between ATI and code-share fares, we present results in Section III-D that define code-share tickets to include only alliance code shares (w ith other code share tickets classified as interline), with no resulting change in our conclusions.

 DOJ indicates that its connecting analysis excludes routes from U.S. cities that are gateways for European airlines, while our affidavit included such routes. To demonstrate that this does not affect our c onclusions, we have built a dataset to match DOJ’s (to the best of our understanding, w ith details provided below). As shown in Section III-D, running our analyses on this alte rnative dataset does not change any of our conclusions. 

### C. Absence of carrier fixed effects as the explanation for differences between our findings and DOJ’s findings 12. Given that the implementation issues raised by DOJ have, at most, a small effect on our results and no effect on any of our conclusi ons, the natural question is what does explain the difference between our findi ngs and DOJ’s (with regard to the effect of ATI on nonstop fares and the difference in connecting far es for ATI vs. code-share service). As we demonstrate in the tables presented in Secti ons III-A through III-D, below, the single, common answer for both non-stop and connecting fa res is that we control for the identity of the marketing carrier(s) setting the prices, while DOJ does not. So, apart from the numerous topics covered in our Affidavit for wh ich DOJ offers effectively no rebuttal, to accept DOJ’s conclusions on the topics it does address would require one to reject the

28 Indeed, as explained above, when we limit the data to only tickets marketed entirely by carriers in a single immune alliance, we find that ATI fares are below codeshar e fares whether or not we include marketing carrier fixed effects. As such, it appears that restricting the set of marketing carriers to the relevant set of ATI carriers provides an additional way to control for pricing differences across different marketing carriers. 29 Id, pp. 28-29.

### 11 appropriate use of marketing carrier controls and instead accept analyses that mistakenly confound the effect of which carrier(s) set pr ices with the competitive effects of interest.

13. Not surprisingly, then, DOJ spends a substantial portion of Appendix B arguing that, in the current context, the standard econometric pr actice of including carrier fixed effects, or otherwise controlling for the identity of the price-setter(s), is somehow improper. However, DOJ’s logic on this topic is fundamentally flawed for reasons it seems to recognize in other portions of its Appendix. Specifically, at the bottom of page 17 of Appendix B, DOJ clearly and correctly notes that the controls in a regression model should include all the things that one wa nts to “hold constant” when studying the competitive effect of interest. So the critical question to guide the decision of whether to include carrier controls is whether one wants to hold the identity (or mix) of carriers constant, in order to isolate the effect of AT I. As explained below, for both analyses of non-stop and connecting fares, the answer is clearly yes – it is critical to control for the identity of the carrier(s) setting fares to is olate the competitive effect of interest. Non-Stop Fares

14. In discussing the non-stop fare results, DOJ corre ctly notes that, if one were studying the entry or exit of a specific non-stop competitor on a route, one would not want to hold constant that carrier’s share on the route (or, put differently, one would want to account for both the competitive effect from a change in the number of competitors and the effect of that carrier’s specific pricing practices). 30 However, as we have repeatedly pointed out, that is not the question at hand for this proceeding. The question at hand is what happens when, for a particular route with a particular mix of carriers, one grants ATI to two more of those carriers. 31 To answer this question, we certainly do want to hold the mix of carriers constant in order to see how ATI will affect fares given the set of carriers on the route.

15. To clarify the importance of controlling for th e mix of carriers on a route, consider the following example. Suppose hypothetically that carriers in immune alliances (“ATI

30 Note that this would not be true if, instead, on e wanted to measure the effect of entry or exit by a “typical” carrier on the route. In that case, since another “typical” carri er would not change the nature of the carriers on the route, one would want to hold constant the mix of carriers by route in order to isolate the pure competitive effect of adding or subtracting a carrier. 31 This is true even if one asserts that the effect of ATI can be measured using the variable for the number of carriers (as DOJ did in its June 26 comments) – the relevant measure remains the pure competitive effect, holding the mix of carriers constant.

### 12 carriers”) tend, on average, to have higher prices than other carriers, not because of any competitive effect of ATI, but rather because those carriers tend to have higher costs, better service quality, or other differences. Then, if the regression does not include controls for the mix of carriers on the route, the ATI effect will capture not only the truecompetitive effect of ATI but also the fact that there are at least two of these highcost/high-price carriers on the route. On ly with carrier controls in place does the regression hold the mix of carriers fixed and t hus isolate the competitive effect of ATI by comparing situations where there is or is not an overlap between members of one ATI on the route, More generally, whatever th e correlation between the presence of multiple carriers in the same ATI alliance on a route and the mix of carriers serving the route, results generated without carrier controls neces sarily confound the true effect of ATI with the effect of the carrier mix across routes. Hence, the difference between our non-stop results and DOJ’s can be explained simply – our results (showing no effect of ATI with carrier controls in place) isolate the true ATI effect, while DOJ’s results confound the true ATI effect with the effect of the mix of carriers present on routes with or without an ATI overlap. 32

16. In addition to ignoring the importance of cont rolling for differences in the carrier mix by route, DOJ also makes several flawed arguments against our use of carrier shares as controls. 33 First, it argues that we should not use DB1B shares, which do not include foreign carriers, but rather should use some other source (such as MIDT data) that includes the foreign carriers as well. 34 This entirely misses the point of using the carrier shares as controls. The point is to control for the mix of carriers whose fares make up the

32 We note that the coefficients on our carrier sh are variables are generally large and statistically significant, so it is not surprising that failure to incl ude these controls has a large effect on the results. As one specific example, consider UA (an immune member of the Star Alliance) and US (a member of the Star Alliance without immunity). Even after controlling for competitive c onditions on each route, including whether there is an ATI overlap, US consistently ha s substantially lower carrier fixed effects than UA. Given that US does not have immunity and UA does, this is the type of pattern than can lead to biased conclusions about the effect of ATI overlaps if not properly controlled for. Of course, with many fixed effects in the data, one example does not capture the full story. The ultimate proof of the effect is in the results, where failure to conduct the proper “experiment,” which requires controls that hold fixed the mix of carriers on each route, generates the spurious appear ance of higher fares due to competitive effects from ATI. 33 On this point, see W. Tom Whalen (2007), “A panel data analysis of code-sharing, antitrust immunity, and open skies treaties in international aviation markets,” Rev Ind Organ, 30:39–61. With similarity to our approach, Whalen’s paper includes models of route-level fares using shares to control for the mix of carriers on the route. 34 DOJ oneworld Comments, Appendix B, p. 16.

### 13 average price used as the dependent variable in our regression. Since those prices are drawn from DB1B data, it is essential that we control for the mix of carriers reflected in the DB1B data, not the shares from some othe r data source. Second, DOJ claims that market shares are endogenous because “unobserved factors in the model that affect market shares on a route also affect prices.” 35 If true, this in essence means that the carrier shares would “proxy” for some of those “unobservable factors,” which would enhance the accuracy of the findings since a goa l of the analysis is to include control variables that reflect the impacts of such unob servable factors, so that the ATI and carrier count variables measure only the competitive effects of interest, holding all else equal. 36 Finally, DOJ contends that the correlation between the market shares and the carrier counts creates a “co-linearity” problem. 37 While it is true that there may be correlation between our carrier share controls and the carri er counts, this is not a problem, but rather, as explained above, is the reason for including the carrier controls, so that the carrier count variables do not mistakenly pick up the effect on fares of the mix of carriers on the

route. 38 Connecting Fares

17. For the connecting analysis, the goal is not to measure the effect of different prices set by different marketing carriers, but rather to m easure the effect of changing the relationship among a fixed set of carriers (to include immun ity). The need to control for the identity of the marketing carrier to achieve this goal is clear from DOJ’s own discussion. In discussing the analysis of connecting fares in its Comments, DOJ spends multiple pages

35 Id, p. 16-17. 36 We also note that this is not a situation where th e regression has the price of a single carrier on the left-hand- side and its share on the right-hand side, which may create endogeneity due to reverse causality (if prices affect shares). Instead, the left-hand-side va riable is the average fare on the route, and the share variables simply measure the mix of di fferent carriers making up that aver age fare, with a separate variable controlling for the number of carriers (and ATI overlaps). Note that the share variables in this case always add up to 100, with the variation coming from the mix of carriers making up that 100 percent. 37 DOJ oneworld Comments, Appendix B, p. 17. 38 DOJ also notes that such corre lation or co-linearity tends to increase the standard errors of the variables making “it appear that the results are not statistically significant.” While it is true that including correlated right hand side variables increases the st andard errors of the asso ciated coefficients, the implication that the resulting insignificance of results is somehow incorrect or illusory is nonsensical. The higher standard errors correctly refl ect the fact that, to measure the competitive effects of interest, one can only rely on independent variation in the number of carriers after controlling for the mix of carriers on the route. If including these controls renders the carrier co unt or ATI coefficients statistically insignificant, this correctly indicates that the data do not provide support for a hypothesis that these variables affect fares after controlling for other relevant factors.

### 14 explaining that “the average fare difference between the vast majority of code-share and ATI tickets sold by an alliance depends on the variables denoting the ticket type and the marketing carriers.” 39 We agree. However, DOJ seems to miss the import of this statement. The fact that the fare difference depends on both ticket type and the identity of the marketing carrier presents a substa ntial econometric challenge. If (like DOJ) one does not include marketing-carrier fixed effect s, then the measured difference between ATI and code-share (or other service types) fares will reflect the combination of the true effect of ATI (through elimination of double ma rginalization) and differences in the price setting practices of different marketing carriers. 40 For example, if the carriers in immune alliances are also carriers that tend to set higher prices – for reasons having nothing to do with the effects of ATI but rather havi ng to do with the cost, quality, or other characteristics of those carriers – then failure to control for the price setting marketing carrier may make it appear that ATI generat es higher fares simply due to the identity of the price-setter, not to due to any effect of ATI on the prices charged by a given carrier. 41

18. The appropriate solution to this econometric ch allenge is not to leave out the control for marketing carriers and thereby settle for estim ates that confound the ATI effect with the effect of variation in the price setting practices of different marketing carriers. Rather the appropriate solution is to cont rol explicitly for the marketing carrier(s) on the ticket, and then to study differences in prices based on the relationships among the carriers serving

39 DOJ oneworld Comments, Appendix B, p. 26-27. 40 DOJ does include carrier fixed effects in their analysis. However, these carrier fixed effects are based on the U.S. carrier reporting th e ticket, regardless of whether that carrier actually markets the ticket. (DOJ oneworld Comments, Appendix A, pp. 4-5.) B ecause the U.S. reporting carrier need not be the marketing carrier on the route, su ch controls do not accomplish the goal of controlling for pricing differences across marketing carriers, and the U.S. carri er may only operate a small portion of the route. For example, there is an itinerary in the data from FLL (Fort Lauderdale) to OTP (Bucharest), through CLT (Charlotte) and MUC (Munich). The first leg is operat ed by US, but marketed by LH. All subsequent legs are both operated and marketed by LH. In this exampl e, the major US carrier is US, while the marketing carrier is LH (which, in our setup, receives the Star fixed effect, as an immunized member of the Star alliance). US accounts for only 11 percent of the to tal distance on this itinerary and does not market the ticket. 41 We note that, in results described below, wh en we limit the analysis on connecting routes described to only those itineraries marketed by an ATI alliance carrier , we reach the same conclusion regardless of whether we do or do not include marketi ng carrier fixed effects. This indicates that codeshare fares charged by marketing carrier(s) not in an ATI a lliance drive the DOJ’s results. But these non-alliance codeshare fares (for which there are not ATI fares set by the same marketing carrier(s) to compare to) are not directly relevant to the question of how immunity affects the fares charged by a given set of carriers. Our use of marketing carrier fixed e ffects controls for differences in th e fares charged by carriers not in ATI alliances, thus addressing this problem.

### 15 that itinerary. This is precisely what we do in our analysis of connecting fares. 42 Our results demonstrate that there is sufficient vari ation in the data to generate statistically significant results in this way, and that when one properly controls for the identity of the marketing carrier, one restores the logical and standard result that ATI fares are significantly lower than code share fares.

19. The biases created by the DOJ approach are re flected in its counterintuitive findings on connecting fares. In particular, DOJ consis tently finds that, for connecting itineraries, ATI fares are significantly higher than code-share fares and often finds that even online fares are significantly higher than code-share fares ( see Tables 4 and 6 of DOJ’s December 21, 2009 Comments). While DOJ ha s argued that immunity is not necessary to achieve double marginalization savings, we have seen no theory from DOJ that would explain why a connecting itinerary served by a set of code-share pa rtners would have lower fares than the same connecting itinerar y served by more-tightly integrated ATI partners, let alone by a single carrier providing online service. 43 In contrast, our results, with appropriate controls in place, generate the ordering that is consistent with economic theory and the previous literature, with online and ATI fares lower than code-share fares, which are in turn lower than interline fares. 44



### III. Our Substantive Econometric Results a re Unaffected by DOJ’s Response 20. In this section, we provide detailed tables s upporting the conclusions described in Section II. In particular, for our cross-sectional resu lts on non-stop fares (Table 5 of our original affidavit), we present an updated Table 5R . For our panel results on non-stop fares (Table 4 of our original affidavit), we pr esent an updated Table 4R. In each case, we begin by showing that, regardless of whether they are considered one at a time or in combination, the various implementation issues raised by DOJ have, at most, a small

42 As explained in our Affidavit, if the marketing carrier(s) are in an immune alliance, we include a fixed effect for that alliance. Otherwise, the fixed ef fect defines the full set of carriers marketing the ticket, with a unique fixed effect for each comb ination of carriers seen in the data. 43 One possible explanation would be that online and ATI service is higher quality than code-share service, but that would also demonstrate the benefits from ATI. 44 See, e.g., Jan Brueckner and W. Tom Whalen (2000), “The Price Effects of International Alliances,” Journal of Law and Economics , 43, 503-545; Jan Brueckner (2003), “International Airfares in the Age of Alliances,” Review of Economics and Statistics , 85, 105-118; W. Tom Whalen (2007), “A panel data analysis of code-sharing, antitrust immunity, and open skies treaties in international aviation markets,” Review of Industrial Organization , 30:39-61.

### 16 effect on our results and no eff ect on any of our conclusions. 45 Next, we show that changing the specification of the number of carriers to match DOJ’s specification (with carriers in an immune alli ance counted as a single carrier), while including a dummy variable for the presence of two or more i mmunized members of the same alliance on the route, provides affirmative evidence that an AT I overlap is not the same as a reduction in the number of carriers and does not lead to higher fares . Finally, we show that only by excluding carrier fixed effects can we generate the DOJ result that ATI overlaps lead to higher non-stop fares, although, even without carrier fixed effects, the cross-sectional results indicate that the ATI effect is signifi cantly different from the effect of a change in the number of carriers.

21. After discussing our results on non-stop fares, we turn to our results on benefits to connecting traffic from ATI (and the loss of benefits when segments are carved-out from immunity). Because DOJ offered no substantiv e critique of our results on these benefits (contained in Table 9 in our original Affida vit), we do not present an updated Table 9. Rather we explain why DOJ’s arguments that our results are unreliable are without merit. We then present 95% confidence intervals fo r our estimates of consumer benefits, to show that even using the low end of the c onfidence interval, the benefit to connecting passengers from ATI, as well as the harm from carve-outs, is substantial.

22. Given the lack of evidence for higher non-st op fares from ATI, along with the clear evidence of benefits to connecting passe ngers from ATI, which are substantially undermined if the otherwise ATI itinerary uses a carved-out segment, the case for granting antitrust immunity to the applicants (without imposing carve-outs) is clear regardless of whether ATI reduces connecting fa res. Nevertheless, we also present Table 8R as an updated version of Table 8, which contained the main results on connecting fare effects in our original Affidavit. In this updated table, we first show that addressing DOJ’s implementation issues – by using combin ed route-year fixed effects, including only “alliance” code-share itinerarie s as code-share with all othe rs classified as interline, and modifying those data to match DOJ’s da ta by excluding routes from US cities that are gateways for European airlines – has, at most, a small effect on our results and no effect on our conclusions. Second, we show that, if in addition to adjusting for DOJ’s implementation issues, we also add additional controls for variation across segments –

45 Note that these issues were generally raised by DOJ in the context of our panel model, but we apply the relevant comments to our cross-sectional model as well.

### 17 specifically fixed effects for the “midpoint” airport(s) that the itinerary flows through – our conclusions are unchanged. Third, we show that if we take the additional step of following DOJ’s suggestion to restrict our analysis to only tickets marketed entirely by members of one ATI alliance, our conclusions remain unchanged. Finally, we show that the only change which generates the DOJ’s patte rn of fares (with code-share fares below ATI and online fares) is to drop the marketi ng carrier fixed effects and thus confound the effect of the identity of the price-setting ma rketing carrier with the effect of ATI. A. Updated cross-sectional results on non-stop fares 23. Table 5 of our original Affidavit presented results from a cross-sectional model (i.e., without route fixed effects) of the effect of ATI on non-stop fares, which made five main changes to the DOJ specification. First, it employed additional quarters of data, from Q1:2005-Q4:2008, rather than the needlessl y limited (Q3:2008 or all of 2008) time period that DOJ relies on. Second, it include d only routes with three or fewer carriers (regardless of whether or not they are in an immune alliance) to focus attention on those routes most likely to show an effect from ATI overlaps on non-stop fares if one exists. Third, it included a more flexible “five-part spline” to control for the effect of distance on fares. None of these three changes seems controversial to us and we have seen no criticism of any of them from DOJ. The fourth change was to add a separate dummy variable for the presence of an ATI overlap on the route, in order to address the policyrelevant question concerning the price effect of ATI, an approach which DOJ now seems to have adopted. 46 As noted above, DOJ’s definition of the number of carriers on a route is different from ours – counting carriers in an alliance as one carrier, while we count them as separate carriers – but as shown below, this has no effect on our conclusions. As such, only the final change – to include carri er controls (specifically, the share of all tickets in the pricing data accounted for by each carrier) – remains the subject of debate. However, as explained above, th is change is critical if we are appropriately to separate the true effect of ATI from the effect of variation in the identity of carriers present on routes that do or do not have an ATI overlap.

46 DOJ defines its ATI variable as the number of additional carriers (above its base carrier count which treats all firms in an ATI as a single carrier) rather than a dummy va riable for the presence of an ATI overlap. However, this specification imposes the assumption that a third ATI carrier would have the same incremental effect as a second ATI carrier, for which we see no basis. So, instead, we include a dummy variable for the presence of an ATI overlap as a simple test of whether such an overlap has any effect on fares.

### 18 24. Table 5R presents our original cross-sectional results as its first column and then goes on to present the results of a series of modifications to that specification, each of which addresses DOJ comments and confirms our conclusions.

Table 5R

Price Effects from Loss of Nonstop Competition on Transatlantic Routes

The Dependant Variable is ln(Average Fare)

Affidavit (1) (2) (3) (4)

0.0043 -0.0047 -0.0125 -0.0534** -0.0337* (0.0220) (0.0214) (0.0174) (0.0184) (0.0138)

-0.0357 -0.0250 -0.0730** (0.0200) (0.0167) (0.0122) -0.0113 -0.0124 -0.0130 (0.0178) (0.0175) (0.0095)

-0.0675** -0.0941** (0.0109) (0.0119) -0.0122 -0.0161 (0.0097) (0.0099) -0.0026 -0.0051 -0.0032 -0.0034 -0.0086** (0.0035) (0.0034) (0.0023) (0.0023) (0.0023) 0.3833** 0.3457** 0.4803** 0.4775** 0.5054** (0.0831) (0.0832) (0.0376) (0.0375) (0.0343) 0.5355** 0.5746** 0.4210** 0.4410** 0.4549** (0.1170) (0.1163) (0.0583) (0.0590) (0.0606) 0.3946** 0.1255 0.2866** 0.2784** 0.1716** (0.0781) (0.0743) (0.0585) (0.0584) (0.0597) 0.0899 0.1997** 0.0849* 0.0853* 0.0070 (0.0565) (0.0704) (0.0402) (0.0402) (0.0410) -0.0299 -0.1007 0.0191 0.0087 0.1359** (0.0792) (0.1056) (0.0304) (0.0308) (0.0272) 4.8635** 5.3756** 4.6290** 4.7032** 4.0572** (0.4405) (0.4887) (0.2634) (0.2578) (0.1178) Observations 781 863 863 863 863 R^2 0.691 0.693 0.846 0.846 0.789 Weighted No No Yes Yes Yes Carrier Fixed Effects Yes Yes Yes Yes No Route Fixed Effects No No No No No Year-Quarter Fixed Effects Yes Yes Yes Yes Yes Adjusts for DOJ Implementation Issues No Yes Yes Yes Yes Sources: DB1B, OAG; 1Q2005-4Q2008 Notes:

Robust standard errors in parentheses ** p<0.01, * p<0.05 Data include route-quarters with 3 or fewer carriers Weighted regressions weight by passengers using Stata's analytic weights --- Number of Nonstop Competitors (Carriers in

same immunized alliance treated as one) >= 1 ---

>= 2

>= 3 --- --- Explanatory Variables

>= 1

>= 2

>= 3 --- Number of Nonstop Competitors (Each carrier counted separately) ATI

Mean of City Populations in the Route

Constant Term Mileage on the Route - Spline 1

Mileage on the Route - Spline 2

Mileage on the Route - Spline 3

Mileage on the Route - Spline 4

Mileage on the Route - Spline 5

### 19 25. In each column, the key variable to consider is the ATI dummy in the first row, which measures the effect of an ATI overlap on fares. In the base model from our Affidavit, we found that the ATI effect was almost exactly zero and clearly statistically insignificant. Columns (1) – (2) of the table implement th e following changes, each of which confirms this finding:

 Column (1) modifies our dataset by precisely matching the 65 routes used by DOJ and including the routes that we inadverten tly omitted for Quarters 2-4 of 2005. In this case, the measured effect of an ATI overlap on fares actually becomes negative, although still very close to zero and insignificant.

 Column (2) modifies column (1) by wei ghting each observation in the regression by the number of tickets used to compute the average fare, in order to account for the heteroskedasticity induced by different sa mple sizes on each route-quarter. The ATI effect remains negative and insignificant. Together, columns (1) and (2) show that, whethe r they are considered one at a time or in combination, the implementation issues raised by DOJ have, at most, a small effect on our results and no effect on our conclusions.

26. With these changes to address the implementati on issues raised by DOJ in place, Column (3) then adopts the DOJ method for countin g carriers, with carriers in a single ATI counted as one. 47 While DOJ makes it seem that this is a starkly different method from ours (see footnote 11 of Appendix B of th e DOJ oneworld Comments), both methods actually allow for separate measurement of the effect of the number of carriers from the effect of their ATI status, only changing th e interpretation of the ATI dummy variable. In our method, the carrier counts “act” as though ATI does not increase non-stop fares, so if it actually does, this will be reflected in a significant, positive ATI coefficient. As seen in our affidavit and columns (1) – (2) of Ta ble 5R, there is no evidence for such an ATI effect. In contrast, in the DOJ approach, the carrier counts “act” as if ATI has the same, positive fare effect as a reduction in the number of carriers. If this is wrong, this will be

47 We note that DOJ appears to ignore carve-outs wh en it counts carriers. That is, it treats immunized carriers in the same alliance as a single carrier even on routes that are carved out of the relevant grant of immunity. This approach appears to be inconsistent with DOJ’s view of carve- outs, which is that they preserve competition between ATI partners on specific routes. In any runs in which we count immunized carriers of the same alliance as one, we count those carriers separately for any routes that have been carved out of the ATI.

### 20 reflected in a significant, negative ATI eff ect, to (at least partially) “undo” the fare increase that the carrier count variabl es implicitly apply to ATI overlaps.

27. As seen in Column (3), when specifying our cross-sectional model with DOJ-style carrier counts, the ATI effect is, in fact, negative and significant. This provides affirmative evidence that observed data rejects the hypot hesis embedded in the DOJ carrier counts – that ATI has the same effect as an actual reduction in the carrier count. Indeed the ATI coefficient of -0.0534 is nearly as large as (and not statistically distinguishable from) the measured 2:1 effect (0.0675). This means th at the ATI variable nearly fully “undoes” the 2:1 fare effect implied by the carrier counts, meaning that this DOJ-style specification provides affirmative support for the fact that ATI overlaps do not increase fares

. 28. Finally, Column (4) shows that when we ex clude carrier controls, we obtain a result similar to DOJ’s, as the coefficient on the ATI variable becomes significantly smaller than that on the 2:1 effect. Comparing columns (3) and (4) – across which the only difference is the presence or absence of ca rrier controls – shows that it is only by confounding ATI effects with the carrier-mix effects that we generate the significant gap between the ATI coefficient and the 2:1 effect that is required for there to be a significant ATI effect on non-stop fares (when using DOJ-s tyle carrier counts). However, even here, the ATI effect remains significant and negativ e, providing affirma tive evidence that the effect of an ATI overlap is not the same as a reduction in the number of carriers.

B. Updated panel results on non-stop fares 29. In our original Affidavit, we also included a panel version of the non-stop fare analysis, which just replaced the route-level controls (distance and populati on) with route-level fixed effects, 48 which fully control for all time-invari ant cross-route variation that might otherwise be confounded with ATI fare effects. 49 While these more complete controls

48 We allowed the route fixed effects to vary by quarter in order to control for any route-specific seasonal variation in economic conditions. 49 On pp. 14-15 of the DOJ oneworld Comments, DOJ argues that failure to control for routespecific changes in economic conditions may bias our panel results. While it is theoretically possible that route-specific changes could coincide with the timing of entry or exit by carriers (or new ATI overlaps), this issue seems small compared to the corresponding is sue for cross-sectional anal ysis – that any of the myriad factors that differ across r outes could influence both the number of carriers on the route and the average fare on the route, thus biasing results. A pane l analysis controls for all this cross-route variation via route fixed effects thus mitigating this problem. We also note that DOJ’s claim that failure to control for variation in economic conditions over time necessar ily biases estimated fare effects down is simply wrong. For example, in contrast to the demand-based example that DOJ gives, suppose there is an increase in costs on a particular route that leads to both exit of some carriers and to higher fares (or in a crosssectional setting, that some routes are more expensive to serve and therefore have fewer carriers and higher

### 21 are appealing – and panel analysis has the advantage of actually measuring the effect of changes in ATI status on given routes, the re levant policy question for this proceeding – they come at a cost of reducing the variation used to identify ATI effects (as we acknowledged on p. 11 of our Affidavit). Give n these strengths and weaknesses of both panel and cross-sectional approaches, the ideal situation is for the two approaches to yield the same conclusion. Fortunately, that situ ation holds here, as both types of analysis demonstrate the lack of ATI effects on non-stop fares.

30. Table 4R presents our original panel results (originally included in Table 4 of our Affidavit) as its first column and then goes on to present the results from a series of modifications to that specification, each of which confirms our conclusions, as detailed below.

Table 4R

31. As with Table 5R, in each column, the key vari able to consider is the ATI dummy in the first row, which measures the effect of an ATI overlap on fares. In the base model from our Affidavit, we found that the effect of an ATI overlap on non-stop fares was almost exactly zero (actually slightly negative) and clearly statistically insignificant. Columns

fares). In that case, failure to control for the cost va riation will lead to an upward bias in estimated fare effects. So there is no a priori way to determine the direction of any bias. Price Effects from Loss of Nonstop Competition on Transatlantic Routes

The Dependant Variable is ln(Average Fare)

Affidavit (1) (2) (3) (4) (5) (6) (7) (8) (9)

-0.0071 -0.0277 -0.0271 -0.0393 -0.0442 -0.0337 -0.0514 -0.0414 -0.0626** -0.0218 (0.0620) (0.0573) (0.0206) (0.0369) (0.0383) (0.0343) (0.0387) (0.0534) (0.0221) (0.0194)

-0.0537 -0.0544 -0.0452** -0.0371* -0.0564** -0.0437* -0.0126 -0.1152 (0.0278) (0.0280) (0.0153) (0.0188) (0.0187) (0.0200) (0.0585) (0.0660) -0.0739** -0.0738** -0.0286 -0.0252 -0.0741* -0.0585 -0.0576 -0.0335 (0.0214) (0.0228) (0.0159) (0.0303) (0.0288) (0.0303) (0.0710) (0.0770)

-0.0519** -0.0503** (0.0156) (0.0139) -0.0255 -0.0400** (0.0153) (0.0149) 6.3017** 7.0754** 6.6575** 6.7811** 6.8862** 6.8218** 7.3834** 7.1891** 6.6948** 6.1606** (0.2688) (0.3421) (0.2476) (0.3459) (0.3578) (0.3395) (0.3342) (0.4124) (0.2537) (0.1019) Observations 781 863 863 727 742 730 571 607 863 863

R^2 0.864 0.861 0.954 0.952 0.951 0.952 0.958 0.956 0.954 0.950 Threshold (Flights per Quarter) 60 60 60 60 20 40 80 70 (50) 60 60 Weighted No No Yes Yes Yes Yes Yes Yes Yes Yes Drops Quarter of Change No No No Yes Yes Yes Yes Yes No No

Carrier Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes No Route-Quarter Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Year-Quarter Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Adjusts for DOJ Implementation Issues No Yes Yes Yes Yes Yes Yes Yes Yes Yes Sources: DB1B, OAG; 1Q2005-4Q2008 Notes:

Robust standard errors in parentheses ** p<0.01, * p<0.05 Data include route-quarters with 3 or fewer carriers Weighted regressions weight by passengers using Stata's analytic weights ATI

Constant Term ---

Explanatory Variables

Number of Nonstop Competitors (Each carrier counted separately) --- >= 1

>= 2

>= 3 --- --- ---

N umber of Nonstop Competitors (Carriers in same immunized alliance treated as one) >= 1

>= 2

>= 3 --- --- --- --- ---

### 22 (1) - (2) of the table implement the followi ng changes, each of which confirms this finding:

 Column (1) modifies our dataset by precisely matching the 65 routes used by DOJ and including the routes that we inadvertently omitted for Quarters 2-4 of 2005. The estimated effect of an ATI overlap on fares remains negative and insignificant.

 Column (2) modifies column (1) by wei ghting each observation in the regression by the number of tickets used to compute the average fare, in order to account for the heteroskedasicity induced by different sa mple sizes on each route-quarter (including the effect of route-quarters that have particularly small sample sizes due to the predominance of foreign carriers that gene rally do not report fares to DB1B). The ATI effect remains negative and insignificant. Because each of these changes – updating the data and weighting routes by the number of observations used to compute the average fa re – represents a sensible advance over our previous model, we treat Column (2) are our “new base” model and apply all additional changes to this model.

32. Columns (3) – (6) build on the new base model by addressing DOJ’s comments regarding how our model identifies a change in the number of carriers (or the presence of an ATI overlap) on the routes.

 Column (3) addresses the DOJ criticism that our measured fare effects are biased downward because we specify a fixed number of carriers (and fixed ATI dummy) for the entire quarter, even when the variable ch anges mid-quarter. To deal with this, we drop the quarters surrounding a change in the number of carriers or in the ATI dummy. The estimated effect of an ATI overlap on fares becomes even more negative, although still insignificant.

 Columns (4) – (6) build on column (3) by considering different cutoffs for the number of flights that a carrier must operate in a quarter to be counted as serving the route – replacing 60 with 20, 40, and 80 respectively. The measured ATI effect remains negative and insignificant in each case.

 Column (7) presents an alternative approach to the issue of counting entry/exit when carriers move just above or below 60 flight s per quarter. In this specification, we allow for the possibility that when there is a carrier with between 50 and 70 flights per quarter, it may be not entirely clear how to classify that carrier and thus there may

### 23be no clear measure of the number of carriers serving the route. So we drop routequarters with any carrier between 50 and 70 flights as “indeterminate,” which effectively requires a carrier to go from below 50 flights to above 70 to count as an entry (and vice versa to count as an exit). The estimated ATI effect remains negative and insignificant. Together, columns (1) – (7) demonstrate that, regardless of whether they are considered one at a time or in combination, the implementation issues raised by DOJ have, at most, a small effect on our results and no effect on our conclusions.

33. Column (8) modifies our new base model by shifting to the DOJ method for counting carriers, with carriers in a single ATI counted as one carrier. As noted above, in this specification, if ATI overlaps do not actually increase fares in the same way as true reductions in carrier counts, this will be refl ected in a significant, negative ATI effect, to “undo” the fare increase that the carrier count variables im plicitly apply to the ATI overlaps. As seen in Column (8), when speci fying our panel model with DOJ-style carrier counts, the ATI effect is, in fact, negative and significant. This provides affirmative evidence that observed data reject the hypothesi s that an ATI overlap has the same effect as an actual reduction in the carrier count. Indeed, the ATI coefficient of -0.0626 is actually larger than (but not statistically distinguishable from) the measured 2:1 fare effect (0.0519). In other words, the ATI variable fully “undoes” the 2:1 fare effect implied by the carrier counts – meaning that this DOJ-style specification provides affirmative support for the fact t hat ATI overlaps do not increase fares

34. Finally, Column (9) shows that we can gene rate results similar to Table 3 from the DOJ oneworld Comments – including an insignificant ATI coefficient of roughly -0.02 (using DOJ-style carrier counts) – if we drop the carrier controls. Comparing columns (8) and (9), across which the only di fference is the presence or absence of carrier controls, shows that it is only by confounding the true ATI effe cts with the effect of the differing mix of carriers by route that we can generate the DOJ results on fare increases from ATI overlaps. C. Results on quality benefits from AT I and corresponding harm from carve-outs

35. DOJ’s only response to our quantification of the consumer benefits from higher-quality ATI service – as measured by the consumer pr eference for ATI itinerar ies revealed in the data (holding fares constant) – is to assert that our results are not “plausible.” DOJ

### 24 provides no evidence in support of this asser tion and no indication of what level of consumer benefits it would consider plausible, how it would know what was plausible, or why the plausible number should not be that revealed by consumer choices. Our results show that, in the data, after controlling for fa re differences, substan tially more consumers choose available online or ATI options than c hoose code-share or interline (or ATI carveout) options and that the extent of the higher online/ATI share is equivalent to that associated with a substantial fare reduction.

36. DOJ also claims that the fact that, on aver age (with no controls), fares for online, codeshare and interline itinerari es are “similar” is “sharply at odds” with our results. 50 This is incorrect. Similar fares for the three typ es of service would only be at odds with our findings if those similar fares were not also as sociated with substantially higher shares for online and ATI service. Instead, what our model shows is that, holding fares constant, substantially more consumers choose online or ATI options. Indeed the presence of higher shares given similar prices is the fundame ntal basis for our conclusions. Further, there is nothing inconsistent about online and ATI itineraries having fares that are similar to fares for interline service (although somewhat lower with controls in place, as shown in our Affidavit and below) even though their quality is substantially higher. Instead, given that online and ATI itineraries both limit or eliminate double marginalization (lowering prices) and offer higher quality (which may lead to higher prices), there is no clear theoretical prediction about the relationship between these prices. However, the full set of empirical evidence we present shows that ATI itineraries actually have fares that are somewhat below code-share (or inte rline) itineraries, with shares that are substantially higher (holding fares fixed), reflecting both cost and quality advantages from ATI service.

37. It is also important to note that our resu lts show that the quality effects of ATI are substantially undermined when the otherwis e ATI itinerary makes use of a carved-out segment, a point that DOJ also does not refute.

38. Finally, to further document the clear evid ence for consumer benefits from ATI, which are undermined by carve-outs, Table 9R presents the 95% confidence interval for the consumer benefits presented in our affidav it. The “point estimate” for the consumer benefits from ATI service relative to code-share service in our affidavit (which represents

50 Id, p. 32.

### 25 the size of the benefits that is “most lik ely” according to the estimates) was $175 (per one-way ticket) which is 28% of the average fare in the data. However, as for any statistical estimate, there is a confidence in terval around this estimate. Even if one conservatively uses the lower bound of this inte rval, the benefit from ATI service relative to code-share service remains $94 (15% of the average fare in the data). Similarly, our point estimate of the benefit from full ATI ser vice relative to carve-out service (and thus the harm from carve-outs) is $67 (11% of the av erage fare in the data), but even if one conservatively relies on the lower bound of the confidence interval, the harm from carveouts is $31 (5% of the average fare in the data).

Table 9R

D. Updated results on connecting fares

39. Given the lack of evidence for competitive harm from ATI service and the clear evidence of consumer benefits from ATI and harm from carve-outs, the question of whether ATI service generates lower connecting fares than code-share service is of somewhat diminished importance. Nevertheless, as we f ound in our affidavit and continue to find in additional runs, with proper c ontrols in place, our results demonstrate that ATI service has lower connecting fares than code-share se rvice, with this advantage undermined or eliminated for otherwise ATI itineraries making use of a carved-out segment.

40. Table 8R presents our results on connecting fa res, with the first column replicating the results from our affidavit and the subsequent columns addressing various issues raised by DOJ. 95% Confidence Interval Estimate Lower Bound Upper Bound Valuation ($) of ATI service relative to codeshare $174.57 $94.06 $255.07 Valuation ($) of ATI service relative to ATI (Carve-Out) $67.14 $30.79 $103.49 Sources: DB1B, OAG; 1Q2005-4Q2008 Notes:

Confidence intervals estimated using the Delta method Based on Table 9 of September 8, 2009 Affidavit

### 26 Table 8R

41. While most of the implementation issues that DOJ raised with regard to this specification were intentional and appropriate choices in est imation, rather than errors, Column (1) modifies our analysis to adjust for these issu es, in order to show that these changes have, at most, a small effect on our results and no effect on our conclusi ons. In particular, following DOJ’s comments, we include combined route-year fixed effects (eliminating the need for any route-year level control variables), include only code-shares between alliance partners in our code -share category (with all othe r code-shares classified as interline), and exclude routes from U.S. cities that are gateways for European airlines. 51

51 In building this new dataset, we have attempted to match closely the data used by DOJ in the DOJ Star Comments and the DOJ oneworld Comments based on the description in the DOJ oneworld Comments, Appendix A, p. 4. In particular, we focus on city-pairs originating in the U.S. and arriving in Price Effects of Service Type on Transatlantic Routes

The Dependant Variable is ln(Fare)

Affidavit (1) (2) (3) (4)

-0.0533** -0.0355** -0.0325** -0.0403** -0.0282* (0.0061) (0.0101) (0.0112) (0.0130) (0.0112) -0.0273** -0.0233* -0.0260* -0.0741** -0.0253* (0.0056) (0.0110) (0.0123) (0.0146) (0.0123)

0.0131* 0.0425** 0.0627** 0.0717** -0.0135 (0.0063) (0.0131) (0.0142) (0.0239) (0.0133) 0.0384** 0.1521** 0.1447** 0.0161 0.0402** (0.0090) (0.0159) (0.0167) (0.0254) (0.0126) -0.1109** -0.0505** -0.0381** -0.0486** -0.0349** (0.0045) (0.0043) (0.0057) (0.0090) (0.0057) 0.0000 -0.0000* -0.0000** -0.0000** -0.0000** (0.0000) (0.0000) (0.0000) (0.0000) (0.0000) -0.0024 (0.0072) 0.0021 (0.0068) 0.0663** (0.0044) 0.0000 (0.0000) 0.0000 (0.0000) 0.0000 (0.0000) 0.0015* (0.0006) 6.3068** 7.4014** 7.4814** 7.6012** 7.2922** (0.2281) (0.0418) (0.0508) (0.0788) (0.0530) Observations 164539 112736 112736 60895 112736

R^2 0.042 0.015 0.018 0.011 0.018 # of Route-Years 9993 22646 22646 14281 22646

Sample All All All ATI All Carrier Fixed Effects Marketing Carrier(s) Marketing Carrier(s) Marketing Carrier(s) Marketing Carrier(s) US Carrier Through Airport Fixed Effects No No Yes Yes Yes Year Fixed Effects Yes No No No No Route Fixed Effects Yes No No No No Route-Year Fixed Effects No Yes Yes Yes Yes Adjusts for DOJ Implementation Issues No Yes Yes Yes Yes Sources: DB1B; 2005-2008 (3rd Quarter) Notes:

Robust standard errors in parentheses ** p<0.01, * p<0.05 Coupons and mileage are computed as passenger-weighted averages for each route-year-carrier Analysis limited to coach-class tickets Interline Codeshare Explanatory Variables

Service Type Online

ATI

ATI carve-out --- --- --- ---

---

Coupons

Mileage on the Route

HHI OA

HHI Interline

Open Sky

Population of US City

Income of US City

Population of EU City

Income of EU City

Constant Term

### 27 With these changes in place, the difference between fares for ATI itineraries and codeshare itineraries increases, thus bolstering our conclusion that ATI fares are lower than code-share fares.

42. DOJ also argued that our results on ATI carve-out could be driven by the lack of other controls for segment level differences. While we note that the absence of important segment level controls could affect all of DO J’s results as well – and that DOJ did not suggest any specific, omitted controls – co lumn (2) adds controls for the “midpoint” airport(s) through which the itinerary flow s (in addition to the changes from column (1)). 52 This further strengthens our find ings on ATI vs. code-share fares.

43. Finally, DOJ argued that we should not include all tickets in our analysis but rather should include only those tickets marketed entirely by members of a single immune alliance. To this end, column (3) builds on the results from column (2) by including only tickets on which all marketers are in a singl e immune alliance. This substantially increases the measured gap between ATI and code share fares (relative to the gap in column (2) which is itself larger than the gap presented in our Affidavit). Columns (1) through (3) thus demonstrate that, regardless of whether they are considered one at a time or in combination, the implementation issues raised by DOJ have, at most, a small effect on our results and no effect on our conclusions on connecting fares.

44. As a last step, in column (4), we demonstr ate that by eliminating the control for the marketing carrier(s), we generate results simi lar to DOJ’s results, with code-share fares

Europe. We exclude routes originating in U.S. citie s where foreign carriers operate more than 60 transAtlantic non-stop flights in a quarter and routes in which there are more than 60 nonstop flights in a quarter. We keep tickets representing round-trip travel with no more th an six total segments and no more than three in either direction. We drop tickets with fares below $100, at or above $9999, or deemed “noncredible” by DOT. We also follow DOJ in dropping observations with two or more major US carriers. In our analysis, we focus on coach (“X”)-class tickets. As did DOJ, we define observations at the ticket level rather than aggregating to the route-carrier level. Overall, our dataset contains 112,736 observations compared to 126,520 in DOJ’s dataset. In our datase t, 68.3% of the tickets are online (compared to 67.8% reported by DOJ), 7.2% are non-immunized alliance tickets (compared to 7.4%), 17.9% are immunized alliance tickets (compared to 17.4%), and 6.5% are in terline tickets (compared to 7.4%). In addition, relative to the data used in our Affidavit, we have also updated some of our mappings between regional carriers and their network-carrier partners. 52 Specifically, we included separate fixed effects indicating whether the first midpoint airport was any of the following: ATL, CVG, DFW, DEN, DTW, IAD, IAH, LAX, MEM, MIA, MSP, JFK, ORD, PHL, SFO, AMS, CDG, FCO, FRA, LHR, LGW or MAD. We included a second set of fixed effects to indicate if the second through airport was any of those same airports. For, itineraries with just one through airport, each of the second set of fixed effects took a value of zero.

### 28 statistically indistinguishable from tho se for either ATI or online itineraries. 53 Comparing columns (2) and (4), across wh ich the only difference is the absence of controls for the marketing carrier, demonstrates that DOJ’s finding that ATI fares are not lower than code share fares is driven by a failure to control for pricing differences across different marketing carriers. 54 Interestingly, however, even in this specification without controls for marketing carriers, otherwise ATI itineraries using carved-out segments have significantly higher fares than full ATI itineraries. Conclusion

45. DOJ’s response to our empirical work, as presented in Appendix B to its December 21 Comments in the current docket, changes none of the conclusions presented in our September 8 Affidavit. Indeed, what is most striking about the DOJ Response is the number of topics on which it ignores, agrees w ith, or fails to provi de any substantive analysis in response to fundamental points that we made. These topics include the appropriateness of using a separate variable to measure ATI effects (which DOJ now seems to accept), the fact that our Affidav it included a cross-sectional style analysis that confirmed our panel results on the lack of AT I effects on non-stop fares, the substantial consumer benefits generated by ATI servi ce, and the undermining or elimination of ATI’s fare and quality benefits when car ve-outs are imposed. Taken together, these results to which DOJ offers no substantive rebuttal are sufficient to demonstrate the benefits of ATI and the harm from carve-outs. Where DOJ does offer responses to our findings, they largely take the form of deta iled data and implementation issues, many of which reflect intentional and appropriate c hoices that we made in analyzing the data. Some of the implementation issues that DOJ ra ises are invalid criticisms, while others are valid points in response to which we have adjusted certain details of our methodology, but they all share one common feature – regardless of whether they are considered one at a time or in combination, they have, at most, a small effect on our results and no effect on any of the conclusions from our affidavit . Instead, on those topics about which DOJ claims to have refuted our results (price effects of ATI on non-stop routes and the

53 In this run, we replace the marketing carrier fi xed effect with one for the “major U.S. airline reporting the ticket,” like DOJ used in its initial Comments. 54 In DOJ’s December 21 Comments (pp. 22-24), DOJ presents a new model which allows the relative fares for ATI, online, or c odeshare service to vary by the three major alliances – Star, SkyTeam, or oneworld. However, this new model still does not control for the identity of the marketing carrier and thus not-surprisingly generates results consistent with DOJ’s earlier, aggregated model – including the counterintuitive result that code-share fa res are lower than ATI and online fares.

### 29 difference between ATI and code-share fares for connecting traffic), the source of the difference between their findings and ours re mains the same as it has been throughout this proceeding – DOJ’s failure to include impor tant and standard controls for the identity of the marketing carriers setting the fares under analysis. Put concisely, DOJ continues to confound pricing differences across carriers with the relevant competitive effects of ATI and thus to draw incorrect conclusions about ATI effects.

# EXHIBIT 2

### page 1 of 8 The Brattle Group 

## Observations on DOJ’s Analysis of Co nnecting Passenger Fare Relationships in General and Its Analysis of oneworld in Particular 1 

### As part of its filing in this docket, the Depa rtment of Justice (“DOJ ”) provides additional economic analysis of airline fare data for connecting passengers, 2 

### which supplements its prior analysis submitted in the Star-Continental docket. 3 

### DOJ concludes that airlines can achieve the same fare coordination benefits for conn ecting passengers under non-immunized code-sharing arrangements as they can under antitrust im munity or single-carrier online service.

This memorandum contains some observations on inaccuracies created by DOJ’s empirical approach and provides additional information regarding the fares paid by passengers that are served online by a single oneworld carrier as comp ared to those who travel between the same origin and destination using multiple oneworld car riers. For reasons explained herein, DOJ’s current results are larg ely counter-intuitive. We find that, in contrast to DOJ’s results, onewo rld’s code-share fares ar e significantly above the online fares of individual onewo rld carriers serving the same or igin and destination during the same time period. Thus, there is clear eviden ce that oneworld carriers, who do not have an immunized relationship with one another, f ace fare coordination difficulties in serving connecting passengers. Granting an titrust immunity would allow fa re coordination to occur that could produce significant consumer benefits to connecting passengers. Brief Summary of DOJ’s Analysis of Prices for Connecting Passengers In Appendix B of its filing in this docket, DOJ again uses DOT DB1B data to examine fare differences between passengers traveling under online, code-share , ATI, and inte rline service. 4 

### DOJ extends its earlier analysis by examining th e fare differences across these service types within specific alliances, such as oneworld, Star , and SkyTeam. In assessing the results of its analysis, DOJ finds that:

“ oneworld code-share fares currently are 1.6% less than online fares offered by oneworld members. As online fares already incorporate any pricing efficiencies

1 These comments were prepared by James Reitzes, Daniel Gaynor, and Guillermo Sabbioni of The Brattle Group

. 2 See OST-2008-0252, “Comments of the Department of Justice, Appendix B: Empirical Addendum Response, December 21, 2009. 3 See Docket OST-2008-0234, Comments of the Department of Justice to the Show Cause Order, June 26, 2009, Appendix B. The analysis in Appendix B of the Star-Continental docket is re-submitted as Appendix A of the DOJ filing in the current docket. 4 DOJ Appendix B, pp. 20-30. When multiple carriers provide service to a given passenger and those carriers are members of the same alliance but do not have antitrust immunity with one another, DOJ refers to that as “code-share” service. If the carriers prov iding service to the passenger have antitrust immunity with one another, then DOJ considers that to be “ATI” service.

### page 2 of 8 The Brattle Group associated with unified control, this finding undermines Applicants’ claim that they need ATI to reduce a double-marginalization problem in connecting fares.“ 5 

### “More generally, we find in looking at the SkyTeam alliance and the Star alliance that ATI has failed to deliver pricing efficiencies equivalent to ordinary codeshare arrangements with other non-immunized members of each alliance. We find that SkyTeam ATI fares are 7.2% higher than SkyTeam code-share fares, and Star ATI fares are 11.7% higher than Star code-share fares.” 6 

### Additionally, DOJ concludes that: “To summarize, across the models we have estimated in this proceeding and the Star proceeding, code-share fares are systematically lower than each of interline and ATI fares on connecting routes.” 7 

### From these results, DOJ effectively concludes that antitrust immunity (“ATI”) is not needed to allow interlining carriers to achieve the fare coordinatio n needed to benefit connecting passengers because code-share ( i.e. , non-immunized alliance) relationships can achieve similar, if not greater, fare reductions. 

### Some Observations on the Inaccuracies Created by DOJ’s Empirical Approach Putting aside that DOJ in this docket has examin ed only price effects and not non-price benefits that may arise from antitrust immunity, such as improved service quality and more convenient flight scheduling, DOJ’s methodological approach raises certain issues that may negatively affect the accuracy of its findings, particul arly as they apply to oneworld. DOJ Mixes Different Route Types in a Manner that Confuses the Relationship between Online Fares and Fares for Code-Share, ATI, and Arm’s Length Interlining Service DOJ does not perform separate analyses for “b ehind-beyond” routes (whi ch originate behind a US transatlantic gateway and terminate beyond a European transatlantic gateway) and “behindgateway” routes (which originat e behind a US gateway but terminate at a European transatlantic gateway). On behind-gateway routes ( e.g. , St. Louis – London), a single carrier may offer online service. However, on behind-beyond routes ( e.g. , St. Louis – Lyon), there is no single-carrier online service. The nature of co mpetition may be different on thes e two different types of routes, and the relationship between code-s hare, ATI, and arm’s length interline fares may consequently differ.

5 DOJ Appendix B, p. 23. 6 DOJ Appendix B, p. 24. 7 DOJ Appendix B, p. 24.

### page 3 of 8 The Brattle Group By combining these two route types ( i.e. , behind-beyond and behind-ga teway routes) in its analysis, DOJ may be obfuscating impacts that are identified by analyzing each route type separately. Moreover, by adding routes that have no online service, DOJ’s approach confuses the relationship between single- carrier online service, where the connecting fare is under “unified control” according to DOJ, and code sh are and ATI service where less fare coordination may occur. More specifically, DOJ’s approach implies that it can develop estimates of relationships between ATI and code-share fares by examining only a limited number of routes where there is significant head-to-head competition between ATI and code-share service types. Under DOJ’s approach, a fare relationship between ATI and code-sharing could be es timated by using routes where there is only (arm’s length) interline and ATI service and comparing that to routes where there is only interline and code-share servic e. Thus, DOJ’s estimation of the relationship between code-sharing and ATI poten tially mixes the results from routes where there is head-tohead competition between pa rticular service types ( e.g. , code-share and ATI) with routes where there is no head-to-head competiti on between those service types. DOJ’s Reported Results regarding oneworld’s Fare Relationships Are Potentially Misleading. In Table 4 of its Appendix B f iling, DOJ reports evidence from its statistical analysis suggesting that oneworld’s ATI fares are 16.5 per cent above its code-share fares. DOJ also finds that ATI fares exceed code-share fares for Star and SkyTeam. 

### DOJ’s comparison of ATI versus code-share fares for oneworld is potentially misleading, because ATI as applied to oneworld only refers to the immunized AA-Finnair and (the recently defunct) immunized AA-SN Brussels relationships. 8 

### While there are some city pairs that are served via both a oneworld code-share and a oneworld ATI arrangement, the number of passengers that connect to European destinations through Finnair (or SN Brussels) is quite small. Consequently, there are very few city pairs wher e there is a DB1B fare observation for an ATI passenger as well as a code-share passenger in the same quarter. Thus, DOJ’s analysis of codeshare and ATI fares for oneworld is not based on a comprehensiv e head-to-head comparison of passengers who use code-share and ATI service to travel from the same origin to the same destination. Based on the approach used by DOJ , it is difficult to make strong inferences regarding the relationship between code-share and AT I fares in general, and particularly within oneworld (as DOJ purports to do in Tabl es 4 and 6 of its Appendix B filing).

DOJ is even less careful when it draws conc lusions regarding the re lative price differences between oneworld online and code-share fares beca use many of the routes that DOJ relies on for this comparison cannot (by definition) be served by online service. As mentioned previously, DOJ’s data contains behind-beyond r outes that are not served by on line service. However, since these routes can be served by code-share servi ce, their inclusion affects the magnitude of the

8 The immunized relationship between AA and Swiss International Air Lines was terminated in mid-2005.

### page 4 of 8 The Brattle Group coefficient estimated for DOJ’s code-share variab le. An appropriate analysis that compares online fares to code-share fares should be cons trained to routes where online service exists. DOJ’s Approach Produces Counter-intuitive Results Strangely, DOJ’s results (see Tables 4 and 6 of its Appendix B filing) indicate that code-share fares are below online fares for oneworld, Star, and SkyT eam, even though DOJ believes that

“ online fares already incorporate any pricing efficiencies associated with unified control.” 9 

### DOJ apparently hypothesizes that, all else equal, online fares should be below code-share fares, 10 

### but its empirical approach produces a contradictory finding. This suggests that, by estimating fare relationshi ps between various service types using combined data for behind-gateway and behind-beyond routes, and by not attempting to focus on routes where there is head-to-head competition between online service and other service types, DOJ is obtaining misleading results. By correcting these deficiencies , Brattle obtains very different results from those obtained by DOJ, particularly as they apply to oneworld. 

### DOJ May Not Have Adjusted Its Results for Passenger Volume Differences across Itineraries The number of passengers that travel on different itineraries can differ markedly. As representative of an average air fare pertinent to a particular service type on a particular city pair, an average fare derived from 1 sample d passenger may contain more “noise” than an average fare derived from 100 sampled passengers. Ideally, a regression analysis should accord different weights to a fare observation based on 1 sampled passenger and one that is based on 100 sampled passengers. Although we do not ha ve access to DOJ’s data and programs, DOJ appears to treat a fare observation based upon 1 passenger as having equal weight to an observation based on 100 passengers.

Brattle’s Modifications of DO J’s Connecting Passenger Model To address our concerns rega rding DOJ’s methodology for estima ting connecting passenger fare relationships, we construct a model that largely re plicates DOJ’s approach but-for the criticisms outlined above. 11 

### Consistent with DOJ’s approach, we us e DB1B fare data for the third-quarter of each year from 2005 to 2008. We define a route as a city pair where a passenger’s origination point is in the United States and its destination point is in Europe. We omit routes involving US and European cities where non-st op transatlantic service is offe red. In addition, we remove routes where single-carrier online se rvice is unavailable. This leaves us with a set of routes that

9 DOJ Appendix B, p. 23. 10 It is conceivable that if there are quality differences across service types, online fares could exceed codeshare fares when online service is cons idered to be of superior quality. However, DOJ’s analysis does not attempt to account for quality differe nces across different service types. 11 Because we do not have access to the exact data used by DOJ, we use DB1B data obtained from Database Products for our analysis.

### page 5 of 8 The Brattle Group can be served only through connec ting service, but where there is a single carrier that provides online service. In addition to removing itinerarie s where online service is not pos sible, we also consider two scenarios that differ in the way that service t ypes are defined. The first approach adopts DOJ’s definitions for online, ATI, code-share, and interline services, using information on the operating and marketing carriers. A second approach de fines these relationships purely based on the identities of the operating carri ers. The use of the second a pproach reflects concerns over possible distinctions between DOJ’s approach to identifying the carriers who determine a particular connecting passenger’s air fare and the realities of fare-setting decisions. Consistent with DOJ’s approach , we use route-quarter (or itin erary-quarter) fixed effects to account for differences in competitive conditions that are unique to a particular route (or itinerary) during a particular time period. Finall y, we use weighted least squares to allow for differences in the number of passengers that comp rise an individual aver age fare observation for a particular itinerary and service type.

Results – Initial Modification The results from our modificati on of DOJ’s approach, as contai ned in Table 1, contrast with those obtained by DOJ. Instead of finding that oneworld’s code-sha re fares are below its singlecarrier online fares, it now holds that the onlin e fares of oneworld carrier s are below code-share fares offered by oneworld carriers. Moreover, the relationship between oneworld ATI fares and oneworld code-share and online fares changes dram atically from DOJ’s results, such that ATI fares appear comparable to online fares. However, even this modification of DOJ’s appr oach includes routes where oneworld does not offer online service, but instead offers only code-sha re or ATI service. So, these results are still affected by the fare behavior on routes where there is no head-to-head comparison between oneworld online and code-share fares. Further Modifications of DOJ’s Approach While the above re-specification of DOJ’s mode l improves the analysis, a more appropriate analysis would compare oneworld’s online and code-s hare fares solely on routes (or itineraries) where both types of service is offered. This wo uld allow for a head-to-head comparison between these two service types. In Table 2, we compare AA online fares and AA-BA code-share fares only for routes (or itineraries) where the DB1B database identifies passengers using both service types in the same quarter. 12 

### Under this more direct comparison of onlin e and code-share fares, we find that online fares are between 7.2 and 7.4 percent lower than code-share fares.

12 Due to the imposed limitations on the number of r oute segments, the analysis essentially covers routes originating behind US gateway cities and terminating in London.

### page 6 of 8 The Brattle Group This suggests that oneworld is unable to achieve the fare coordination for connecting passengers through code-sharing that can be attained under more “unified co ntrol,” such as single-carrier online service. To the extent that oneworld’s proposed metal-neut ral joint venture attempts to mimic the unified control achieved by a single carri er, one would expect price reductions to arise for connecting passengers as a result of antitrust immunity.

### page 7 of 8 The Brattle Group Table 1 Price Differences Across Tickets based upon the Type of Service DOJ Results Brattle Results Service Type Defined Using Service Type Defined Using DOJ Definitions Operating Carriers Only

Explanatory Variables Estimate Within Alliance, Estimated Fare Differences Relative

to code-share Estimate Within Alliance, Estimated Fare Differences Relative

to Code-share Estimate Within Alliance, Estimated Fare DifferencesRelative to Codeshare Online -0.111 * 1.6% -0.074 0.005 * -0.9% -0.078 0.005 * -1.4% ATI 0.026 16.5% -0.082 0.017 * -1.6% -0.076 0.018 * -1.1% Code-share -0.127 * -- -0.065 0.007 * -- -0.064 0.007 * -- Online -0.030 * 7.2% ATI -0.042 * 6.0% Code-share -0.100 * -- Online -0.072 * 3.8% ATI 0.000 11.7% Code-share -0.110 * -- Online 0.001 0.005 2.3% -0.004 0.005 1.9% ATI -0.008 0.005 1.4% 0.000 0.005 2.4% Code-share -0.022 0.006 * -- -0.024 0.007 * -- Interline

-- -- -- Number of Coupons -0.052 * -0.014 0.003 * -0.019 0.003 * Mileage -0.076 ** 0.000 0.000 * 0.000 0.000 * Number of Observations 123,522 81,561 81,561 * Statistically significant at the 99% confidence level ** Statistically significant at the 95% confidence level Star Alliance OneWorld Alliance SkyTeam Alliance Standard Error Standard ErrorService T ype

All Other

### page 8 of 8 The Brattle Group Table 2

Price Differences Across Tickets based upon the Type of Service 

### Route-Year Fixed Effects Itinerary-Year Fixed Effects

Explanatory Variables Estimate Within Alliance, Estimated Fare Differences Relative

to Code-share Estimate Within Alliance, Estimated Fare Differences Relative

to Code-share

AA Online -0.077 0.04 ** -7.4% -0.075 0.04 *** -7.2% AA-BA Code-share -- --

-- -- -- -- Mileage -0.170 0.27 Number of Observations 548 421 * Statistically significant at the 99% level. ** Statistically significant at the 95% level. *** Statistically significant at the 90% level.ServiceType Standard Error

OneWorld Alliance Standard Error

# EXHIBIT 3

### page 1 of 5 The Brattle Group 

## Some Potentially Relevant Rece nt Experience with Carve Outs 1 

### As part of its filing in this docket, the Department of Justic e (“DOJ”) provides information regarding the performance of routes that were subject to carve-outs by the DOT. 2 

### Specifically, DOJ states as follows: 3 

### “With respect to adding new flights, th e experience of other alliances operating with carve-outs belies the claim that carve-outs prevent the addition of new capacity. Since 1996, United and Lufthansa ha ve operated in the immunized Star Alliance with two carved-out routes: (1) Chicago and Frankfurt and (2) Washington and Frankfurt. Capacity has risen 75% on the route between Chicago and Frankfurt and 105% on the r oute between Washington and Frankfurt, and the number of local passe ngers traveling on the rout es has remained virtually unchanged.” “These alliance partners did not share re venues during this period, so the carrier operating a new flight receive d all the revenue from not only the local passengers (as would be the case with oneworld) but also the connecting passengers. Recognizing that it was in their mutual interest to increase capacity on the hubhub routes to capture connecting pa ssengers, they added flights.” DOJ’s empirical observation regarding the gr owth of capacity on the carved-out ChicagoFrankfurt and Washington-Frankfurt routes is difficult to evaluate in isolation, given the general changes in economic conditions that affected transatlantic passenger volumes between 1996 and today. Moreover, the empirical evidence surrounding the more recent carve-outs of SkyTeam’s Atlanta-Paris and Cincinnati-Paris routes sugge sts that DOJ had drawn an erroneous conclusion regarding the impact of car ve-outs. Since these rout es were carved out in 2002, 4 

### SkyTeam has shown substantially greater increases in passenger volumes and seat capacity on its non-carved-out transatlantic trunk rout es to Paris when compared to its carved-out transatlantic trunk routes (see Tables 1 through 4 below). When all carriers ar e considered, the results still show greater growth on the non-carved-out rout es (see Tables 5 and 6 below), although the magnitude of the differential is somewhat smaller. In particular, Table 1 shows that between 2001 ( i.e. , the last pre-carve-out year) and 2008, Delta and Air France reduced their pa ssenger volumes by 9.7 percent on the carved-out Paris trunk routes, while increasing their passenger volum es by 26.1 percent on the non-carved-out Paris trunk routes. Overall, seat capacity decreased by 12.4 percent on the carved-out Paris trunk

1 These comments were prepared by James Reitzes, Daniel Gaynor, and Guillermo Sabbioni of The Brattle Group. 2 See OST-2008-0252, “Comments of the Department of Justice, December 21, 2009 (“DOJ Comments”). 3 DOJ Comments, p. 34. 4 See DOT Order 2002-1-6, January 18, 2002.

### page 2 of 5 The Brattle Group routes and increased by 18.1 percent on the non-carved-out Pa ris trunk routes over the same period (see Table 2). If the comparison peri od is from 2000 to 2008 (instead of 2001 to 2008), the results still show substantially greater grow th in passenger volume and seat capacity on the routes that were not carved out. 5 

### Thus, the results reported by DOJ on the impact of carve-outs are misleading at best. Our comparison of the changes in passenger volu mes and seat capacity on carved-out routes relative to non-carved-out routes should account for changes in supply and demand conditions that affect air travel in gene ral, and thus provide a more va lid basis for evaluating carve-outs. 6 

### Lastly, it should be mentioned that the Star carve-outs ( i.e. , Washington-Frankfurt and ChicagoFrankfurt) apply to all passengers , while the SkyTeam carve-outs ( i.e. , Atlanta-Paris and Cincinnati-Paris) apply only to first, business, an d unrestricted coach passe ngers. However, it is the desire to attract these high-margin, “time-sensitive” passengers that have a substantial impact on whether airlines decide to increase capacity.

5 The results are similar if we use 2007 instead of 2008. 6 Of course, more precise conclusions may be obtained through an econometric analysis that more formally considers the impact of supply and demand conditions that affect air travel in general and those on the specific routes of interest.

### page 3 of 5 The Brattle Group Table 1 Percentage growth in passenger volume for Delta and Air France combined on carved-out and non-ca rved-out trunk routes, U.S - Paris

Carved-Out Non-Carved-Out Total

2000 to 2008 1.6% 22.1% 18.4% 2001 to 2008 -9.7% 26.1% 18.9%

Source: T-100 International Segment Trans-Atlantic flights between the U.S. and Paris Carved out routes include At lanta-Paris and Cincinnati-Paris



### Table 2 Percentage growth in volume of se ats available for Delta and Air France

combined on carved-out and non-ca rved-out trunk routes, U.S - Paris

Carved-Out Non-Carved-Out Total

2000 to 2008 -2.2% 17.1% 13.6% 2001 to 2008 -12.4% 18.1% 12.0%

Source: T-100 International Segment Trans-Atlantic flights between the U.S. and Paris Carved out routes include At lanta-Paris and Cincinnati-Paris

### page 4 of 5 The Brattle Group Table 3 Percentage growth in passenger volume for Delta, Air France and Northwest combined on carved-out and non-ca rved-out trunk routes, U.S - Paris

Carved-Out Non-Carved-Out Total

2000 to 2008 1.6% 23.9% 20.1% 2001 to 2008 -9.7% 29.1% 21.6%

Source: T-100 International Segment Trans-Atlantic flights between the U.S. and Paris Carved out routes include At lanta-Paris and Cincinnati-Paris KLM reported no passenger volume.



### Table 4 Percentage growth in volume of seats ava ilable for Delta, Air France and Northwest combined on carved-out and non-ca rved-out trunk routes, U.S - Paris

Carved-Out Non-Carved-Out Total

2000 to 2008 -2.2% 19.4% 15.6% 2001 to 2008 -12.4% 21.1% 14.7%

Source: T-100 International Segment Trans-Atlantic flights between the U.S. and Paris Carved out routes include At lanta-Paris and Cincinnati-Paris KLM reported no seats available.

### page 5 of 5 The Brattle Group Table 5 Percentage growth in passe nger volume for all carriers combined on carved-out and non-ca rved-out trunk routes, U.S - Paris

Carved-Out Non-Carved-Out Total

2000 to 2008 1.6% 3.1% 2.9% 2001 to 2008 -9.7% 10.2% 7.9%

Source: T-100 International Segment Trans-Atlantic flights between the U.S. and Paris Carved out routes include At lanta-Paris and Cincinnati-Paris



### Table 6 Percentage growth in volume of seats avai lable for all carriers combined on carved-out and non-ca rved-out trunk routes, U.S - Paris

Carved-Out Non-Carved-Out Total

2000 to 2008 -2.3% 0.5% 0.2% 2001 to 2008 -12.4% 3.5% 1.6%

Source: T-100 International Segment Trans-Atlantic flights between the U.S. and Paris Carved out routes include At lanta-Paris and Cincinnati-Paris**CERTIFICATE OF SERVICE**

I hereby certify that I have this day served the foregoing document by email on the following persons:

scott.mcclain@delta.com sametta.c.barnett@delta.com kquinn@pillsburywinthrop.com bkeiner@crowell.com sascha.vanderbellen@nwa.com bruce.rabinovitz@wilmerhale.com jonathan.moss@wilmerhale.com jeffrey.manley@united.com bob.kneisley@wnco.com robert.land@jetblue.com msinick@ssd.com cdonley@ssd.com anbird@fedex.com dvaughan@kelleydrye.com kevin.montgomery@polaraircargo.com jrichardson@johnlrichardson.com lhalloway@crowell.com efaberman@wileyrein.com mroller@rollerbauer.com howard_kass@usairways.com benjamin.slocum@usairways.com jhill@dlalaw.com bill@mietuslaw.com mgoldman@sgbdc.com rsilverberg@sgbdc.com dhainbach@ggh-airlaw.com mcmillin@woa.com mchopra@jamhoff.com russell.bailey@alpa.org dkirstein@yklaw.com jyoung@yklaw.com donna.kooperstein@usdoj.gov dwight.moore@ustranscom.mil jim.ballough@faa.gov byerlyjr@state.gov recohn@hhlaw.com cjsimpson@zsrlaw.com pmurphy@lopmurphy.com lachter@starpower.net anita.mosner@hklaw.com

_______________________________ JEFFREY A. OGAR January 11, 2010