MOTION FOR LEAVE TO FILE AND

5UPPLEMENTAL COMMENTS OF HUBERT HORAN

AMERICAN AIRLINES BRITISH AIRWAYS-IBERIA-FINNAIR.ROYAL JORDANIAN

JOINT APPLICATION FOR ANTITRUST IMMUNITY

DOCKET DOT,O5T-2008-0252

31 lanuary 2010

MOTION FOR LEAVE TO FILE

On January 10'n, Ifiled public comments in re5ponse to the Department of Jurtice's December Comments.r

The5e comment5 were tiled during the public comment period established by the Department's order of

22 December.': My romments were filed via regulalions.gov and have been available to the Department

and the public aince 11 .January 2010.r My comments were largely tocused on the Joint Applicants'claim

that a grant of antitru5t immunity would generate $92 million in annual public benefits due to lower

fares in connecting markets-the largest and most important economic claim in thelr application. The

Department of Justice took no position on the legitimacy of this claim, but argued that iJ any such

consumer bene{its existed, they could be largely achieved without a grant of immunity. My comments

challenged the DOj position that the possibility of beneJitt of thi5 magnitude could be assumed without

analysis or other 5crutiny.

On 28 January, while discossing an unrelated matter on a 5eparate case, a DOT stafJer informed me that

my public comments had been rejected by the Department, and the evidence Ipresented about the public

beneJit claimr would be totally ignored. This was be<ause I had failed to meet the requirements ot 14 CFR

302 07 mandating email or physical distribution to all parties to the case, and inclusion of a signed

"certificate of servi(e" stating that su(h distribution has o<curred. Although the Department actively

encourages public commentg via regulations.gov, and there ir nothing in 14 CFR 302.07 specifically

precluding the use of docket managernent sy5temsuch as regulations.gov as a means of distributing ca5e

Jilings, Iwa9 told that the Department interprets 14 CFR 302.07 to mean that evidence introduced by

tilings distributed solely via regulations.gov are wholly inadmissible. I had no knowledge of this issue prior

to 28 lanuary, ar the Department had (and hat not provided me with any official communication

indicating the deficienq or its intentlon to reject the comments. Ihave not received any informal

communication about any de{iciency other than the "certi{icate o{ service" issue.

I am filing this motion Jor leave to refile my original 10 January comments, including the missing

certiJicate, that will bring my filing into compliance with the Depafrment's intefpretation oJ 14 CFR

302.07. The January 10'n comments are completely unchanged from the version that has been available to

the Department and the public since 11 lanuary. I believe the Department lhould grant thi5 motion, a,

r The public comments are {ully consistent with the reasons the Department estab ished the

supplemental comment Deriod on 22 December

. The public comments provide objective evidence and substantive analylis of one oI the most

important asDects o{ this case

r I had made a sincere, good-faith effort to comply with the Department's public comment and filing

requirements; there is no reasonable way that a member o{ the general public wishing to file a

public comment on an imoortant case such as this would have reajized that the email and

certilicates were mandatory requirements; when I initially inquired about making public comments

on cases such as this, staff at the DOT Dockets Office informed me that I simply had to follow the

filing procedures at regulations.gov, and complete the tiling within the designated public (omment

period. which I have done

DOT-OST-1008-0252-3i7.l I DOT Ordcr 1009-12 t6 ' Dor-osr-2008-0252,i379
: There is no inJormation at regulations.govr any DOT website ;ndicating that evidence

introduced via public comments would be automati(ally rejected unless the distribution and

certificate requirements had been met

. The public dockets on this and similar cates include many submissions that do not include

certifi(ates, thus a reasonable member ol the general public would not assume this is a

mandatory requrrement

. I have made a sincere, good faith effon to remedy the distribution and certificate defi(iency as soon

as I discovered it was an issue, and would have done 3o 5ooner, had the Department made me

aware of the issue sooner.

. The diltribution and certificate requirements oI14 CFR 302.07 rerve legitimate, important purposes,

but those purposes will have been met if this motion is granted. Granting this leave to refile a{ler

the end oJ the official comment period places no terious disadvantage on any party to this casel as

the comments have been fully available for review by all partier gince 11 lanuary, and the

Department had never issued any public statement disqualifying them; the initial omission of the

certiJicate and this motion {or late (re)filing is obvioLrsly not attempt to artificially disadvan'tage

other parties to this case, who largely consist of large international airlines, represented by some ol

the top aviation counsel in Washington.

. Granting this leave to retile after the end of the official comment period would be fully consistent with

all past actions taken by the Department in thi5 case, including the granting of all prior motions for

leave to file late comments in its December Order. In all of these past de(ision5, the Department ha5

properly given higher priority to establishing a complete case record, and allowing all partiet full

opportunity to review and comment on that re(ord, than to producing a less complete decision on a

tighter schedule.

r For many years. the Department has actively encouraged public input into regulatory and

administrative decisions, and was one of the pioneers of the us€.Jriendly internet-based docket

management systems that have evolved into regulations.gov. Granting thi5 motion would indicate

that the Department places greater weight on the importance ol public a(cest to and parti(ipation

in its decision making, that it places on any unintended in(onvenience caused to the airline3 and

law firms that have had aace5s tothese oublic commentr tince 11 lanuary, but had not received a

direct emailwith these comments until thie filing.

The batance of this filing consists of a verbatim copy o{ my 10 january comments and the certilicate o{

servi(e. Following an introduction explaining my background, experience and interest in this (ase, the

aommentt are divided into five sedions

A. RECENT SUBMISSIONS HAVE NOT ADDRESSED THE IOINT APPLICANTS' HIGHLY DEFICIENT CLAIM OF

$92 MILLION lN ANNUAL PUBLIC BENEFITS FROM CONNECTING SERVICES (pages 'l-6)

8, THE ORIGINAL NORTH ATLANTIC ALI.IANCES OID CREATE 5IGNIFICANT CONSUMER WELFARE BENEFITS

BUT WELFARE GAINS DUE TO ALLIANCE PRICING WERE VERY NARROW AND THESE WELFARE EENEFITS

WERE FULLY EXHAUSTED BYTHE LATE 905 (pages 7-9)

C. THE BRUECKNER WHALEN REGRESSIONS FUNDAMENTALLY MI5REPRESENT THEHISTORICAL

CONSUMER PRICING BENEFITS FROM ALLIANCE ANTITRUST IMMUNITY (pages 10-11)

D. DOUELE MAR6INALIZATION DOES NOT EXIST, NEVER EXIsTED. HAS ABSOLUTELY NOTHING TO DO

WITH THE BENEFITS OF IMMUNIZED ALLIANCES. AND ERUECKNER AND WHALEN'S THEORIES AEOUT

DOUBLE MARGINALIZATION ARE NOT SUPPORTED BY ANY DATA OR ANALYSIS (pages 12'18)

E. THE jOINT APPLICANTS' CLAIM5 OF J92 MITLION IN ANNUAL PUBLIC BENEFITS IN CONNECT MARKETS

MU5T BE RE.IECTED. ITNOT ONLY FAILS TO MEET THE MINIMIMUM REOUIREMENTS OF THE HORIZONTAL

MERGER GUIDELINES, BUT THE CLAIM 15 DEMONSTRABLY FALSE. (paqes 19-20)
SUPPLEMENTAL COMMENTS OF HUEERT HORAN

AMERICAN AIRLINES-BRITISH ARWAYS,IEERIA-FINNAIR-ROYAL,JORDANIAN

JOINT APPLICATION FOR ANTITRUST IMMUNITY

DOCKET DOT-O5T-2008-0252

8 January 2010

My name is Hubert Horan. Iam Jiling these comments in rerponse to the Department o{ Justice filing at

OOT-O5T-2008-0252-3374. There are supplementalto comments I originally {iled on 15 October 2009

under DOT'OST-2008-0252-3362

Ouring my 25 year aviation career Ihave done consulting work with over 30 airlines and held airline

management positions with Northwest, Ameri(a West, Swirsair and Sabena- | have signilicant experience

in international airline competition and the actual operation and e(onomics of airline allian(es. While at

Northwesl I was personally responsible Jor the original development of the KLM-Northwest Alliance

network and introdu<ed the intense hub-to-hub operationt that allowed Northwest to be(ome the most

profitable US (arrier on the North Atlantic, and established the template followed by all ol the

subsequent alliance networks. I spent four years at Swissair-sabena, including the transition of 5wigrair'r

alliance from Delta to American, and thus have been involved in alliance management on both 5ides of

the Atlantic. I have not only helped build highly soccesstol allian(es, I have helped shLrt down highly

unprofitable ones, including the intra European QualiJlyer alliance, and the domestic alliance between

Continental and America Wert. Over the years Ihave written extensively on airline competition, global

airline consolidation, and Open Skies treaty negotiations, and I also testified beJore Congress on the

Delta-Northwert merger. I am ba5ed in Phoenix, Arizona. A Jull list of publicationr and {urther

biographical information is available at my webgite, horanaviation.com.

I have no active business or financia! interests with any of the parties to this case. and am only

commenting as a private aitizen concerned about the issuet raised by this case.

A. RECENT SUBMISSIONS HAVE NOT ADDRESSED THE .,OINT APPLICANTS' HIGHLY DEFICIENT CAIM OF

'92 MILLION IN ANNUAT PUELIC BENEFITS FROM CONNECTING SERVICES

A1. DOT may not orant the reouested ltn1munity without eviden(e. meetingthe standardt oI lhe

4_otizontal MetgelSldeljDcf \Latjng colt5q]I€LbclqfLts in no6lqp ald conneltitgiqarkets

Elglilicantly grealellbalelyjllt!!!:tqdneqd,Egmpetition in nonstoo or coli€qlilg markets

. Applicants for antitrost immunity must prove that immuni'ty "is neces9ary...to achieve important

public bene{it5" that "cannot be achieved by reasonably available alternatives that are materially

iegs anticompetitive."' Both the DOT and OOJ have recoqnized that airline antitrust immonity

applications such as this one would directly eliminate competition in the same manner that a loll

merger would and applicants must prove that those public benelits outweigh the risk that it .ould

harm competition by increasing the ability or incentive to raise price or reduce output in any

relevant market.2 The burden of prool for public benefits rests with the applicants, and the

Horizontal Merger Gurdelrrei defines the evidentiary standard5 that must be metl

i "lthe applicantsl must substantiate efficiency claims 50 that the Agency can verify by

rearonable means the likelihood and magnitude of each asserted efficiency, how and when

each would be achieved (and any costs of doing so) how each would enhan(e the merged

{irm't ability and incentive to (ompete, and why each would be merger'specilic. Efticiency

(laims will not be considered if they are vague or speculative orotherwise cannot be verified

by reasonable means"l

rl9 USC secrjons 41308.4ti09(b)

- 

f(J.ra Trcde CornIri.'ion. Deprnnrenr of.lu.lir(.

sccrions l.:. i.3.

Feo(jral I raOe ( ollllnl.rion. Depanmenl ol JU\lr((.

Anlitrusl (;uidelines for Collaboraiions Among Conrpelilors (1000)

Horironldl Meqer Guidelines (1997) p.i I
Horan EAAA Supplemental Comments 8 January 2010

r The Joint Applicants have made four substantive claims in support of their request for antitrust

immunity: (1) that immunity would generate $92 million in annual public beneJits in the torm of

capacity driven price reductions to North Atlantic parsengers using conneding services (2) that

immunity would generate $45 million in annual public benelits from increased nonstop capacity

added to hub-to hub routess (l) competition would not be reduced or eliminated in the

overlapping nonstop markets served by the Applicants6, and carve-outs of nonstop routes from any

immunity grant would reduce consumer benefits by i55 million? (4) competition would not be

redu(ed or eliminated in transatlantic connecting marketss,

- Other alaim5 made by the loint Applicants (increased convenience, applicants better able to

compete) are either derivative claims (the impa(t of increased (onvenience and competition

are already rellected in the quantified public benelit claim5) or are not supported by any of

the typet of evidence required by the Horizontal Merger Guidelines.

A2. Previous !$!im9ny has already fully lelqlqdthe Joint Applicao!!!ai!! tliqljlhCle i5 no rilLtq

consum-erslrom reduced OOIStqp competitioO

r The only veritiablevidence presented by the loint Applications indefense of claim (3), that

competition in nonstop markets would not be reduced enough to increase ability or incentive to

raiSe price or reduce output, and that carve-outs o{ nonstop routet would harm (onsumers, is

in<luded the Willig/Lexecon Compass affidavit. That aJlidavit claimed that its regression analysit

demonstrated that risks from reduced competition were de minimit because "there is no statistically

significant fare effect from reducing the actual number oJ carriers on a route from two to one" and

that "granting antilrutt immunity has no significant effect on fares" and "carving-out Jrom

antitruSt immunity the four oneworld overlap routes would impose harm on (onsumers equivalent

to at Ieast t55 million annually"e

. Previous testimony ha5 already thoroughly refrrted the Willig/Compass Lexecon claims, the only

evidence supportjng the Joint Appliaant5 competition (laimt.

- My October testimonyro demonstrated that the key claims (allowing two (ompetito6 on a route

to (ollude via immunity, and that reducing the number of (ompetitors on a route from two

to one did not atfed pricet, were entirely based on a regression that dad not correctly <ount

the number of competitors historically servin9 a route. The regression iput data explicitly

assumed that immunized partners, such as Northwest and KLM on Detroit-Amsterdam, were

independent price competitors, and that results linking price levels to the number of

competitors on a route were 'fundamentally invalid since the independent variables were

improperly calculated ("rooter with 2 competitors" were a mix of routes with 2 actual

competitors, and routes ruch as Detroit-Amsterdam with 1 actualaompetito0.

L The Department of Justicet December submis5ionri provided a much more exhaustive attack on

the methodological problem5 in the Willig/Compass Lexecon regressions, and the DOI

submitted independent regresrion analysis demonstrating serious risk5 that redoced

(ompetition on nonstop routes would lead to higher prices. The DOJ regressions, based on

data reflecting current market conditionr, showed an average 150lo fare increase when

competition on a route was reduced lrom 2 to I, and 6% when competition was reduced

{rom 3 to 2 carriers. When the DOJ corrected the statistical flaws in the Willio/Comoars

' Joinl Applicatjon ( DO I-OST-1008-0152-0001 ) p.7.:.1. e\hibir JA-li, JA-19 (thc Brarle aftidavir). Allrefercn(cs k)

docket materials in this submi\\ions rclcr to public vcrsfuns : pa-qinalion nra) yary sli-qhtl) liom conlidcnrial !ersions ' Joint Application op.cii.. Joinr Applicanrs Consolidalcd Rcply (DOT-OST,2008-0252-il lJ) p.19.

" Jo int A pplication p. I5 -,1 I . Joint App licants Supplemenral Con m€nts ( DOT-OST-1008-015l-i 35 7 ) p.l-g. n\h ib it | ( rlre

willigLerecon Compass amdavn)

loint Application p.4l-57. SupplementalConrments p.1 l- 19. the W'llig,'Le)iecon Conrpas affida!it ' Joint Application p.4l'57. Suppl€mental Conlrncnrs p.4-9 'Willi9Lexecon Compass amdayil p.6. 13, 18.22 ' Hnran commenrs. DO r-O5T-'008 025:-iJo: I Depanmcnt ofJustice commenrs. DOT-OST-2008-0252-337,1, appendi\ A and B
Horan BAAA Supplemental Comments 8 January 2010 l

Lexecon regressions, resultsupported the DOI findings of (onsumer risks, and no longer

supported the Joint Appli(ants'claims. The DOJ rubmission alro presented HerfindahlHirgchman Idex ("HHl") measures o{ competition showing that these nonstop markets are

afready highly concentrated, and that under the Horizontal Merger Guidellne5 further

reductions in (ompetition (ould be presumed to create additional market power.

: The Joint Applicantr' claim that immunity would lead to increased capacity in the5e market5

does not meet Horhortal Meryer Guidelines standards as it is purely speculative (the loint

Applicants say they would look seriously at capacity increases but have made no

commitments), but the DOJ submis5ion reluted the counter argument that added hub-to-hub

{lights would mitigate pricing risks since any added capacity would be dedicated to

connecting markets.r: More importantly, the OOJ submi55ion rpeci{ically identifies the huge

barriers to potential fulure entry in theJe markets, an issue that is critical to any evaluation

under lhe Horizontal Merger Guidelines.

A3. Tlc JajrtABpljlal$llg? million Public Bene{it claiDs are lhqllrqest and most ilnpolt?IllLaim in

thgi! appli(ation. but neilher the 0epartmed gl l!!lr!€!c.omr!e!l!! lqr other recent submissig]1sjropel]y

addressed the deficiencies in this claims

. The OOT cannot accept the Joint Applicant's claim o{ t92 million in annual public benefits in

connecting markets without

. proper, verifiable, non-speculative evidence supporting the specific eflicien<y benetits that the

loint Appli(ants claim will be created it immunity is granted

! proper, v€ri{iable, non-speculative evidence supporting that these gpecific consumer beneJits are

highly likely to be achieved in the Applicants' markets under current market conditions

: clear evidence that the (laimed public benefits could not be aahieved by reasonably available

allernativer that are materially less anticompetitive

. The Department of Justice's comments did not directly address the loint Applicantl claim that

;mmunity would create $92 million in publi( benefits, but argued more narrowly that these benefits

(ould be achieved without immunityrl

r The Joint Applicant's claim that immunity will generate $92 million in annual beneJits in connecting

markets is entirely based on two theoreti(ai arsumptions

j Attumption 1--lnterline fares on carrie15 with antitrust immunity are a[vays lower than interline

or code5hare fares on carriers that do not hav€ antitrust immunity because carrierr without

immunity are alt rey! stru(turally bound to the higher costs of "double marginalization" (i.e.

successive markupt. This structural efficiency advantage would be observed in any market

and occurs independently otany other factors (supply/demand, competition, etc.).

E Assumption 2-lntroducing antitrust immunity to existing itineraries operated on a non

immunized codesharing ba5is would lead directly to {are reductions of 17.450lo; this

magnitude of fare reduction would occur in any market, independent of any other factors.

These price redu<tions can be assumed even in markets where there is no eviden<e than non

immunized pasrengers (urrently pay higher fares than passengers traveling on online or

immunized allian(e services. These fare reductions would stimulate new tralli( growth based

on a price elasticity measure ot -1.7. d

r The S92 million in annual publi( benefits is calculated by applying the 17.45% pri(e reduction to

all AA-BA,/AA-lB interline pa5sengers identitied in the 2007 DB IA data, and further increasing

'' The Joint Applicalion sho$\ (Supplenrenral Conrmenrs p.5) lhar rhe Dallas-Irr.Wonh-l-ondon ma.ker alrcad! has 8 Iinres

as nranv sents as rcquired lo serve the localmarket '' DeDanmeni ofhrstice commcnrs. D. l2-:9 '' BraBle allldavit p l. 5-8: also restared in Joint Applicanrs Consolidatcd Reply -.tsratllc Group repl] lo Frontier

Econonrici . Brattle would have applied largcr (22%) pfice reduction in non-codesharing interline cascs. but these could

nor be identified in the DB I A data. so dre morc conscrvar ive I 7.4 5% facLor was applicd to al1 coupons.
Horan BAAA Supplemental Comments 8 lanuary 2010

traffic based on the pri(e elasti(ity lactor. These welfare gainr are (laimed to be "annual"--

ongoing and permanent; and would never be eroded or competed away by the marketplacer The sole ba5i5 {or these two asrumptions are theoretical arguments made in pape.s published by .J.K.

Brueckner in 2oo3 and W.T, Whalen in 2007, derived from a single jointly-authored 2000 paperrt.

The later papers updated regression analysis from the original paper but made no significant

change5 to the original theoretical arguments or conclusions.

t This comment will argue that the DoT must completely rejecthe Joint Applicants' claim of $92 million

in publi( benefit5 in connecting markets as it not only tails to meet the evidentiary standards o{ the

Hotizontal Metger Guidelines but is demonstratively false. The Joint Applicants' claims totally rely

on the Brueckner and Whalen theoretical arguments; if those argumenlt meet the Hoaizontal

Meryer Guidelines standards, then the DOT should affirm the .loint Appli(ant!' public benelits claim.

ff those arguments do not meet the Horizonta I Meryer Guidelines standards, then the DOT should

rejecthe.loint Applicants' claim. A5 a result, this comment will:

E Detcribe the Brueckner^vhalen aalysis and arguments from their published papers, including

their regression analysis of (largely) North Atlantic data {rom the 1990s, following the

introduction oJ the originel immunized allian(es

- Des(ribe the actual North Atlanti( competitive environment o{ the 1990s and the actual

competitive and efficien(y advantage5 otthe original immunized alliance5, based on DOT

data and market studies, but also based on my experience as one of the key people

responsible for the development of the original KLM-Northwest alliance network, my

sub5equent srategi( and network alliance work at Swis5air and other carriers, and olher wo*

throughout my 25 year career directly relevant to the competitive is5ue5 raised by thi! cate,

including hub network development, merger' and consolidation, and revenoe management.

! Evaluate Brueckner and whalen's statisticalnalysis, which i5 used to estimate the loint

Applicant's projected public benefits, and their theoretical arguments about "double

marginalization", which are centralto the loint Applicants' claim.

r lt must be emphasized that, while the5e comments will focus heavily on the Brueckner/Whalen

theories and papers, the issue at hand is claims made by the Joint Applicanls, not by Brue<kner or

Whalen personally, neither of whom has submitted testimony in this case.

&Lfhe "Economics Literatore" s!1pp!rting the claim tbat imnldzf! aLrllre alli- ncet-gcM:ate consumer

beneltlllarull15 al? 5in9le joir!!!:a!!halellpaper, plullwqjlqllow-up-lapers by the same authaEthat

uldated r€gre55ip!5trylIbqut changingLtbc_qdg_ilcl argoments or cgn(lusieE

r The "economic literature" on the price effe<ts ot international alliances contitt5 of one journal article

published by Erueckner and Whalen in 2000'0, and reveral follow'up pieces by the same authors

oltering minor updates on the original paper. That original paper outlined the malerial that was

repeated, with minor moditications, in all subsequent papers, including

L- A statement of the general hypothesis that the "cooperative pricing" lowers airtares in

connecting markets; each paper specifically noted that (onsumer benefits from lower airfares

in these coonect markets could be o{fset by reduced aompetition in hub-to-hub nonstop

markets, and that the analysis in the paperl was fo(used on connect market impad5, and was

not intended as an evaluation of the overall wellare impacts of alliances

. A description of the authors' behavioral theories about how interline prices are set in alliance

and non-allian<e situations, which underlay the authors' asslrmptions ot stru<tural barriers to

efficient non-allian(e pri(ing, causing cooperative alliance interline fares to always be lower

than non-cooperative interline fares

'' Jan K. Rrueckner. curently on ihe [conomics lirculty nr rhe Uni!ersir)- ofCalilbmia-lr!ine and w. l om whalen.

currenr ll $ ilh the Anritrust D i\ is ion of l hc Depannrenr ofJ usricc. Borh $ ere ar thc lJ 0 iversit) of I llinois-UrbanaChampaign ar the rime ofthe oricjnalpaper '" Brueckner. J. K. and Whalen. W. T.. (1000). "l he Price Ellect5 of Internalional Airline Alliances ./,r'e Journdl t)l Ld|

dnl Ecor.,ni.s \13 n2. p.503
Horan BAAA Supplemental Comments 8 January 2010

I A discussion of the authors' mathematical models of how interline carrierr, alliance and nonalliance, maximized the ditterence between marginal revenue and marginalrosts, whi(h were

then applied to a 5impliJled (4 to 8 leg) airline network where there economies oJ network

density and either positive or constant scale economies. Since it was assumed that the

structural barriers inherent in non-alliance pricing imposed an efficiency penalty that

immunized airlines did not fa(e, solving these equations (not surpri5ingly) demonstrated that

non-alliance interlining was always less profitable than alliance interlining

r A discu55ion oJthe OOT DBlA data and the regression results, which contirmed the general

hypothesis that alliance interline fares were materially lower than non-alliance interline fares.

. None of Erueckner or Whalen's follow-up papers made any signi{i(ant changes to the approach or

conclutions of the 2000 paper, and should not be seen as separate trom the original analysis

: Brue(kner-Whalen (2000) also attempted to estimate the net welfare impact oJ a Britirh

Airways American Airlines immunized alliance. Thit was calculated by applying the regression

alliance coefficientso all BA-AA interline traffi(, and applying the average price detriment

irom those regressions due to reduced competition to traffi< on BA-AA hub-to-hub flighls.

The welfare losses lrom reduced hub-to-hub competition eliminated almost most gains in

connection marketg, although the exactradeoff depended on price elastiaity arsumptioni.

n Brueckner (2001)r7 did not undertake any regression analysis, but fleshed out the behavior

pri(ing theories and mathematical profit maximization model a bjt. The paper introduced the

terms "double maximization" and "negative externalities" as descriptors Jor the alleged

structural inability of non alliance (arriers to optimize interline revenues.

: Brueckner (2003a)13 was the first paper to recognize multiple levels of alliance codesharing, and

updated the original Brueckner-Whalen (2000) regressions using 1999 data, which separately

identjtied the "marketing" and operating carriers. The results indicated greater price

reductionr for alliances with antitrust immunity than {or coderharing within alliances that did

not have antitrust immunitv.

._ 8rue(kner (2003b)re 5ummarized Brueckner (2OO3a) results for a more general audience, and

estimated the benefit oJ Star Allian(e coderharing in connecting markett. Like the eadier 8AAA analysis, this involved a gimple application of regression coefficients repfegenting "pri(e

benefits of allian(et in (onnecting markets" to all Star Alliance connecting traffic. Brueckner

did not attempt to weigh the conneding market benefits (roughly $80 million) against

detrimentt from lost competition in overlap markets, but a<knowledged thete exirted.

: Whalen (2007)'?o briefly 5ummarized Erueckner'r general hypothesis and theories of pricing

behavior, and presented new reg.essions using 11 year panel data in5tead of <ross-section

data lrom a single quarter as the input to his regression. Panel data minimizes errorr or false

correlations incross sectlon analysis that are due to Jactors such as length oJ haul or local

route characteri5ti(t, although panel data (an introduce problems due to temporal factors.

Whalen also extended the databa5e to include online connecting trip5. His results confirmed

the general hypothesis but Jound smaller price dilference5 than Brueckner's cross-section

analysis. A separate analysis found that the existence of an "Open 5kies" treaty war actually

correlated with higher average connecting tares than found in non-"Open Skies" markets.

l'Bruccfncr.J.K..(100l). rhe Econonricsol lnrernarionnl(ixtcsharing: AI An{l)sis olAirlirrc Alliance\"- lnnratunndl

.hto\tu .l Inlxsttul 0 gdrilltitrl )19. p.l 17J '' BrueckDef. J. K.. (2001a). -lnternational Airt-arcs inthc Agc ofAlliancesi The Effecls ol Codesharing and Antilrust

InrmLrnit) . nd/A .y' tr{ rrr,tit s un.l Stutisti(\ \85 nl. p105. l he papef cires Whalen as an uncrcdired co-author. and was

aclually conrplcred in 2001.

'' Brueckncr. J. K.. (1003b). l he Bene llls o l Codesharinq and A nritrust lmnr un ir) for lniernal iona l Passen gcls. N ith an

Application to rhe Slar Alliarce .JouttldloJ .1n Trdnspoft lktndg4neht \9 \7. paa ' Whalen. W. T.. (200?) _A Panel Data Anallsis ofCode Sharing. Antirruslnltrunil) and Open Skics Trearies in

Internar ionr l A! iar ion Markels . Rdk,r' d r?.rr l1|i al O\ldni.at ion \i0 2007: ntost anal) s i! was conducled ) ears bc lbre

and earlier worliing papcr vcrsions included Whalen. W. T.. (:001) Corslrained CoDtracring and Quasi-Mergers: Price

Eftbcts ofCodcsharing and Antitrusr lmmunit) in Inremational A;linc Alliancei and Whalen. W. T.. (1005) -A Panel

Data Anallsis ofCode Sharjng. Antitrust lmmunir] and Open Skies lrcaries in Inremational Aviarion Markets'
Horan BAAA Supplemental Comment5 8January 2010

r All quantitative evidence of alliance pricing benefit5 quoted in these antitrust immunity cases are

baged on two regression5 of data from the 19909-8rueckner's cross-section analysis of 1999 data,

and Whalen's panel 1990-2000 data. These (and the original 2000 regre55ion5 that were superseded

the 200J work) are summdflzed rn the table below

publication data used in regression author's key findings about price

differences based on reqressions

Brueckner-Whalen

2000

3Q 97 (cross section)

international intedine

connect trips in DB 1A

45,520 trlps in

16,765 0&Ds

alliance vs. non alliance interline

24% total database

15olo total U5 behind gateway

1 5-1 8% Tran5atlantic+Central America

(8%) US-5outh Pacific

0% US south America/North asia

Brueckner-2003 3Q 99 (cross section)

international interline

connect trips in DB 1A

54,687 trips in

17,518 0&Ds

ATI v5 non alliance interline

17-31olo total database

21-2lolo Transatlantic

22Yo total uS behind gateway

non-ATl codeshare vs interline

7-10% totaldatabase

7-9% Transatlantic

5% total u5 behind qatewav

Whalen 2007 11 year panel data

1990-2000 (3Q each)

all U5-Europe connect

trips in DBl A;

120.758 couoons

17-23% online vs non alliance interline

17-20olo ATlv! non alliance interline

6-9% non-ATl codeghare vs interline

(3%) open Skies vs. non-open Skies

Brueckner, the primary author, has been a paid advocate tor United Airlines and the Star alliance

throughout the period when these pieces have been published'?l, and in addition to the Brueckner

(2003b) paper estimating star Alliance consumer benefits, has presented testimony on behalf of the

Star Alliance in the re(ent antitrust immunjty (ases."

It should be noted while he has consistently claimed that immunity generates sizeable <onsumer

benefits, each of Brueckner's papers also rais€d some concerng about possible consumer detriments

when competition is reduced in overlapping markets, and Brueckner has argued that the merger of

the previously independent KLM-Northwert and Delta'Air France groups into a single entity was

anti-competitive. Thus while Brueckner's published opinions are extremely consistent with the

public positions of United Airlines and the Star Alliance, they are not necessarily consistent with the

positions oJ other parties advocating international airline consolidation.

Brueckner's papers can and should be evaluated on their own merits. Nonetheless, there is no basis Jor

the claim by the loint Applicants and other consolidation advocates for the claim that alliance

consumer benefits have been well documented by an independent "economic literature"'zr- The

entire basis fo. the claim conskts of one article plus statistical updates, and the principal author

serves as a paid advocate for United Airlines and the Star Alliance. They should not be evaluated

any differently than the Brattle affidavit in the current cale (written by paid advocates {or Ameri.an

Airlines), or similar paid testimony in other cases.

' Moonnan. R. (2000) United Turns io Acadenics ro Show Alliances Aid Consumers ..1rtr.n,? J,'cek d,/.Spd..

Terhnoh{ \153 nll2 Ocrobcr 2000 p. 56 Bruecknef s paid advocacy rolc was not disclosed ir an} ofthese papors.

" for e\ample "An Evaluarior ofthe Skyream-wings Antirrusr Immunit_v Applicarion" submitled in docker DoT-oS I2004-1921.1and "An Evaluation ofihe Latest Srar Alliance Applicarion for Antihrst Inmunit,"" submiued in dockel DO I

OST 1005-22912. Since the AA-BA analysis in Brueckner-whalen (2000), Whalen has not published anv conrments about

any specific nrerger. consolidatioD orantitrust immunity proposal.

" The Bmftle affidavit makes rhe "has bccn wcll documented inthc economic literature" point ar p.L Anolhcf piccc wrilten

by paid advocat€s fof Amc can Airlines c laimed: "vituall] e\ery peer-re! icwcd academ ic study of immun;7ed

intematioDalliances has concluded rhat. as a resulr ofeliminaring caffiers' incentjves 10 impose successive nurkups on

larcs lor connecting tickets (rhe so called 'double marginalizaiion problem). allianccs have led lo lower firres and

expanded outpuf. Kasper and Lee. -why Aniitrusr Inrmunit] Beneiits ConsurneN" CCP Anritrusr Joumal. Sep. 1009r
Horan BArM Supplemental Comments 8 January 2010 7

B. THE ORIGINAL NORTH ATLANTIC AILIANCE5 DID CREATE SIGNIFICANT CONSUMER WELFARE SENEFIT5

BUTWELFARE GAINS DUE TO ALLIANCE PRICING WERE VERY NARROW AND THESE WELFARE B€NEFITs

WERE FULLY EXHAUSTED BY THE LATE 905

r The consumer benefits of the original North Atlantic immunized alliances (KLM Northwest in 1992,

Delta-Swissair-Sabena in 1995, United-Lufthansa-SAS in 1997) were driven by an efficiency

enhancing network innovation-the use of codesharing and joint scheduling and pricing to create

"quasi online" service in a specifi( (ategory of double (onned O&Ds that prior to 1992 had qdy

been ,erved on interline services

Prior to alliances 70% of transatlanlic demand had nonstop or true online connecting service via

one of the many large network hubs, and these online carriers offered good schedules and a

full range of discount fares; the other 30% oJ the market were required to ute interline

rervices where conne(tions were often poor, and discount fares were more limited; the

original alliances extended the schedule and pricing beneJits that had alway5 been enioyed

by passengers in 'l stop (onnect markets to parsengers inthe 2-ttop double connect markets

The table below summarizes the competitive situation ot the 19905; (ertain carriert focused on

the (ategory (1) large nonstop O&Ds eerving the largest marketr (London, New York, Chicago);

these nonstop services also provided capacity serving the category (2) l-stop markets beyond

their hubs; the new alliances had competitive advantage in the category (3) double connect

markets where the non-aligned carriers could not aompete and the only alternative was

interline connections, but they al5o carried signilicant tra{Iic in (ategory (2) l-5top markets

Mid 1990s Carrier

Competitive Advantage

by North Atlantic

Market Category

o/o of total

Trans-Atlantic

market in

these O&D5 in

1995

Did large non-aligned

carriers

(BA, CO,AA) have

Competitive

Advantaoe?

Did large

immunized alliance5

(KL-NW 5R-DL) have

Competitive

Advantaoe?

(t) Nonitop O&D'

<9areway-gareway>

30vo MAJOR

ADVANTAGE-maior

share of large nonttop

O&Ds

NOUNCOMPETITIVE

(2) Online 1-*op O&Ot

not terved by nonstops

<beyond uS-gateway EU>

<aatewav US-bevond EU>

40% Could compete but no

carrier had strong

Could compete but

no carrier had

strong advantage

(3) Double Connect O&D3

with no online service

<bevond US- bevond EIJ>

3Oo/o NOUI{COMPETITIVEMAJOR

ADVANTAG€-only

interline service

The conrumer pricino benefits oJ the new alliances was significant b!it was strictly limited to the price

reductions achieved in category (3) markets-the difference between interline prices and "online"

allian<e pricer in these spe(i{i( O&D5 that had been exclu5ively terved on an interline basis

c The new allian<eserved a significant amount of category (2) traffi(, but these passengers in

these markets already had online pricing, and thus the new alliances did not create any new

pricjl|g benefitt for these passengers; the overall groMh of these allian(es would seriously

overttate the sjze of the true pricing benetits

Allian(e pricing benefits were only a small part of the overall consumer benefits realized as a result oJ

innovation and increased competition on the North Atlantic; evidence of consum€r benefits

(sustainable lower fares/increased service due to improved industry efficiency) ir not always

evidence of alliance benelits or prjcing benefjtg

r Consumert benefited whenever profitable new capacity added, as this groMh put downward

pressure on fares; most of this capacity growth of the 909 was due to favorable overall

industry supply/conditions and was not alliance related. The graph below shows thal seat

capacity groMh during the 90s on the North Atlantic (where allian(es and codesharing were

strong) tra(ks very closely to seat capacity growth on the North Pacific (where there was no
HOranBAAA Supplementa Comments 8 January 2010 5

antitrust immunity and codesharing was extremely rare); while alllance factors rnay explain

the siightly {a!ter growth on the Atlantic, it is clear that capacity growth war {undamentally

driven by underlylng market conditions, and those conditions explain a large portion of the

pricing changes observed in the regressrons.

p.city Growth-IransAtlantlc v3 transpacili. r99O-2ix)O (nlllion. of oheway

rears DoT Tt00 data)

-r Consumer we fare was gigniflcantly increased by other non pricing factors inc uding increased

market liberalization, the originalOpen Skles treatle5, the growth of network hubs in the U5

(resLrlting from deregulation-based changes in the 80t, major improvement5 ln European

carrier euiciency (including the privatization of British Airways, and the (onsolidation of the

Air France-UTA-Air Inter hub in Parit, major improvements in distribution and other

intormation technologie5, and the widespread introduction of 767 and Al30 air(raft that

made it possible to operate a much wider range of transatlantic llight! profitab y, and

declining fuel prices. The "quari-online" alliance network innovatlon was on€ of the beneflts

of increased transatlantic competitlon, but it was a small part of the overall picture

The ability of the new alliances to generate significant consumer benefits depended on the

<onvergence of three critical factors

Aggressive market-oriented, pro-competitive policies in both Warhington and Brussels,

includinq the Department of State's efforts use of ultra-liberal Open 5kie5 treaties with

countries like the Netherlands and Switzerland to encourage less llberal countries like

Germany and France to remove traditional barriers to open entry and market pricing

. The arge, untapped, Category (3)double-connect market opportunity; priorto KLM Northwest,

no one had recognized the size of this segment (individual O&Os were extremely small and

highly fragmented); given the traffic potential, dornination of this niche became the central

focus of the KLM-Northwest's alliance.'?i The allian(e's network coverage created signifi(ant

marketing and di5tribution efficien(ies, including strong market awareness in every US and

European "beyond gateway" market that KLM-Northwest off€red a full range of flights at

competitive practices to every significantransatlantic destinatlon. The success of KLM

' I sas prrsonalh responsible tbr e\nrnding allianc. hub-ro-lnrb Uighrs lionr I ro 10. {ll 7.17s nnd DC l0s. nllor'$hich

\\ere highl) prolltrblc. a\ part ol a cd scious sr'are!\ ro e\ploit the alliance s llrsr-n)o!er !d!anlage and esubli\h a

dominant position in thi\ nich.. Th,.j l,rtcf Deltn'SwissaiFS b.nr and Lulihania t;nircd 0lliancc\ lbllo$ed rhis c\Lrcl

ncr\!ork terrrp lle. and rendcrcd No|'lh Atlanlic interline service llnost completel! obnrlete.
Horan BAAA 5upplemental Comments 8 January 2010

Northwest and the other alliances in developing this category

several DOT studies at the end of the decade.:!

. The coincidental strongly favorable supply/demand conditions that made capacity growth

profitable; the alJiances'development of secondary connect market5 would have been

significantly riskier in an environment with low demand growth and overcapacity.

r These incremental consLrmer benefits were fully exhausted by the end of the 90s; the allian(es

remained (ompetitive, but were not introducing new efficiencies or reducing prices ln any rnarkets

: ,A5 in any competitive market, the introduction of new efficiency enhanclng innovation spurs

some competitors to match the efficiency gains (via additional alliances or expanded direct

services) and forces other capacity out of the market, and interline rervice had become totally

irrelevant on the North Atlantic by 1999'?6. Alliances only create pricing benefits to the extent

they introduc€ online pricing to a market previously only served by high fare interline servi(es

. The category (3) doubl€ connect niche that drove all alliance pricing benefits also shrank

dramalically with the major expansion of new nonstops, which shifted most category (3)

O&De into online 1 stop category (2) O&D5; rnany citiet 5uch as SLC, CLE, PDX, MEM, BCN, VCE,

BHX received nonstop transatlantic serv ce for the first tirne, as did rnajor destinalions in Indla,

the Middle Eatt and Afri(a that had previo(]5ly required connections via European hubs

Allian(es are not generating any incrementalconsumer benejits in the low/negative qrowth

environment oJ the last decade; transatlantic demand growth and profitability was halted by

overexpansion in the late 90!, as (arriers assumed growth driven by the one time early-90s

innovations and the dot-com bubble would be sustainable; capacity and traffic hae only

barely returned to peak 90s levels, and mu(h oJ thi5 may have been artifi(ially supported by

the recent financial bubble.

(3) niche was documented by

CrpaclB| Growth.TranrAtl.nti< v5 Transp.cillc 199O-20Oa (mllllons of

on€way re.ts DOT TlO0 d.ia)

'US l)c|rnrlrcnt ol Trnnspornrion. olfcc ofthc Secrcl.rr\. ( l()99) lDtemari(nrirl ,^\iirriof l)c!elopnrenl\ (ilobLrl

l)e.egulflionlnkesOitUSDeprnnrenrolTransportation.OfilccoflhcSccrerar).(10001.-TransathnlicD.rcgulirlion

The Alliarclj Ncl\\ork h flcca- r"\\hilerrmrlcrscotcrinsi0ooolknnldenrand$ereonl)sd\cdb\inrerlineser\ic.striorro1991.inrerlinerrrt\

accounled ii)l -l(f.l50o oftolal Nonh rhn(ic rra\el. since $rre lr$cngers in car.gof) : nrarkers usrd inlcrlirrL irstcdd of

a!ailablc onlinc rnrrkets. The Deplnrnenr ol Justicc rrecenl a al)5is ol l008 con[eclin-q travel sho$ed (nr]\ 1", ofrh.

cotrpons irl ir\ sflnple $ere inrerline trips. \uggcsting rhat inrerline n!!cl probabl) accounrs lbr less tharr :!ro ol lhe total

Norlh Atlanlrc. See Depnrlment olJuslice. ( {rnnrenLs on thc ShoN Cause Order. DO l-( )S I-1008-0li+'0llr). f.lq'51
Horan BAAA Supplemental Comments 8 January 20 10 l0

C. THE BRUECKNER.WHALEN REGRESSION5 FUNDAMENTALLY MISREPRESENT THE HISIORICAL

CONSUMER PRICING BENEFITS FROM ALLIANCE ANTITRU5T IMMUNITY

C1. Almost all of the orice reductions the authors attribote to "coooglative alliance interline olicing" <!!

be better explained by improued upplylclcnlld (onditions artd other chanoes in the marketplalc

r B.ueckner claims that antitrust immunity reduces fare5 by 17 to 30% and that his paper "measures the

separate impacts of (odesharing and antitrust immunity on the Jares charged {or interline trip5".17

He attributes all of the observed alliance beneJits to pricing, specifically "the cooperative pri(in9 of

trips by the partners puts downward pressure on fares in the interline city pair markets."'?3 None oI

these papert are attempting to measure the overall benelits created by alliancexpansion, they are

spe(ifically attempting to measure alliance pricing benefits. While there is no quettion that

consumers benefited from lower fares in transatlantic markets in the 1990s, and thete regressions

thow a (lear correlation between "alliance prerence" and "lower lares" in connecting markets,

there is nothing in the data or analysis presented in these papers justifying the claim that

"cooperative alliance interljne pricing" behavior was the sole and ex(lusive cause oJ price shilts of

this magnitude. This is an unsubstantiated theoretical argument based on claims of structLrral

"double marginalization" barriers to elficient non-alliance pricing that will be discussed in 5ection D,

bot the regressions provide absolutely no empirical data supporting the theoretical causation claim.

I The actual primary driver of the observed pricing changes was the highly {avorable supply/demand

and competitive conditions of the mid and late 90s- As shown in the graphs in the previous section,

transatlanti. (apacity grew rapidly during this period (7.4% CAGR 1990-97,4.9Vo aAGR 1990-2000'z)

with overall strong growth in international trade and travel. some of this occurred in the hub-tohub routes serving alliance (onnect markets, but the huge increaset in nonstop and true online

connect servi(es would have had a much bigger impact on market price leveb than the increased

connecting !eruice in markets that had no online service.

r At noted earlier, there were other important non'alliance {acto15 that also contributed to the

observed price (hange5, including pricing liberalization iEurope, carrier efficiency (the expansion

of hubt terving jnter(ontinental tlights, marketing and distribution te(hnology 9ains, 757 and A330

aircraft efficienciet. and declining tuel prices.

C2. TheJegle$jon analvsis seriously overstated the correlatign attributed to "(oooerative allian(e

interline pricing" by failing to reslrict inpqt data to the marketst41belefhelqpricing benefits would have

actuallv o(aurred

I Alliance connecting fares were in fact lower than pre'alliance interline fares, and alliancexpansion

did create legitimate consumer benefitr, but Brueckner and whalen seriously overstate this benefit

by defining their data sets in a manner inconsistent with their own pricing hypotheges and

inconsistent with the actual dynami(s oJ these markets. As discussed in section B, alliance pricing

benefitt only occurred in category (3) double'aonnect markets that had only been served on an

interline basis, and did not occur when alliances served category (2) connect marketthat already

had online service and prices. All of Brueckner and Whalen's papers expliaitly assume that the

"online" pricing the existed in category (2) markets prior to alliances was fully efficient. But their

regre5sions overstate the beneJit becau5e the data in(ludes a very large number ol category (2)

connect markets.r0 Category (2) is the most competitive category of markets on the North Atlantic

since they (an be served by every network carrier and all three alliances-11 But "allian<e price levels"

- Brueckner ( l00ia ) p. | 05. Whalen (2007) mak.c thc nafio\ler. nrore appropriate c laim\ rhat .-alliances are lbuftl to hnle

significantl) lo$er prices or "are associated wiih' price benelits p.39.

" Brueckncr (200l) p.1.175

'' DOT T-100 sear capacilv dala '"-fhe rcgressions exclude carcso!- (2) haffic originaling l tJS gatcwar- cities served by Etrropcan caffier nonstops (due to

inhcrcnt limilalions in the DBIA data). but includc allothcr catcgory (2) one-stop markets '' Calegory 3 markels can only bc scNed by the three allianccs. and calegory Imarket compcliLion is a tirnction ofthc

numbcr ol caniers that choosc lo operate nonstops.
Horan BAAA Supplemental Comments 8 January 2010 ll

in the regressions are being measured by the prices in a combination of category (2) and (3) markels,

while they should have been measured solely based on the (higher) category (3) observationr.

r lnterline fares were also not properly restricted to category (3) marketr, and "interline tares" were not

defined in a way to show the actual pricing impacts. Most (if not nearly all) the interline (oupons in

Erueckner't 1999 sample were incidental trips representing a tiny fraction of total demand in each

O&D and wholly unrepresentative of any "market" price points. In 1999 almost every North Atlantic

O&D would have had actual or alliance online service-any interline travel would have represented

diversion5 due to flight cancellations or last minute emergencies or perhaps the occasional expenre

account traveler going out ot hi5 way to collect frequent flyer miles. By definition these tickets

would show a high average fare, but they are meaningless in any evaluation of possible allian(e

pri(e benefits. Srueckner's primary regressions includes interline pri(es worldwide, including

markets where all pri<es are much higher than the North Atlanti<. A legitimate attempt to ettimate

alliance price benefits would have been stridly limited to alliance verrus interline coupons in the

Nonh Atlantic O&Ds that had no true online servi(e, but none of these regressions were

appropriately foculed. Thege would have been included in Whalen's tran5atlantic panel data, but

his data also included large quantities of onrelated non-category (2) market couponrr The analysis not only failed to limit the regression data to the appropriate markets, but the papers

made no aftempt to place their "17 to 30% lower pri(e" type consumer welJare conclusiont in any

type of meaninglul context. There ir nothing in any of the papers that would help readers

understand the magnitude of the alleged (onsumer benefits relative to the 5ize ol the overall

market, or even to understand the saope ot the markets in the regression relative to the 5ize of the

market. Despite an analytical scope specilically targeting "interline" traf{ic and markets, the

autho15 made no attempt to show what portion oJ there markets actually use non-alliance interline

ticket, or what percentage of the O&Ds in the regression were only served on an interline basis, and

failed to show that these interline-only markets had almost completely disappeared by the end of

the decade. An analysir appropriately targeted at category (3) interline markets might have Jound

simila. price reductions Jollowing the introduction ot alliance online pricing, but from an economics

and policy standpoint. itis mu(h more important to understand what the actual historical consumer

wel{are gain from antilrust immunity had been, and whether there are opportunitieg Ior tuture

gains in markets that could, but do not <urrently enjoy "online pricin9".

r Any gerious, caretully designed analysir of North Atlantic competition in the 1990s would 5how a clear

correlation between the introduction and expansion of immunized allian(e and growing consumer

benefits (lower prices and increased capacity). But (orrelation does not equal causation. Not all oJ

the observed consumer benefits would have been caused by alliance5 (most were caused by capa(ity

9roMh, increasing liberalization, industry efficiency and other fadort, and not all of the observed

price reductions on alliance tickets were cauted by effi<ienciet spe(ifically related to antitrust

ammunity. A proper analysis of the Nonh Atlanti( would also show consumer benefits in general,

and specific allian(e pricing gains fully exhaurted by the end of the decade.r')

': See tbr e\ample. Rob) n. J.. Reitzes.J (2005 ) untitled paid ana l) sis of tbe Sl)team anl itrust iln m un;l\ .pp licat ion

preparcd on befialfofAmerican Airlines DOI-OST-1004- lSl IJ. Robyn. J.. Reitzes.J. (1006) ntiiled paid anal)sis ofrhe

Star Alliancc anlitrust immuniq application prepared on behalfofAmerican Airlines DOT-OST-1005-2lgll
Horan BAAA Supplemental Comments 8 January 2010 12

D, DOUBLE MARGINALIZATION DOES NOT EXI5T, NEVER EXISTEO, HA5 ABSOLUTELY NOTHING TO DO

WITH THE BENEFITS OF IMMUNIZED ALLIANCES, AND ERUECKNER AND WHALEN'5 THEORIES ABOUT

DOUELE MARGINALIZATION ARE NOT SUPPORTED BY ANY DATA OR ANALYSIS

D1. Brueckner and Whalen specificallv claim that all of their observellGgle5tlalprlce correlation5 are due

to the abilitv of coooerative oricino to eliminate "Doublel4arginalization" or "Double Markups" and that

thi5 is the orimarv consumer benefit (reated when antitlu5t jmryr!lnity aoolications are aDoroved

Brueckner and Whalent (entral "Double Marginalization" (laim ir repeated in each of their papersir.

They believe that all ol the price/alliance correlation in the regressions is (aused by a "negative

externality", a gtructural barrier that prevents non-alliance carriers from setting optimal interline

fares, even when it would be in their joint economic interest to do so. The claimed rtructural barrier

arises becaute non-aligned <arriers allegedly e5tablish "5ubfare5" (prorates) for interline travel over

their routes without any consideration of the prorate levels of connecting airline5, or any

consideration of the joint interline fares that might result from the sum of these two prorates. This

"non(ooperative pricing of an interline trip leads to an excessively high fare whi<h does not

maximize joint prolit"ia. The two interline carriers are making "two separate markups" while

immonized alliances and online carriers would only make onels, Becaute alliances can eliminate the

"double marginalization", their interline {ares are alwayg lower than non-alliance interline fares16.

Thug when Br!eckner and Whalen solve orofit maximization eouations for alliance and non-alliance

interline services, the non-alliance equation includes the effiaiency penalty of the "double

marginalization" and is always less profitable. The internalization ofthis "negative externality", i!

not just a useful teature, but ir lhg primary benefit of immunized airline alliances.3'

The alleged efficiency penalty of non-alliance "double marginalization" i5claimed to add $200 to the

price ot a roond-trip ticket. Whalen cites an average non alliance fare of $929 in one of his

regression sets versus an average immunized alliance fare ol $727.33 The idea that eliminating non

alliance "markups" would create a 25olo efficienry gain is preposterous on the Jace of it; su(h an

efficiency gain would be of the same order of magnitude of eliminating all wage and benelit

expenses.re The Joint Applicants are claiming benefits of $257 per ticket in this cate (applying the

smaller regrestion gap between alliances and existing codeshares to higher 2007 faret). l{ t200'250

per ti(ket price redudions actually o<(ured in the market every time airlines receiv€d antitrust

immunity, there would be ample evidence from multiple sourcer, and immunity advocates would

not be relying exclusively on this a(ademic paper.

D2. The entire "Double Marginalization" theory i9 based p! !!!qbrte!!!ated claim5 that normal

(qnpetitive, ratiqnql, plol!! maximizinga_efr_a_vioral assumptions!19 !ql!!dyto interline pJlcjlg. and the

theorv is fundamentallv contradicted by actoal airlile pricing practices and systems

r Brueckner and Whalen'r theory of "double marginalization" assumes phygical barriers to optimal nonalliance interline pricing that do not exist and ignore5 the existence of revenue management. The

" Brucckncr rnd Whalen (2000) p. 505'6. Brueckner (2001) p. 1J77. arucckner (200ja) p. 106. tsrucclncr (l00lb) p.8.1-85.

whalen (:001) p. 2-4. Whal€n (2005) p.24- whalen (2007) onrirs rhe bcha!ior c\planation found in all prc!ious pap€rs.

and sinpl) not€s thal lhose papers idenrified a Double Mar_qinaliTation problem. and that rhe regression anrllsis ir lhos€

Pnpers found a correspondirg price difference p.l0

" Arrrclncr (1003a) ibid-

" Brueckner. J.K.. Proost. S (1009) -Carve-ou6 Under Airline Antitrust lmmunir) CESIFO working papcr ''' Whalen (2005) p. .l sa)s lhat the double marginalization cosr probl€ onl) erists when fte two carriers ha!c marlcl

power on their respective portions oflhe roufe, and can set price abolc marginal cosi. bur Whalen (100?) deleles all

rcl-crcnccs ropricing powe.. bur offers no altcmatc c\planation for the alleged cost problcm- ' Brueckn€r (2003b) ibid. Whalen (2007) ibid. r3 Whrilcn (2003) p. 24. Orhcr.cgrcssion s€ts havc rlighrly kNcr olerall average l-ares. bul alc.age hres lbr ke) subgroups

$ere not identiflcd. I'Accordirrg to its l0-K. rvages, salafies and benefirs accounted fi)r 26% ol Anrerican Airlines'total 2008 op€fating
Horan BAAA Supplemental Comments 8 lanuary 2010 1i

assumed independent noncooperative processet with fixed (per route) mileage based prorates

(derived from IATA practices) were abandonedecade5 agoao. Even carrie15 with limited automation

were always fully capable of designing and adjurting interline faret to more profitable levels.or.

Although interline fares were not easily handled by first generation yield management tools,

interline fares are now easily linked to both (arrjer's inventory systems; prorates can vary by

booking class, so that interline farer can be revenue managed just as effectively as online

connecting {aret,

r The "double marginalization" theory al5o assumes that fares are set with reference to the marginal

cost o{ {light legs. This ignores overwhelming historical evidence that fares are set with respect to

(ompetitive "market pri(es" and not with resoect to internal cott measures. The entire claim of

"double marginali2ation" is based on "markups" above marginal co5t, but the claim falls apart

because real world airlines do not construct price5 on a "cost plus markup" basis, and do not

evaluate prices or prorates againgt marginal cost. lf prices were se1 on a markup basis with respect

to marginal cost-type measures/ one would observe wild price fluduations when tuel pricer are

volatile. lf prices were set on a markup ba5is with respect to marginal cost-type measures, one

would rarely observe pri.e matching on competitive O&Os, given underlying cost differences

between carriers, aircraft and routin95.

t Brueckner and Whalent physical barrier theory explicitly assumes that alliance interline fares will

always be lower than non-alliance interline fares, which would be irrational, and also ignores the

basic "opportunity cost" logic behind inventory management at hubs, which Jocoser on revenue

contribution/dilutiona?. (Jsing "marginal cost" logic, Brue(kner and Whalen Ialsely assume any

"hi9h" interline prorate suboptimizes joint revenue. Most KLM-Northwest alliance fares in the 90t

might have been lower than mo5t alternative interline fares, but ratjonal, profit-maximizing airlines

(alliance or other) will vary these levels based on specilic opponunity costs and marke't conditions.

Carriers with "high" proratet may be maximizing profits based on opportunity cost of connecting

traffic from other route5. Connections over hubs with capacity limitt and high localarer (London,

Tokyo, New York) will have high prorates (to limit yield dilution) regardle5s oJ whether the5e are set

on an immunized alliance arms-length codeshare or traditional interline basis. Connections over

hubs with ample (apacity and low localfares l8angkok, Amsterdam, Los Angelet are rationally set

at lower levelt. "High" prorates ;n very tiny interline markets may be entirely rationel in the sense

that the added pricing and revenue management costs needed to maximize joint traffic in each of

the thousands of these markets could easlly exceed the potential revenue gain. International

codesharing and interline prorate arrangements have always been highly dynamic, as carrierg adjust

and cancel arrangements that are not profitable.

. The Brueckner/whalen claim that there are behavioral barrie6 to optimal non'alliance prorate setting

was never true, and is in ta<t a claim that market competition does not work. They claim that nonaligned carriers are incapable oJ improving or optimizing prorate levels even in the {ace ol evidence

that existing prorates do not maximize joint revenue. Thus the theory asrumes that the classic

'Brueckner(2001)claimstharhknoncooperativeproccssisbasedonhistoricallAlApracriccs.b rlfienquoresDougrnis

(198:) Fltins OlJ CLMx!. sa) ing that (cvcn b) 1985)majorairlincsalmosr neveruscd IATA-derivrd pro.n(e fbrnrulns.

Bnreckncr (200ia) p. 108 also notes that nlost inrcrlinc fares are in l-act bascd on 'special prorare agreemcnrs that do not

fbllo$ his modelofseparate leg prorates set in istalion ofwhal interlirc p!(ners arc doing. and rotrlly conlradicrs th.

'unavoidable e\temality' claim when he adn)irs that those agreenrents ma) Iroduce fares nol much highc. than droso

observ€d under antilrusl immunil\".

" I $orled e\lensivcl) t\ irh SN B.usscls Airlines. which belrlcen 1002 and 1009 $as no. a nrembcr ofan\ alli.rnce but hrd

i5 diflercnt l)pes of inlerline agreements whh ovcr 80 airljnes. alladministered ma uall). Alla_qrcenrcnrs capable ol'

gcncrating significant tralllc llorfs trere carefully designed $ith respect ofthc competirive pricing situalion in rhe inrerlinc

O&Ds. and the local dcmand levels and patterns (time ofday, day ofweek. scasonal) on each al-lected flight leg. Profalcs

werc not lixcd by roule. but varied wiih the booking classes used. so thal partnefs nrainrained full bilit) to limir inlcrline

sdles thal would dilute )iclds. Defauh prorates were used i'r b\r-!olume cases. bul these reflecrcd rhe opportnDil\ costs

ofcapaciry'on individudl SN llights. nol dGunce based fonnulas. ' -Opponunit) cosC is uscd in irs revenue nanagement contcr\l here: rhe opporrLrnit) cost ofan) potential neN Iralllc flo$

is lhc revenue from the traffic il m ighr d isp lace: carriers wou ld a l\!a) s set proralcs fi;gher than thc opportun it) cosa le\ e lWith low load factors. lhis opportunity cost approaches zero. Actual evaluations $ould be bascd on a range of lhclon.

including seasonality and how revenre manag€ment sr'stenrs aclually allot irvenrory to differenlare caregorics.
Horan BAAA Supplemental Comments 8 January 2010 l.l

modek ol dynamicompetitive markets that apply well to every other (ategory of airline prjcing

suddenly break down at the door ol the int€rline pricing department.

E Thi5 behavioral theory oJ competitive market failure rests upon the unsubstantiated assertion

that at all non alliance airlines, the process oJ establishing le9 prorates is completely isolated

Irom any consideration orpublication of joint interline fares. "Neither carrier considers what

effect setting a high prorate would have on the other"ar The aulhors explicitly assume that

online fare setting is efficient, which implies they believe thet online fare setting Iollowt

rataonal profit maximizing (riteria, and is rapidly adjusted in the tace oI new information

about the marketpla<e. However they offer no explanation ol why rational, protitmaximjzing logic cannol be applied to interline pricing

: Hub complexity cannothe source of the alleged structural problem; every large international

carrier operates hubs, and its pricing 5taffs understand the process of prorating thru fares

across connecting hub5, and how prorate formula5 affect the pro{itability oI the varioLrs longhaul and short-haul legs at the hub. Thus they would have a very strong unde.standing of

how any given prorates or joint fares would affed the protitability of a potential interline

partner, and could negotiate joint fares within ranges that would be profitable for both

carriers. Information cannot be a serious issue; thanks to highly sophisticated yield

management and route profitability systems, airline staffs have detailed information about

leg contribution5, can establish the "opportunity co5t" oJ any potential new revenue {lows.

and can readily understand how other airliner would value these interline opportunitie5.44

. Brueckner and Whalen's theory oI strudural barriers (au5in9 competitive market failure cannot be

accepted without substantial real-world examples of carriers refusing to introduce or adiust

prorates to leveh that would increase total revenue contribution. At noted above, the existence of

interline fares that are higher than online or alliance fareg does not demonstrate suboptimality, as

there could be many rational reasons {or maintaining "high" prorater in there ca5es. The inability of

airlines to agree on joint interline {ares is also not evidence ol irational suboptimalilty, as there are

many cases where there is no jointly benefjcial solution.

:: Whalen's analysis illustrates that interline negotiations normally only have a limited set of

jointly beneficial solutions. He presents a detailed (omparison oJ hypotheticalalliance and

non-alliance interline negotiations,howing the full range ol posrible prorate5 that would be

profitable for both carriers,a5 In Whalen's example there i5 a narrowerange of golutions

beneficial to both (arriers in the non-alliance case because of the rtructural "double

marginalization" costs he has assumed, but a timilar retult would hold iI the assumed higher

(osts were due to higher "opportunity corts" ol displa<ing high yield traffic, and there would

(ertainly be cases where "opportunity (ost" differentialr lead to higher allian(e versus nonalliance prorates, lrrational guboptimization would only occur il there was a consastent

pattern where non-alliance (arrierr failed to achieve recognized opportunities beneficial to

both carriers existed, consistently reducing their own proJits. His example assumes price in the

interline O&D is 3-4 times greater than cost, while in the real world airlines evaluate trafJic

options with only ra2or-thin margin. In that world the opportunities to improve joint profits

vla lower prorates would be rare, and it would be entirely rational to turn down moet

reouestt to lower ororates.

'' Whalen (2003) p.3. In certain situations. caricrs might r{tionally set deiirult pnrroles in isolatnri, brred otr the

opporluniry costs on Li routc. tJSAirways nrishl have a delhult prorate avaihblc lbr ils midda) Los Angcles-l.as Vcgas

flight alailablc to lranspacilicarfiers wirh morning affivrls al l.os Angeles interestcd in selling rhe conncclion. and given

nrodern reveDue managefiert systenrs lhis dclbull prorale nrighl be ven closc to an optimal lelcl. But fie _doublc

mar-qinalization lheor-l 5pccificall) c laims lhar USAinva) s \\'ou ld refuse ro aher rhis prodc. elcn if a tran spac ific carrier

proposed an altcmalive lhat \forld bc morc prcfirable for USAir$a)s-

" Ihe aurhors nrake passing reterence ro -double marginalization inrhe literarurc un negoriarion \!hhin lcrticaI indusnics.

but this is largely focused on hrms lhat have ver) Iimited inlbrnration about thc costs. internal operations and proutabilit)

ofconrpe(ilors. conditions rhat do not apply to aviation. Ironically. the authors apply the low-conrperiti!c inf-oflnation

concept ol ndoubie nrarginalization lo an analysis based on DBIA. a comprebensivc dalabase that providcs conrpetitors

$ith ncar-perfecr jnlbnnaiion abour pricillg in everv significant nrarker.

" \!halen (200i) p. l.l-15 and Figures l.: p.35
Horan BAAA Supplemental Comments 8 January 2010 t5

r . There has been no research showing that any carriers currently set interline prorates or joint interllne

prices {ollowing the approaches theorized. None of the hundreds of non-aligned airline5 in the

world seem to think that "double marginalization" exists, 5ince none of them have undertaken any

efforts to minimize or overcome the huge ($200 250 per ticket) competitive pricing disadvantage it

is alleged to createD3-Ihq!0!rkeI!5!!c B4ecknef ard \&halqr bavci lpropldy atldbutedlailrullq4l barrlq! ?aO

"Doublc l4arqLoaljzeljall Lbe readilycrplailcllbLfallqrs unrelated tq antitl!'Lh[qnity

r Brueckner and Whalent pape15 have totally mischaracterized theactual nature of the etJiciencies

achieved by the orlginal 9Os North Atlantic alliances. As discussed in section B, real consumer_

welfare enhancing benefits were created, but they were strictly of {unction of the unusual

opportunity presented by the category (3) double-connect markets. There was not only the "online

vs. interline" price benefit, but more importantly, there was the marketing/distribution ef{iciency

opportunity created by the large size of the category (3) niche. The size ot the market. comblned

with the size of the KLM-Northwest priclng advantage created the opportunlty to quickly and

cheaply establish powerful brand awareness among frequentravelers and travel agents in all of

these many non-gateway cities. KLM-Northwest had no etJiciencies allowing them to determine

profit-maximizing levels oJ connecting fares any better than codesharing or non_aligned carriers

on initially entering the large set oJ category (3) double-connect markets, they did exploit brand

marketing efficiencies, but these were the same e{{iciencies any hub network operator would enjoy

against point-to'point competitors46, and were not a unique Jrlnction of antitrust lmmunity

r To the extent that there was a historical obstacle imiting the spread of interline fares, it had nothlng

to do wjth alliances, but was due to the major economi( differences between thorthaul and

longhaul flights. Prorate tormulas-the 1960's IATA formulas, the {ormulas currently u5ed in every

carrier's pricing and route profitability systems, and everything in between-all attempt to reflect

the nonlinear relationship of operating costs and length o{ haul. Unit costs accelerate rapidly with

shorter flights, more rapidly than unit revenues do in the vast majority ot markett Prior to

deregulation, the CAB imposed pricing formulas that did not reflecthe underlying cost curves,

creatjng structural profitability problems tor local service carriers, and artiJicial advantages for trunk

carriers operating longhaol routes. The problem can be seen today within the route profitabillty

reports of hub operators, most c early at large European hubs like Amsterdam or Frankfurt that

have a di5tinct mix of short 60-90 minute flights, and longhaul intercontlnental flights, where

shorthaul Jlights carrying significant connecting traffic will appear very unprofitable, while the

longhaul connecting flights appear highly profitable.o'The obstacle here is that it ls extremely

dillicult to find jointly beneficialjoint fares in longhaul'shorthaul situatlons, where the very low

shorthaul prorate will rarely approach the opportunity cost ot alternative local or short haul

connecting traflic. KLM-Northwest and the subsequent North Atlantic alliances did not break

through this barrier because of an ability to internalize "double markups" as Brueckner and Whalen

claim, but because the North Atlantic alliances, by pure happenstance, paired partners with highly

parallel networks. In each.ase partners had equivalent longhaul operations and equivalent

shorthaul feedinq flights, so there was no "big prorate v5. small prorate" or other type o{ structural

imbalance. Desoite the Droven success ofthe North Atlanti( alliances, this model has not been

r" The illirial KLM-Nonhwesr rersus inrerline conrpcrition \vas analogous to a niew hub enlcring nlarkets prc!iousl] served

by ftagmented point-ro-poi flights.

I'ln one ofthe firsr KLM-Noiht!esr alliance rexvork nreetirgs 1 allended. we rlofked with our KLM coufterparts to sho$

then llut the Alllsterdanr-Hcalhrorv roule was nol the biggesl money losing foutc on their s)stenl. and \\h) the ctrlbacks

rher were planning \lould bc highl) damaging ro profitabilit). l hcir lleatlrro\! route P&L accounting dala $ as accurate.

buL did nor sho\r.the value of longhaul connccting .evenue that would be lost ifflights were cut. Sevcral )eaIS late.. lrlter

revie$ ing sim ilar rmrc P& L dala. Sabena d id eliminale ils anBscls-l learh Iow .oute. reduc ing pro fitabilit] b] tcDs o I

millions ofUS dollars.
Horan BAAA Supplemental Comments 8 January 2010 16

duplicated in any other market, because the parallel markets needed to enrure mutual benefits and

to facilitate cooperation between independent companie5 doer not exist.aB

In the environment of the 1990s, KLM Northwest would have never been able to stumble onto

and figure out how to exploit this market opportunity without antitrust immunity,"" but

effective, efficient prorate and revenue sharing approaches {or these types of parallel

alliances are now well understood, and co!rld now be applied without immunity 50

Codesharing at hubs between mainline and regional carriers further illustrates the longhaul

shorthaul prorate imbalance issues, and disproves the claim that productive international

allian(es are impossible without full antitrust immunity. No regional operator could exist

without extensive revenue and network integration with the mainline partner. This can be

solved with common owner5hip (as with American Airlinee and American Eagle), but thi5

approach has rnany disadvantages and is now exceptional, and airlines have devlsed a range

of contract structures that can allocate market and financial risks in different ways.

D4. Anticipatino the Joint Aoolilant's u5e of their regressi9I1 results in tXe (!tlc{L!ale-gMlkler and

Whalen use their Jegressiot coefficients to predict consumer beneJits in other. unrelated m4ke!!-b4 lLq

so in Ways that violate the basic looic of their "Double Maloinalization theorv

Brue(kner and Whalen's theory 5ay5 that consumer benefits Jrom collusive alliance pri(es will occur

totally independent of market and competitive conditions, because every interline Jare in every

market suffe15 trom the same structural "double marginalization" cost problem, and thu5 any

immunity grant will internalize the problem, and will directly lead to lower farer. In line wlth the

presumed universal truth of this "immunity always lower fares 17-3070 " claim, thelr papers provide

two examples using their regression coefficientso predi(t future price changes in other markets

The Brueckner-Whalen (2000) analysis of a potential British Airways-American Airlines alliance

took the 25% price/alliance correlation found in the original regression and then 5implistically

claiming that the fare on every BA-AA interline itinerary would immediately fall 25% as soon

as immunily was granted, creating a direct annual consumer welfare gajn between $48 and

'b5 mllron-.

L Brueckner (2003b) applies the same simplistic approach in reverse, takhg a 27% "benefit" rate

Jrom the later regressions, and then claiming that if the United'Lufthansa'SAs alliance

suddenly lost its antitrust immunity, its interline fares woLrld immediately rise 27%, leading

(after knock-on effects) to a consumer welfare loss on the order of $80 million annually.

Applying coefJicients {rom the5e regressions to future cases in di{{erent markets is only plausible if

oneacceptsthatnoneoflheregressioncorrelationswereexplalnedbyl990smarketconditionsand

one accepts the Jull logic of the structural barriers/double marginalization theory, but even under

these dubious conditjons, the forecasting ose o{ the coefficients in these papers violated the logic of

that theory.

'" lor c\amplc. ahypothetical innunized alliance bcrwccn l.ufthansa and Thai Ainlays would offer'l'hai nearl) 100

importanl conncclins destilalions befond Lutihansa s htrb. btrl Thai only operales nhandtul ofroures at its Bangkok hub

\fhefe LLrfthansa- l hai alliance conncctions rlould be meaninglully conpetirive. Undcf a Kl-M-Nonh$est revenue sharing

approach. even wjlh oretal ncurralit). Lufthansa $ould be saddled with a dispropo(ionaro drarc ol-ldv !.r1tre shonhaul

prorates. which might oor onl) displacc high l-afe intra'Fufopean short haultassengcA. but loDghaulpassengers tlral

Lulihansa could have caried on ils o$n longharl llights. Wilh toda\'s s\stcms. a iointl) prolit improvirrg s)stem could

certainly be designed. bur evcn in lhe absence ofany regulatory or antirrust issLres. the net gairs mighl ot i1l\rit),lhe

reouired investmenr.

" Aq \tith nlost etficienc) elrllancing innolaLions. the imponance ofluck and thc lack ol prior rnderstandirg ofthe n ue

opportunit) cannot be ovcrstated.

"'For discussions ofapproachcs see Gellman Research Associares (1991) A Siud) ollntemational Aiflirc Codc Sharing.

Department ofTransponarion Office ofAviation and lnternational Econo ics 'ThedaiapresenledinthepaperisfronrheDOTDBlArenpercenrsample.andrnusrbenrultipliedb)lentupru

tulleslimaredmarkeiplaceimpact.NoneofwhalenslyritingsaftertheBA-AAanal)sisintheorignralioinr2000paper

regression resulis as predictive ofimpacts nr other markets
Horan BAAA Supplemental Comments 8 January 2010 t7

. The BA-AA forecast erroneously assumes that every current BA-AA interline ticket is sold in a

markethat has no existing online or alliance interline service. In fact Brueckner and Whalen

made no effort to determjne what markets these passengers flew in, or whether they were

even paying higher fares than passengers in other connecting market5 were paying. Given the

broad market coverage o{ the existing KtM'Northwest, Delta Swissair'Sabena and united

Lufthansa SAS alliances at the time this was written, it is sate to assume that the vast majority

of this traffic, perhaps over 90% was in markets that already had the benefit on online or

alliance pricing, and the (laim that allthese BA-AA inlerline tickets were sold at rates 25%

higher than ones in comparable alliance and online markets is wildly implaurible.

- The Star Allian(e calculations assume that it the alliance lost immunity, none ot its (urrent

passengers could find equivalent fares on other alliances or online carrjers, and that United,

Lufthanrand SA5, after six years of immunized cooperation. They would not only be totally

incapable of establishing any type oJ alternate codesharing arrangement, but since they

would have reverted to "double maximization" practices, they would be establishing leg

prorates with markups over marginal costs, wo!ld do in asolation ofthe pricing situation on

any interline market, and would refure to (onsider any proposalt from their former partners

to alter these proratet to levels that would increase joint profits. Brueckner also cal(ulated

transatlantic consumer impads using the 27% factor from his worldwide regression, instead

of the 21olo fador from his transatlanti( regre5tions, 5Lr99estin9 this analysis may best be

viewed as corporate advocacy, and not 5erious academic tesearch.

D5. Brueckner?ndl /halen clairn thet.'lPguble Marginalization" is a rtructural i$ue inherent to alliances.

and that anv and all new immunltyjlallls-tryould create sjmil?r consuOer gaint (dlre to the

internalization of these barriers) is fuld!rnedeXylate-ald is contjadiqlCllby all available_Cyiden(e

. The Joinl Applicants'claim ofpublic benefits in connecting markets totally dependt on the claim that

"double marginalization" not only exists, but would have the powerful effect on (onsumer pri(eJ

(17'307o reductions, t200'250 per ticket) any and every time a new g.ant of immunity was made,

regardless otsupply or competitive conditions in the specitically affected marketr at the time of the

immunity grant. Neither the Joint Applications inthis case, or any prior applicantt for antitrurt

immunity, have 5ubmitted any proper, veriliable, non'speculative evidence oJ this alleged universal

causal link between immunity and lower connecting tares ercept tor (itations of the

BruecknerMhalen articles discussed here. All other availablevidence directly contradictshe Joint

Appli(ant5'claims.

. In order to claim that the Srue.kner^r'r'halen regression coefficient5 can be osed to predict price effects

jn other, unrelated, markets, one must demonstrate that their regrelsion' were able to surgically

isolate the "cooperative alliance pricing" impact on interline prices from all other marketplace

Iactors influencing these fares, including rupply levels, efficiency improvements. and the general

level of fares in the 70-95olo of all market5 retued bv true online servicer. This woLrld be an

astounding statistical caim, but it :s not supported by any analysis showing similar price effects in

any post-1999 markets, and it ir not sl.rpported by analysis putting the allian(e impacts in the

context o{ the broader North Atlantic consumer pri(ing gains that occurreduring the mid 90sE l{ one is to argue that these regression perfectly isolated the impact of "cooperative alliance

pricing" from all other possible factors, then one must be willing to argue that the consumer

beneJits actually enjoyed by KLM-Northwest and Delta-Swirsair parrengerr in the 90s, was not

the 17-30olo, or $200 per ticket identified here, but a substantially greater number. One must

concludeither that these immunity grants were the single most economically beneficial

decision in the history of aviation, or that the "double marginalization" coeffi(ients cannot

be used in forecasts.

c lf immunity grants really did drive these huge (17-30%, S2O0 250 per ticket) type of price

reduclion5 under any market condition, there would be ample evidence, in DB lA and other

industry databases, that one could use to supporthe claim. Neither the Joint Applicants, nor

anyone else, has produced any su.h evidence.
Horan BAAA Supplemental Comments 8 lanuary 2010 l8

I Neither Brueckner, Whalen, or anyone else has replicated these "17-30%" type resul$ in any

regressions of any other markets. The analysis that has been conducted shows ab5olutely no

evidence of "market-independent (ooperative alliance pricing" consumer benefits, and tends to

supporthe (laim that consumer benefits, i'f they exi5t, are not large enough to offsethe consumer

welfare losses due to reduced competition.

E lames Reitzet and Dorothy Robyn oJ the Brattle Group, the authors of the Brattle affidavit in

this loint Application, al5o submitted analysi5 on behalf oJ American Airlines in the Star I and

Skyteam I cases.sz These affidavits updated analysis of transatlantic market growth since the

initial introduction of antitrust immonity that had been performed by the DOT in 1999 and

2000.5r The new analysis found that the pro-con5umer pi(ing trends of the 1990s had been

reversed, and that the greatest 1999'2005 price increased had come in the connect markets

predominately served by carriers with antitrust immunity. Price5 had increased 21olo across the

entire North Atlanti( (CAGR 3.5%) and 23olo in category 3 double connect ma.kets, despite

flat capa(ity. Thir suggested that whatever efficiency/consumer benefits had been generated

by the original alliances had been short-lived, and had been {ully offset by increased pricing

power. lt also suggested that the later Star Alliance immunity grants did not have the " 17 to

30%" level effeds that the earlier alliances were alleged to have, and had no impact after

1999.

r In the Continental/star Alliance care, The Department of Justice presented original rtatigtical

analysit of price differences in connecting North Atlantic markets based on DB 1A data from

2005 through 2008.54 The regults directly contradicted claims of "double marginalization" and

immunity e{ficiencies. Interline ti(kets only comprised 7% ot the total rample, suggesting that

interline only accounted {or 3'4% of total No.th Atlanti( travel. The analysis found that

immunized alliance fares were 2.1% higher than online fares and 3.6olo higher than nonimmunized codeshare farer. This contradicted the claim that immunized fares would be lower

than non-immunized codeshare {ares because of "double marginalization" problems, and

lent {urther supporto con(erns that the immunized alliances had developed market power

and were not maximizing conSumer welfare.

:r In the current case the Department of Justice conducted lurther new analysis o{ conneding

market fares based on 3Q2008 DBlA data, with results further broken down by alliance

group.ss This (onfirmed the earlier con(lusion that current market data did not support claims

about "double marginalization" and immunity efficiencies, and the DOI spe(iJically noted

that they "make no representation that fare dilterences across ticketr, as estimated by this

type oJ work, are intormative about causality between immunity grants and double

marginalization"- The results Jound that Oneworld codeshare lares were 1.50loess than

Oneworld member onl:ne lares, undermining the Applicants claim that immunity is needed to

reduae artilicially hjgh non-immunized fares. The results also {ound that Skyteam immuni2ed

lares\\ete7.2Va higherthan Skyteam non-immLrnized {ares and that Star immunized fares

were 11.7olo higher than Star codeshare Jares.

. The argument "(onsumers benefit from international <ollusive pricing arrangements" isexplicitly

saying "consumers benefit whenever international (ompetition is eliminated". lfthis were rrue, it

would require rethinking a great deal o{ antitru5t and industrial organization theory. But if each

new immunized alliance actually generated price cuts on the order of l7-30%, or t200-250 a ticket,

then the rethinking would undoubtedly be worthwhile.

r All oJ the available evidence suggests that lhe two BruecknerAVhalen rgressions failed to surgi<ally

isolate "cooperative alliance" pricing effects in connecting markets from the many other factors

influencing these prices. The observed correlations between "17-30% price reduction5" and

"alliances" is not explained by "the internalization oJ double markups" which does not happen.

The correlations are likely to be largely, if not fully explained by the marketplace changes described

in section B, including strong, profitable capacity growth, market liberalization, and ef{icien.y

:: Rob)n. J.. Reiucs.J. (1005) and. (1006) op. cir.

" DOT. orJ.cit

" Dcpannrm ol-Justice. Conrmenrs on rhe Sho\ Cause Order. p..19-51

" Comncnts ol-rhc Depanmcnl ofJusrice. p.ll-.I
Horan EAAA Supplemental Comments 8 lanuary 2010 l9

growth. The original antitrust immunity grants undoubtedly contributed to thete overall effects in

the mid 90s, but specific alliance pricing benefits would have been limited to one seqment of the

markets, and would have been fully exhausted by the late 90s, as "online" schedule and pricing

optionr expanded from 60 70% to nearly 100% of the market.

r Since there ir no demonstrated "universal market,independent <ooperative allian(e pricing" impacl, it

i5 totally inappropriate to apply the coefficients of these two regressions to any other markets with

different supply or competitive characteristics. The Joint Applicantr are tpeciJi(ally claiming thar

regressions refle<ting the highly competitive, strongly profitable, high demand growth 1990r North

Atlantic can be used to predict price effects in 2010. This is the equivalent of saying that an analysi5

of the price impa(t of new low cost carrier entry onto markets tolely served by Legacy carrie15 inthe

1990s can be ueed to predict the price impact of the entry of a low (oit carrier onto a market

already s€rved by other low cost carriers in 2010, when the pricing and efficienry 9ap between low

cost and Legacy carriers was substantially smaller than it had been. This is the equivalent ot saying

that an analysis o{ the price appre(iation of Las Vegas housing in the 1990s can be used to predict

the exact level of hou5ing appreciation in 2010. The loint Appli(ants' use oJ these regressions to

torecast future priae reductions is completely indefensible and the consumer beneJit claims based

on tho5e "predictions" must be rejected.

E, THE JOINT APPLJCANTS' CLAIMS OF $92 MILLION IN ANNUAL PUBLIC BENEFITS IN CONNECT MARKETS

IV]UST BE REJECTED, IT NOT ONLY FAILS TO MEET THE MINIMIMUM REOUIREMENTS OF THE HORIZONTAL

MERGER 6UIDETINES, BUT THE CLAII\4 I5 DEMONSTRABLY FATsE.

El-Jhe .loint Aooli<ant's Claim 01t92 millioO il aMalpubli( benefits in connect Darkets is er'!tirely

b!!ed on two demonstrably talse.as5umptions. and thutmust be reiected iLil! elljrety.

. The Joint Appli(ant's public benefit claim depends on the false assumption that there are structural

"Double Marginalization" barriers to efficient non-alliance pricing that would be found in any and all

non-alliance cases a5 these barriers are indeoendent o{ market or comoetitive conditions.

n There have never been seriout structural or behavior barriers preventing non-immunized

carriers from setting rational, profit maximi2ing interline fare levels; carriers do not set

prorates in total irolation of interline markets and partners as the "double marginalization"

theory attumes, and do not refuse to (onsider more jointly beneficial alternative prorates

: "Double markups" never exitted be(ause airlines never price on a "(ost plus markup" basis;

I The general claim that "high" interline prorates are evidence ot structural barriers be<ause they

are inherently suboptimal is false; there are many examples o{ rationally higher prorates, and

the theory i5 not based on any actual examples of irrationally suboptimal pri(ing;

Effi(ient interline pri.ing can be managed at small airlines with limited automation, and i5 easily

managed via fate mapping at any carrier uSing modern r€venue management tools;

o Themarketinget{iciencyoftheoriginal l990sNorthAtlanticallianceshadnothingtodowith

pricing; the actual brand awareness and distribution efficiencie5 achieved are found in any

"hub network versus point-to-point" situation and were not uniquely caused by antitrust

rmmunrty

: Historical limitations to more widespread interline pricing had nothing to do with the lack of

alliances or antitrust immunity but was due to the inherent difficulty of establishing jointly

profitable interline fare5 between longhaul and shorthau operators.

r None of the statisticalnalysig in the Brueckner and Whalen paperr demonstrates the existence

of "double marginalization" orany related structural barriers or supports the claim that it is

the tau5e of higher non alliance prices; there is ab5olutely no empiri<al evidence that the

theorized structural barriers to efficient interline pricing adually exist.

The Joint Applicant's public benefit claim depends on the {alse assumption that non-immunized

interline fares are always higher than immunized alliance and online connectinq fares in all
Horan EAAA Supplemental Comments 8 lanuary 2010 20

situations, regardlegs of market or (ompetitive (onditions, and that these higher non immunized

fares would immediately fall to the lower immunized/online level upon grant of immunity

! The only legitimate historical cate of consumer pricing benelits from immunity occurred in the

1990s in a specific range ol double-connect North Atlantic markets that had no online service,

where new alliances prices were subitantially lower than the previously available interline

pri(es; this benefit is only possible in cases where new allian(e servi(e enterr an O&D solely

served on an online basir; "interline-only" O&Dr had been almost completely eliminated on

the North Atlantic by 1999, and thus it would not be possible for any new alliance to achieve

material pricing benefits from thi5 5ource.

- Brueckner and Whalen's regression correlation5 between "alliances" and "lower prices" vastly

overstate the claimed alliance pricing benefit, as their regressions were not properly restricted

to the double-connect, interline-only markets and included many markets that already had

online pricing. There were major consumer benefits realized on the North Atlantic following

the introduction of alliances in the mid 90s, but most were due to non-alliance Jactors

including prolitable capacity growth and hub expansion, market liberalization, increased

carrier efficiencies due to fleet and technology improvements, and lower fuel pricer. The

consumer benefils due to alliance pricing in previously interline-only markets had been fully

exhausted by the end of the decade, and all ol the available empirical evidence shows that

the consumer welfare impact of antitru5t immunity grant' since 1999 has been negative.

- The loint Applicant's' provided no evidence that their current non-immunized code5hare and

interline fares in any given market are higher than competitive online and alliance fares,

much less evidence showing that they are 17.45% higher as their testimony claims; Neither

the Joint Application or the Brue(kner and Whalen pri(ing theories are 5upported by any

empirical evidence that non-immunized carriers publish higher fareg than online and alliance

carriers in any given market, and the claims of structurally higher non-immunized fares would

contradict all hirtori(al evidence that airlines with comparable products cannot sustain higher

than "market" tares in (omoetitive O&Dt.

, The Joint Applicants'claim that non-alliance fares are structurally higher than alliance lare5 is

based on the false assumption that all of these competitors sel farer on a markup basis

relative to a marginal cort-type rneasure; iJthir were troe, airline {arer would fluctuate wildly

with volatile input costs such a5 fuel. lf a given interline fare was rationally pro{it maximizing

prior to an immunity grant, it would irrational to reduce it after an immunity grant. Since

there is no evidence that currentarer are irrationally set above profit-maximizing levels,

there is no reason to believe that an immunity granl would systematically reduce fares.

There is no empirical evidence oJ any fare reductions dire(tly attributable to any antitrust

immunity grant in the last decade, and certainly no evidence of {are reductions of the 17-30%,

$200'250 per ticket magnitude suggested by the "dooble marginalization" theory and

claimed by the.Joint Applicants.

: 5ince the Brueckner and Whalen theories and regressions do not justify the "universal marketindependent cooperative allian(e pri(in9" impacts.laimed by the loint Applicants, there is no

basir {or using (oefficientg from those regressions athe basis of predi(ting such alliance

pricing impacts in today's market.

E2. Theloint ABpli<nitl-.Clqltr 9i$92 mr!!!o!ln a04ual publi. benefite comoletely fails to meet t[e

qvideltljarylle]]d?Ids of the Horizontal Meroer Guid_e_!j!C|!Id mq5lbqlejected in itr edlgl!

r The Joint Applicants have failed to provide proper, veriliable, non-speculative evidence that the

claimed structural "double marginalization" barriers to efficjency actually exirt

,: The (ited Brueckner and Whalen "double marginalization" theories do not constitute legitimate

evidence ot actual barriers to ajrline elficiency

E The cited Brueckner and Whalen "double marginalization" theories are not sLrpported by their

own empjrical evidence or any other independent analysis 5howing systematic barrier5 to
Horan BAAA Supplemental Comments 8 January 2010 2l

non immunity pricing efficiency, all of the assumptiong underlying the theory can be plausibly

challenged, and there are highly plausible alternate explanationr for all oI the evidence they

cite in support of their theory

E The credibility of the theory must be questioned further given Brue(kner's longstanding role as

a paid advocate for another airline with similar interests in reduced competition among

international airlines

: The Joint Applicants'failed to provide any other eviden(e tupporting thejr "double

marginalization" claim.

. The Joint Applicants have failed to provide proper, verifiable, non-spe(ulative evidence that the

proposed immunity grant would lower prices in the spe(ific markets served by the applicants, under

current market Conditions.

E The loint Applicants provided no evidence that the (urrent interline pricing functjons of Eritish

Airways, American Airlines, Finnair, lberia or Royal Jordanian actually suffer from any of the

structural inefticiencies implied by the "double marginalization" claim

c The Joint Applicants provided no evidence that their current interline pricing is currently above

online or altiance levels in the markets where it currently provides service

. The.loint Applicants provided no evidence ol any specitic (onsumer-welfare enhancing pri(e

redu<tions it would make in any market it currently server following a grant of immunity, and

no evidence that these merger-specific changes would create 992 million in annual publi(

benetits.

r At has already been shown in the (omments of the Depa.tment of Jurticet5, the loint Appiicants

provide no proper, verifiable, non-speculative eviden<e that it would be unable to provide the

alleged consumer pricing benefits in the abtence ol a grant ot immunity, although this point is

mooted by the lack of evidence tor the alleged consumer pricing benefits.

r A5 the DOT has acknowledged on many occasions, the law placer the burden of proof on the carriers

requesting exemption from the antitrust laws; this burden has clearly not been met.

Reipect{ully submitted,

7t a xt*-

Hubert Horan

S lanuary 2010

'" UOI cornnrents. DOT-OST,2008-0252-3i?4 p. 22-28
CERTIFICATE OFSERVICE

I hereby certily that I have thi5 date served the foregoing document on the persons

identified below by causing a copy to be sent by electronic mail

anbird@fedex.com

andrew,forman@cwt.com

anita.mosner@hklaw.com

aserranzana@geclaw,com

benjamin.slocum@usairwayt.com

bill@mietuslaw.<om

bkeiner@crowell.(om

blabow@omm.com

bob.kneisley@wnco.com

bruce.rabinovitz@wilmerhale.com

byerlyjr@rtate.9ov

(arl.nelson@aa.com

cdonley@ssd.com

cgosain@steptoe.com

(jsimpson@zsrlaw.(om

cwilson@omm-com

david.heffernan@wilmerhale.com

d{isher@kelleydrye.com

dhainba(h@ggh-airlaw.com

diarmuid.ryan@hammonds.com

dkirstein@yklaw.(om

donna.kooperstein@usdoj.gov

dvaughan@kelleydrye.com

dwight.moore@ustranscom.mil

ebailey@wileyrein.com

efaberman@wileyrein.com

gmurphy@(rowell.com

howard kass@u5airways.com

james.garzia@apgnet.com

jashetaylor@gibsondunn.(om

jeff.o9ar@aa.com

jeflrey.manley@united.com

jenniler.tro(k@pillsburylaw.com

jhill@dlalaw.com

jill.ptacek@usdoj.gov

jim.ballough@faa.gov

jrichard5on@johnlrichardson.com

julie.oettinger@united.com

jyoung@yklaw.com

karine.laden@freshf ields.com

kevin.montgomery@polaraircargo.com

kohstantinos.adamantopoulos@hammonds com

kquinn@pillsburylaw.com

lachter@starpower.net

leslie.abbott@wn(o.com

lhalloway@crowell-com

libowd@snllcrom.com

mamaila@airfaance.,fr

mchopra@jamhoff.com

mcmillin@woa.com

mgerchick@gerchickmurPhY.com

mgoldman@sqbdc.com

mholland@condonlaw.(om

mroller@rollerbauer-com

mroSia@crowell-com

msini(k@ssd.com

npeteGon@wileyrein.com

paul.jasinski@ba.(om

paul.yde@f reshf ield5.com

peter.irvine@dot.gov

pmurphy@gerchickmurPhY.(om

pmurphy@lopmurPhY.com

prrizzi@hhlaw.(om

pruden@asta.org

rbkeiner@crowell.com

rclayman@geclaw.com

recohn@hhlaw.com

rick.rule@cwt.com

robert.land@jetblue.(om

rrilverberg@sgbdc.com

russell.bailey@alpa.org

sametta-c.barnett@delta.com

sami.sarelius@Iinnair.fi

sascha.vanderbellen@delta.com

scott.mcclain@delta.com

sllunsford@fedex.com

sophy.chen@hklaw.com

thomas.bolling@aoair.com

tmuriS@omm.com

todd.homan@dot.9ov

wkaras@steptoe.com

Hubert Horan

1 February 2010

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