SU PPLEMENTARY COMMENTS

JOINT APPLICATIONF DELTAIR LINES, INC., VIRGIN BLUE AIRLINES PTY LTD, VIRGIN BLUE

INTERNATIONAL AIRLINES PTY LTD D/B/A V AUSTRALIA, PACIFIC BLUE AIRLINES (NZ) LTD, PACIFIC BLUE

AIRLINES (AUST) PTY LTD Under 49 U.S.C. 5S 41308-41309 FOR APPROVAL OF AND ANTITRUST

IMMUNITY FOR ALLIANCE AGREEMENTS

DOCKET DOT-OST-2009-0155

Hubert Horan

19 October 2010

I am filing these comments as supplementary to comments submitted on 12 October DOT-OST-2009-

0155-0030 which were my initial response to the Department's Show Cause Order of 8 September filed

under DOT-OST-2009-0155-0026. These comments are being filed pursuant to the Department's Order

2010-9-18 which established a 22 October deadline for answers and objections to initial comments on

the Show Cause Order.

In addition to other legal tests, airline applications for immunity from the antitrust laws cannot be

granted unless applicants meet the section 41308(b) requirement that they prove the likelihood of

significant Public Benefits. The original Delta/Virgin applicationl identified potential Public Benefits using

the exact approaches and methodologies used by ATI applicants in the Skyteam, Star, Oneworld and USJapan Alliance cases.' In each of those cases, the Department granted immunity, and in each of those

cases the Department's decision was based on the clear, explicit ruling that the applications had fully

proven the likelihood of substantial Public Benefits as required by section 41308(b). In the Show Cause

Order, the Department reached the exact opposite conclusion, and rejected the Delta/Virgin application

on the grounds that it had "failed to show that the proposed alliance will generate sufficient Public

Benefits to justify a grant of antitrust immunity."3

In my initial commentsa, I objected to the Department's ruling and pointed out that every significant

aspect of its Public Benefits analysis in this case was inconsistent with the Public Benefits analysis in the

other four cases. My testimony laid out incompatible approaches in the area of "double marginalization"

driven pricing benefits in connecting markets, in the area of benefits from increased nonstop capacity, in

the area of benefits from increased inter-alliance competition, and in all of the other benefits (such as

cost reductions, network and frequent flyer scope expansion, revenue increases due to expanded yield

' Joint Application Of Delta Air Lines, Inc., Virgin Blue Airlines Pty Ltd, Virgin Blue International Airlines Pty Ltd

D/B/A V Australia, Pacific Blue Airlines (NZ) Ltd, Pacific Blue Airlines (Aust) Pty Ltd Under 49 U.S.C. $$ 41308-

41309 For Approval Of And Antitrust Immunity For Alliance Agreements, DOT-OST-2009-0155-0001.

'Joint Application of Alitalia-Linee Aeree Italiane S.p.A., et.ql. for approval of antitrust immunity (the "Skyteam"

case), DOT Docket OST-2007-28644); loint Application of Air Canada, The Austrian Group, British Midland

Airways Ltd., Continental Airlines, lnc., Deutsche Lufthansa AG, Polskie Linie Lotniecze Lot S.A., Scandinavian

Airlines System, Swiss International Air Lines, Ltd., TAP Air Portugal,. to Amend Order 2007-2-16 under 49

U.S.C. 8$ 41308 and 41309 so as to Approve and Confer Antitrust Immunity, (the "Star/Continental" case);

American Airlines-British Airways-lberia-Finnair-Royal Jordanian Joint Application For Antitrust Immunity (the

"Oneworld" case), Show Cause Order l3 February 2010, DOT Docket OST-2008-0252-3390, and the "US-Japan

Alliance Case" or "Japan case" which consolidated the separate antitrust immunity applications of All Nippon

Airways, Continental Airlines, Inc., United Air Lines, lnc and American Airlines and Japan Air Lines, DOT-OST20r 0-0059

3 Delta/Virgin Show Cause Order, DOT-OST-2009-0155-0026, p.l, 5,

" Horan Comments. DOT-OST-2009-0 l 55-0030
Horan, Supplemental Delta/Virgin Comments 1-9 October 2010

management system scope) ever cited by previous applicants. The DOT had not changed its decisional

standards based on new evidence or conditions, in fact the DOT falsely claimed that its "approach to this

case is consistent with past cases."s I demonstrated that all of these differences were due to

inconsistencies in the Department's analytical assumptions and approaches, and none of these

inconsistencies could possibly be explained by factual evidence or case-specific conditions. Since there is

only one law establishing the Public Benefit ATI requirement,here can only be one Public Benefits

review process consistent with the law. I argued that at least one of the Department's two utterly

inconsistent Public Benefits approaches must be inconsistent with the law. I demanded that the DOT

publically acknowledge that the Delta/Virgin Public Benefits analysis was inconsistent and incorrect, that

DOT publically affirm that there could only be one legally valid Public Benefits approach, and that DOT

publically affirm that it would not change basic decisional standards without clearly stating that it was

doing so, and without clearly defining the legal and evidentiary basis for changing those standards, and

allowing interested parties an opportunity to review and comment on the changed decisional standards.

I demanded that the Show Cause Order's objections be withdrawn, and that the original Delta/Virgin

application be approved because it clearly met all of the Department's previous, consistently applied

Public Benefits decisional standards.

On 13 October Delta and Virgin submitted comments on the Department's Show Cause Order.6 Many of

these comments simply soughto clarify or more fully explain claims made in their initial application.

However the comments included a series of totally new Public Benefits claims that were materially

different from their original claims and are materially different from claims made by any previous ATI

applicant. The applicants paid the consulting firm of Compass Lexecon to undertake a study that

purports to show tangible ATI driven consumer benefits from lower prices and increased nonstop and

connecting service. The studyT was included as an appendix to the applicants L3 October comments and

is the basis of new claims that ATI would increase the consumer welfare of US-Australia passengers by

5zl to 54 million annuallv.s

The revised Delta/Virgin application was not posted to regulations.gov until 15 October. Under the

conditions defined in Order 2010-9-18 other parties to the case had less than a week to review and

comment.

The Compass Lexecon analvsis that is the basis for the totallv new 527-54 million benefit claims appears

hiehlv dubious; althoueh Order 2010-9-L8 does not permit a fullv rieorous critique, it appears unlikelv

that these benefit claims could survive a serious. obiective review

I Delta has proven its willingness to present deliberately inappropriate and deceitful claims based on

internal planning models in past cases. The Department of Justice discovered that benefit claims

based on QS|-models in the Delta-Northwest merger that were "wildly inconsistent" with

5 Delta/Virgin Show Cause Order, p.2; case data in the table are from the US-Japan Alliance Case Show Cause

Order, pp. 13-15 and Delta/Virgin Show Cause Order, p.5-t2.

" Delta/Virgin Comments DOT-OST-2009-0155-0033

' Robert Willing, Mark Israel, Byan Keating and Jonathan Orszag, "Measuring Consumer Benefits From Antitrust

lmmunity for Delta Air Lines and Virgin Blue Carriers", paid advocacy work prepared on behalf of Delta and Virgin

Blue, DOT-OST-2009-0 155-0033, appendix. As the authors are all members of the consulting firm Compass

!-execon, this will be referred to as "the Compass Lexecon study". 8 Delta/Virgin Comments p. 2; Compass Lexecon study p. I
I

Horan, Supplemental Delta/Virgin Comments L9 October 20L0

predictions that the model actually used in the carriers' normal course of business.e Airline QSI

models are highly sensitive to coefficients reflecting the relative "quality" of alternative schedule

options (i.e. the extent to which consumers would favor online connections over ATl, codeshare

or interline connections) and the testimony presented to DOJ had been deliberately rigged to

show greater merger benefits than Delta and Northwest would have estimated in their own

internal studies. The Compass Lexecon studies makes no effort to explain the coefficients that

drove its QSI traffic estimates, and makes no effort to demonstrate that the coefficients have any

rigorous statistical basis, or are identicalto the ones that Delta routinely uses to evaluate the

impacts of competitive alliance and codesharing shifts. This data drives all of the subsequent

"consumer welfare" estimates and cannot be accepted without independent verification.

I The testimony also fails to demonstrate that results were not artificially distorted by using

the before-and-after ATI schedule scenarios that did not properly reflect changesolely

attributable to ATl. There is no way to evaluate the legitimacy of these claims with data on

the public record.

Even if Delta has not artificially manipulated model coefficients, the Compass Lexecon use of QSI

model as the foundation of its "consumer welfare" analysis appears fundamentally flawed. As the

study points out, airline QSI (or related logit) modeling of consumer choice fundamentally ignores

price.1o Compass Lexecon assumed some current Qantas and United passengers shifted to

Delta/Virgin because it assumed all passengers have a greater preference for "ATl connections"

than they do for "codeshare non-ATl connections." But in the real world this shift would only

occur if the price offered by Delta/Virgin to these incremental passengers was fully competitive

with the prices paid by highly marginal United and Qantas passengers. The applicants own

testimonyll suggests the assumption is false-DL/VA already achieve higher fares in markets

where they have competitive service so the QSI predicted share shifts might also be false. The

marginal passengers are flying United because of lower fares, and there is nothing in this analysis

to justify the claim that they would switch solely because of strong preference for ATI connections

over regular codeshare connections. The Compass Lexecon analysis also fails to address the real

world yield management issues on beyond gateway connecting flights. The QSI-predicted share

shift would not occur unless the value of the incremental Atlanta-Sydney passenger was greater

than the separate Atlanta-Los Angeles and Los Angeles-Sydney passengers that they would

displace. The QSI model explicitly ignores the possibility that the marginal new traffic might be

lower value.

The logic used by Compass Lexecon in its QS|-based "consumer welfare" calculations violated basic

laws of supply and demand. lf scheduling improvements increase demand for scarce seats on the

applicants' flights, all other things equal it should allow them to increase fares. Yet Compass

Lexecon explicitly assets, without any plausible supporting evidence, that as the applicants see

increasedemand for these seats they will sell them at lower fares. 12

' The Year in Review: Economics at the Antitrust Division, 2008-2009, Review of Industrial Organization (2009)

v35 o356

r0 Oi alternatively QSl/logit network planning tools assume that the marginal passengers predicted to switch from

one schedule option to another are paying average. and not marginal prices. This directly violated the logic of all

airline revenue management systems. Airlines using these network planning tools are fully aware of these issues,

and do not apply the tools to inappropriate cases as Compass Lexecon has done here.

" Delta/Virgin comments p. l0

'' Compass Lexecon study p.7 Under certain limited conditions the increasedemand for these seats could lead to

lower average fares, but Compass Lexecon has falsely assumed that this would automatically occur under any

conditions

T
Horan, Supplemental Delta/Virgin Comments 19 October 2010

I All of Compass Lexecon's "consumer welfare" analysis is based on flawed competitive response

assumptions. lf this application is granted, Delta and Virgin will be the only US-Australia carriers

offering "true ATl" interline connections. lf consumers actually have a strong preference for these

connections over existing Qantas-American "alliance codeshares without ATl" as its modeling

assumptions explicitly claim, then Qantas-American and others will surely apply to match these

advantages, and the "consumer welfare" gains Compass Lexecon is claiming will be wiped out.

f Compass Lexecon inappropriatelyimits its estimated "consumer welfare gain" to the QSl-estimated

traffic shift from Qantas/United flights to Delta/Virgin flights. lt has failed to demonstrate true net

positive gains across the entire market. lt does not show the offsetting Qantas/United losses, or

the losses in other Delta/Virgin markets where traffic has been displaced bythe hypothetical new

transpacific traffic.

I The quantified "consumer welfare" gains improperly conflate alleged gains from increased nonstop

service and alleged gains from gains for connecting passengers on the existing capacity base.

Nothing in the public Compass Lexecon testimony addresses the Show Cause Order concerns that

nonstop benefits cannot be accepted without clear, convincing evidence that Delta and Virgin

would increase operations above today's levels solely as a result of profitable increasedemand

generated as a direct result of immunity. These claims must be evaluated totally separately from

the "improved connection quality" claims.

I Compass Lexecon's use of price elasticity measures from a separate, totally unrelated studyl3

appears totally inappropriate. There is no basis for their assumption that estimates of average

price elasticity across the entire US domestic markets based on time series analysis would

accurately reflect elasticities for an extremely narrow category of marginal traffic (people highly

sensitive to "true ATl" versus "alliance codeshare without ATl" quality differences) in a single

international market at a single point in time where (as the Show Cause Order notes) there has

been unusually intense price competition of late.

I The regressions used by Compass Lexecon as an alternative basis for claiming ATl-driven price

benefits appear totally useless in this context. The approach appears fundamentally flawed, and

there is no basis for the claim that the coefficient demonstrates that changing the nature of

connecting service causes consumer prices to change. The regressions assign all observed

consumer behavior differences to the small difference between "true online", "ATl alliance",

"alliance codeshare without ATl", "codeshare but not alliance" and "traditional interline"

connection differences. The study totally ignores huge correlations between these categories and

other factors (schedule competitiveness, frequent flyer loyalty, local market presence, the level of

price competition) that are actually driving the observed behavior. A regression based on data

from a single point in time cannot be used as evidence that major shifts between these categories

over time actually led to price cuts in the markets where the shifts occurred. The study's claim of

a statistically significant price difference between online and true ATI contradicts the applicants'

basic claim that with ATI these services would be priced in an identical manner. The regression

results suggest that non-immunized alliance codesharing provides no consumer pricing benefits

relative to traditional interline connections which suggests that the vast majority of industry

codesharing is of no value to consumers . These regressions are largely driven by structural

differences between the North Atlantic (the only place where ATI is found) and the Pacific and

Latin markets. Compass Lexecon has no basis to claim the regression coefficients reflecthe

" The study, Berry, S. and Jia, P., (2008)"Tracing the woes: An Empirical Analysis of the Airline Industry", NBER

working paper 14503 was trying to develop a very high-level estimate of the importance of increased (aggregate

average Domestic only) price sensitivity to the decline in aggregate industry financial performance.
I

I

Horan, Supplemental Delta/Virgin Comments 1-9 October 20L0

pricing differences between different connections that would be observed within markets with

si mila r structura l/competitive conditions.

n Two comments in the Oneworld caseto found serious deficiencies in the regression analysis

that Compass Lexecon submitted in that case, and a more detailed review might identify

many more problems with the regressions presented in this case

I The Compass Lexecon paper fails to acknowledge (much less address) the Show Cause Order's

concerns that measuring pricing shifts solely attributable to ATI is very difficult under conditions

where other much more powerful factors (global recession, major recent competitive shifts)

would tend to overwhelm any impacts that alliance pricing might have

It is especiallV unreasonable to expecthat testimonv that proposes a radicallV new approach to ATI

benefit claims. and is based on detailed statistical modelins can be fullv reviewed within the timeframe

established bv Order 20L0-9-18

By basing its Public Benefit claims on the Compass Lexecon study, Delta/Virgin has clearly rejected

the Brueckner/Whalen "double marginalization" hypothesis that had been used to justify claims

of connecting market consumer pricing gains in all other casestt, and is proposing a totally new

basis for connect market pricing gains that is totally inconsistent with "double marginalization"

based claims. DOT cannot accepthe new, incompatible Compass Lexecon based claims without

explicitly acknowledging that its findings in all other cases were illegitimate.

The two approaches to estimating connect market pricing gains are mutually exclusive; one cannot

accept one approach without rejecting the other. The "double marginalization" claims in the

original Delta/Virgin application and in every other ATI application are explicitly based on the

belief that granting ATI eliminatestructural barriers to efficient interline pricing, and prices fall

automatically once the barriers that force airlines to set inefficiently high prices are removed. The

Compass Lexecon paper claims that consumer pricing benefits in connecting alliance markets are

strictly due to consumer preferences for the higher "quality" of "true ATl" connections. "Double

marginalization" says consumer behavior changes because new, lower prices are introduced

following ATI; Compass Lexecon says consumer behavior changes aren't price driven but are

because of preferences for "higher quality" schedules, "Double marginalization" says that

beneficial change occurs when internal airline pricing staff change their behavior; Compass

Lexecon says prices fall due to marketplace shifts that internalairline staff practices had nothing

to do with.

I The Compass Lexecon study falsely implies that their explanation is consistent with the

Brueckner/Whalen "double marginalization" hypothesis.lu Compass Lexecon present

absolutely no evidence demonstrating any logical or factual connection between the two

approaches. Either they do not understand the "double marginalization" hypothesis or are

trying to deliberately mislead the Department given its past rulings

The applicants are certainly free to develop totally new Public Benefits estimation approaches but

there is no way that the legitimacy of any totally new methodology could be demonstrated under

the extremely brief review period established under Order 20I0-9:J.$ especially given the many

ra Depaftment of Justice Oneworld Comments, DOT-OST-2008-0252-3374, appendix A and B; Horan Oneworld

Comments, DOT-OST-20 08 -0252-3 3 89

'' Horan Delta/Virsin Comments. p.2-6.

16 Via references tJBrueckner/Whalen claims or "double marginalization" effects at pp 3, 4,6 and 14.

T
Horan, Supplemental Delta/Virgin Comments L9 October 201-0

questions and deficiencies this comment has already identified. The Department cannot accept

the new Delta/Virgin connect market Public Benefits without accepting that the "structural

interline pricing barriers" theory used to justify connect market Public Benefits claims in every

other case is wrong. lt is difficulto believe that the Department could reach such a conclusion

within the defined review period.

I The totally new Compass Lexecon testimony on connecting market pricing benefits includes

detailed data submissions filed as confidential company data. lt is ludicrous to asserthat DOT or

other interested parties could possibly review the detailed data and regression methodology

within the week allowed under the Order. In the Oneworld case parties had (and required) several

months to prepare rigorous rebuttals to the (seriously deficient) Compass Lexecon statistical

analysis presented in that case. Parties in this case would require even more time to thoroughly

review the Compass Lexecon testimony, as they must address the legitimacy of the detailed data,

the statistical methods, and attempt to supplant the longstanding "double marginalization"

approach with a totally new approach to connecting market price benefits.

I By supporting a fundamental change to its connecting market price benefits claims with

confidential data filed at this very late date, Delta/Virgin make it impossible for any outside

party to fully review the legitimacy of these claims.

lf DOT and the Applicants would like a full, rigorous review of these radicallv new Public Benefit claims,

DOT must reopen the case and permit the thorough review that would have been possible if these

claims had been included in the orisinal application.

lf DOT and the applicants want a full resolution of claims in the L3 October submission, the new

schedule must allow for a full review of the statistical methodology, the data used in the

regression analysis, the schedules used in the "before-and-after ATl" comparison, the coefficients

and algorithms used in the QSI planning tool, and the fundamental logic behind the totally new

methodology linking benefits to consumer preferences for "higher quality" connecting schedules.

There must be opportunities to test whether the statistical methods produce similar results using

data from other time periods and markets, and there must be full opportunity to evaluate

whether the proposed new benefits hypothesis should supplant the incompatible "double

marginalization" hypothesis used in all other ATI cases.

Since a full review would require DOT to either explicitly reject or reaffirm the "double

marginalization" based claims behind all previous ATI Public Benefits decisions, other parties that

have not yet participated in this case may have an interest in doing so

Such a review would require at least 4 to 6 weeks from the point that all interested parties had full

access to the relevant data. In establishing such a review process, DOT and the applicants must

ensure that all parties filing confidentiality affidavits have full access to the relevant data.

Alternativelv, the DOT could strike all Compass Lexecon based Public Benefit claims from the case

record, and erant the application on the basis that it meets the Public Benefitstandards all other ATI

applications have met

I lf DOT does not wish to reopen the case, the Compass Lexecon based claims must be stricken, as it

would be impossible for DOT or any other interested parties to complete a full, rigorous review of

these claims within the current schedule.

I

I

I
T

Horan, Supplemental Delta/Virgin Comments 19 October 2010

As demonstrated above, there is little likelihood that the Compass Lexecon based claims would

survive a full, rigorous review, thus it is highly likely that striking the claims at this point would

produce the same effective result as a full, rigorous review would. Nothing in the Compass

Lexecon based testimony appears to come anywhere close to meeting the burden of proof of

Public Benefits that section 41308(b) imposes on applicantseeking antitrust immunity. None of

the radically new approaches for estimating connect market pricing benefits have ever been

tested using data from other markets or time periods. The applicants have provided no evidence

showing that the statistical correlation that they attribute to "consumer preference for higher

quality connecting schedules" could not be explained by any of the other, more powerful factors

that usually explain consumer behavior.

lf the Department maintains the current case schedule it is importanthat the Compass Lexecon

based claims be formally stricken, so they cannot be quoted as evidence or precedent in any

future case.

Respectfully submitted,

I

ubert Horan

19 October 20L0
Horan, Supplemental Delta/Virgin Comments 19 October 2010

CERTIFICATE OFSERVICE

I hereby certify that I have this date served the foregoing document on the persons

identified below by causing a copy to be sent by electronic mail.

carl.nelson@aa.com

howa rd_kass@usa i rways.com

benja m i n.slocum@ usa i rways.com

hkamen@coair.com

dan.weiss@coair.com

j eff rey. m a n I ey@u nited.com

steve. morrissey@u n ited. com

jhill@dlalaw.com

byerlyjr@state.gov

todd.homan@dot.gov

peter.irvine@dot.gov

ch ristopher. ma ndel @dot. gov

sacha.vanderbel len@delta.com

anita.mosner@hklaw.com

sophy.chen@hklaw.com

merren.mcarthur@vi rginbl ue.com.au

dayna.hall@virginblue.com.au

jeff . morgan@delta.com

Jill.ftacek@usdoj.gov

A--

19 October 2010