SUPPLEMENTAL COMMENTS OF HUBERT HORAN

AMERICAN AIRLINE5-BRITISH AIRWAY5.IBERIA-FINNAIR-ROYAL JORDANIAN

JOINT APPLICATION FOR ANTITRUST IMMUNITY

DOCKET DOT,OST-2008,0252

8 January 2010

My name is Hubert Horan. Iam filing these comments in response to the Department o'f Justice filing at

DOT-OST-2008-0252-3374. Theseare supplemenlal to commenl5 | originally {iled on 15 October 2009

under DOT-O5T'2008-0252-3362

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

management po5itions with Northwest, America West, Swissair and Sabena. I have signilicant experience

in international airline competition and the actual operation and economic5 ofairline alliances. While at

Northwest I was personally responsible for the original development oI the KLM'Northwest Alliance

network and introduced the intense hub-to-hub operations that allowed Northwest to become the most

pro{itable US (arrier on the North Atlantic, and establjshed the template followed by all of the

subsequent alliance networks. I spent four yeart at Swislair-Sabena. including the transition of Swissair's

alliance trom Delta to American, and thus have been involved in alliance management on both tides of

the Atlantic. I have not only helped build highly successJul alliances, I have helped shut down highly

unprofitable ones, including lhe intra-European Quali{lyer allian(e, and the domertic allian(e between

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

airline consolidation, and Open Skies treaty negotiations, and I also testified betore congress on the

Delta-Northwest merger. I am based in Phoenix, Arizona. A full lkt of publications and further

biographical inJormation is available at my website, horanaviation.com.

I have no actjve business or financial interests with any of the parties to this cate, and am only

commenting as a private citizen (oncerned about the issues raised by this (ase.

A- RECENT SUBMISSIONS HAVE NOT ADDREsSED THE JOINT APPLICANTS' HIGHLY DEFICIENT CLAIM OF

592 MILLION IN ANNUAT PUBLIC BENEFITS FROM CONNECTIN6 SERVJCES

Al. DQT may not grant the requested immunitv witlout evidenCe. meeting the staldllds of the

Hotizontal Merger Guidelines demons:rating ao!\sumer benelits in nonstop and connectingl[l!le$

tioniJicantly greater than any ri5k5 of reduced comoetitjon in nongtoo or(onnectinq markets

. Applicants for antitrost immunity murt prove that immunity "is necessary...to achieve important

public benetitr" that "cannot be achieved by reasonably available alternatives that are materially

less anticompetitive."' Soth the DOT and DOJ have recognized that airline antitrust immunity

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

merger would and appli(ants must prove that those public benefits outweigh the risk that it could

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

relevant market.'? The burden oI proof for public bene{its rests with the applicant5, and the

Horizontal Merger Guidelines defines the evidentiary standards that must be met:

! "[the applicants] must substantiate efficiency claimso that the Agency can verify by

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

each would be achieved (and any costs ot doing so) how each would enhance the merged

firm's ability and incentive to compete, and why ea(h would be merger-specific. Efficiency

claims will not be <onsidered il they are vague or speculative or otherwise cannot be verified

by reasonable means"l

| -19 USC secrions.l1308. .r ti09(b)

r Fedcral Trade Co r issio . Departmeni ofjusiice.

sections Ll. i.l- 'FeJcml fmde Conr rission. Deponrnenl ofJunice.

Anlitrusl Cuidelines for Collaboralions Among Co|r)p€tilor! (2000)

Horizonlol Merger Guidelincs ( 1997) p.j I
Horan BAAA Supplemental Comments 8 January 2010 2

I The .loint Applicants have made four sub5tantive claims in support of their request for antitrust

immunity: (l) that immunity would generate 192 million in annual public beneJits in the {orm of

capa(ity driven price reductions to North Atlantic passengers using aonnecting seNices4 (2) that

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

added to hub-to-hub routest (3) competition would not be redu(ed or eliminated in the

overlapping nonstop markets served by the Applicants5, and carve,outs of nonstop routes from any

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

reduced or eliminated in transatlantic connecting marketss,

I Other claims made by the Joint Appli(ants (increased convenien(e, applicants better able to

compete) are either derivative claims (the impact oJ jncreased (onvenience and competition

are already reflected in the quantified public benefit claimt or are not supported by any of

the types of evidence required by the Horizontal Merget cuidelines.

A2-1rcU9!!1e5t!!taty has alreadj fully reluted the Joint App[lddllalm ttrat there ir no risk to

consum€rs from reduced rqnslop (ompetition

. The only verifiablevidence presented by the Joint Applications indelense oI claim (3), that

competition in non5top marketr would not be redu(ed enough to increase ability or incentive to

raise price or redu(e outpul, and'that carve,outt of nonstop routes would harm (on5umert, it

included the Willig/Lexe(on Compass atfidavit. That aJtidavit claimed that its regression analysis

demonstrated that risks from reduced competition were de minimis because "there ir no statistically

5ignificant fare effect from reducing the actual number oJ carriers on a route trom two to one" and

that "granting antitrust immunity ha5 no significant effect on fares" and "carving-out from

antitrutt immunity the lour oneworld overlap rootes would impose harm on consumers equivalent

to at lea5t $55 million annually"e

. Previou5 testimony has already thoroughly refuted the Willig/Compass Lexecon (laims, the only

eviden(e supponing the Joint Appli(ants competition claimr.

d My O(tober testimonyro demonstrated that the key (laims (allowinq two competirors on a route

to collude via immunity, and that reducing the number ol competitors on a route Jrom two

to one did not a{fect pricet, were entirely based on a regre5sion that did not correctly count

the number of competitors historically serving a route. The regressjon iput data explicitly

assumed that immunized partnerr, 9u(h a5 Northwest and KLM on Detroit-Amsterdam, were

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

competitors on a route were tondamentally invalid since the independent variable5 were

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

<ompetitors, and routes such a5 Detroit,Amrterdam with 1 actual competitor).

r The Department of lusticet December submission" provided a much more exhaustive attack on

the methodological problems in the Willig/Compass Lexe(on regressioni and the DOJ

submitted independent regression analy5is demonstrating serious risks that reduced

competition on nonttop routes would lead to higher prices. The DOJ regressions, based on

data refleding .urrent market conditions, showed an average 15% fare increare when

(ompetition on a rolrte was reduced from 2 to 1, and 6% when (ompetition was redu(ed

{rom 3 to 2 carrierr. When the DOJ corrected the statktical flaws in the Willio/Comoass

rJoinr Application {DOT-OSl -2008-025:-000 I ) p. 7.21. e\hibil JA- ll. JA-19 (rhe Brafile ai}ld0t'it). All rclerences ro

dockei maierials in th is su bnr iss ions refer to public vers ions : pagiDar ion mar- van sl igh ll) liorn conildentia I vers ion s

' Joinl Application op.cil.. Joirrt Applicants CoDsolidared Repl) (l)O t'-OS-l -2008-02 52-l i ll) p.19.

" Joinr Application p.i5-ll. Joinr Applicanrs Supplcmcnral Conrmcnls (DOT-OSI,l008-0151-3357) p..l-9. E\hibit I (the

willig Lexecon Compass atlidaYjl)

Joint Application p. -l l-57. Suppl€mental Comments p.I l-19. thc Willig Le\ccon Compass afYldavir ' Joint Application p..ll-57. Supplemental Commenrs p..l-9 ' williglle\econ Compass afTidavir p.6. li. 18. 22 '' Horan commenfs. DOT-OST-2008-0152-ll6: I Depariment ofJrs(ice comments. DOT-OST-2008-0252,337,1. appendi)i A and B
Horan BAAA Supplemental Comments 8 January 2010

Lexecon regressions, resultsupported the DOI lindings of <onsumer rGks, and no longer

supported the Joint Applicants'claims. The DOJ submission alto pretented HerfindahlHirrchman Index ("HHl") measures oIcompetition 5howing that thege nonstop markets are

afready highly <on(entrated, and that under the Horizontal Meryer Gurdel,nes turther

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

. The Joint Applicantr' (laim that immunity would lead to increased capacity in these markets

does not meet Horizortal Meryer Guidelines standards as it is purely speculative (the Joint

Appli(antsay they would look seriously at capacity increases but have made no

(ommitments), but the DOJ submission refuted the counter argument that added hub-to-hub

flights would mitigate pricing risks since any added capacity would be dedicated to

connecting markets.'? More imponantly, the DOJ submission spe(ifi(ally identifies the huge

bariers to potential future entry in these markets, an issue that is (ritical to any evaluation

under lhe Horizontal Merger Guidelines.

43. The loint Applicalts' $92 milliq! ]PlrUljqBcl€lf]1llaimt are the laroest and most imoortEnt clailli!

their aoolication- but neither the Oepartment of lustice's com.meitl !9I q![er recent submissions proped!

addressed the deficiencies in this clajjlls

. The DOT cannot accept the .,oint Appli(ant'r claim of $92 million in annual publi( benefits in

conn€cting markets without

. proper, veri{ieble, non-spe(ulative evidence supporting the spe(iJic efficiency benefit5 that the

.Joint Applicants claim will be (reated if immunity is granted

. proper, veritiable, non-speculative evidence supporting that these rpeciJic conrumer benefits are

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

. clear evidence that the claimed public benetits could not be achieved by reatonably available

alternatives that are materially less anticompetitive

. The Department of.,ustice's <omments did not directly addre5s the Joint Applicant's claim that

immunity would (reate $92 million in publia benelit', but argued more narrowly that these benefitt

could be achieved without immunity8

. The.loint Applicant's claim that immunity will generate $92 million in annual benefits in connecting

markets is ent rely based on lwo theoreti(al assumptions

c Astumption 1--lnterline lares on carriers with antitrust immunity are alwavs lower than interline

or codethare farer on carriers that do not have antitrust immunity because carriers without

immunity are alwavr structurally bound to the higher costs of "double marginalization" (i.e.

tu(ce55ive markups). This structural efticiency advantage would be observed in any market

and occurs independently ofany other lactors Gupply/demand, <ompetition, e't(.).

r Assomption 2''lntroducing antitrust immunity to exkting itineraries operated on a nonimmunized codesharing basi5 would lead directly to fare reductions ot 17.45o/d; tl',is

magnitude oJ fare reduction would occur in any market, independent o{ any other factors.

These price reductions can be assumed even in markets where there is no eviden<e than nonimmunized pa5sengers currently pay higher fares than paJsengers traveling on online or

immunized alliance services. These fare reductions would 5timulate new traffia orowth based

on a price elasticity measure of '1.7-r'

a The t92 million in annual publicbenelitriscalculatedbyapplyingrhelT.4S% pri<e reduction to

all AA-BA"/AA'lB interline passengers identiJied in the 2007 DB lA data, and further increasing

' 1he Joinl Application shows (Supplelnental Conrnenrs p.5) thathe Dallas-Fl.Worlh"l-ondon nurkel alread) has 8 tinies

as nlan! seats as required to serve ihe local marlier

rr tJeparhrent ofJLrsiice commenrs. p.:2-29

'' Brattle allldavit p l. 5-8: also rcstated in Joinr Applicanis Consolidaled Repl) ..Brattlc crorp .epll lo Frontier

Economics . tlraltle would havc applied larger (22%) pric€ reduction in non-codesharing interline cases. but these could

not be identified in the DBlA da|a. so rhe more conservaiive 17.45o,i, factor \i,as applied ro allcoupons.
Horan BAAA Supplemental Comments 8 January 2010

traffic based on the price elaiti.ity factor. These welfare gains are claimed to be "annual"-

ongoing and permanent; and would never be eroded or competed away by the marketpla(e.

r The sole basis tor these two assumptions are theoretical argument5 made in papers published by LK.

Brueckner in 2003 and W.T, Whalen in 2007, derived from a single jointly-au(hored 2000 paper s.

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

changes to the original theoretical arguments or tonclusions.

r This comment will argue that the DOT murt completely rejecthe Joint Applicants' claim of $92 million

in public benefits in (onnecting markets as it not only fails to meet the evidentiary standards of the

Horizontal Merger Guidelines bLrt is demonstratively {alse. The Joint Applicants'claims totally rely

on the Brueckner and Whalen theoretical arguments; iJ those argument5 meet the Horhontal

Merget Guidelines standards, then the DOT should a{{irm the loint Appli<ants' public benefits (laim.

lf those arguments do not meet the Horizontal Merger Guidelinesstandards, then the DOT should

reject the Joint Applicants' claim. As a result, this comment will:

o Describe the Brueckner/VVhalen analysis and arguments {rom their published pape15, inclLlding

their regres5ion analysis of (largely) North Atlanti( data from the 1990s, following the

introdu(tion of the o.iginal immunized allian(es

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

competitive and efficiency advantages of the original immunized allian(es, based on DOT

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

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

subsequent srategic and network alliance work at 5wi55air and other carrier5, and other work

throughout my 25 year career directly relevant to the competitive issues raised by this case,

including hub network development, mergers and consolidation, and revenue management.

! Evaluate Brueckner and Whalen'9 stalistical analysis, which i5 used to estimate the Joint

Applicant'5 projected public benefits, and their theoretical arguments about "double

marginalization", which are central to the loint Applicant5' (laimI lt must be emphasized that, while these comments will lo(us heavily on the Brueckner/Whalen

theories and papers, the issue at hand is claims made by the Joint Appli(ants, not by Brue(kner or

Whalen perronally, neither of whom har submitted tettimony in this (ase.

4!l-The "E(onomics Literat{fe" supportiDglhelailLthat inmllizqd airline alliances generate (oDluner

bencjit5rplJistj o{ a single jqintly authored paper, plus two fqllow-up oapers bylbe rame aqthqr-s that

updaLe! rege55ialrwithout changjrglh.e-qdgi!al argunerl!5 ar concluig!!.

r The "economic literalure" on the price effeds of international allian(es <onsists ofone journal arti(le

published by Brueckner and Whalen in 2000'6, and several follow-up pieces by the same authors

offering minor updates on the original paper. That original paper outlined the material that was

repeated, with minor modifi<ations, in allsubrequent papers, including

E A statement ot the general hypothesis that the "cooperative pricing" lowers airfares in

connecting markets; each paper specifically noted that con5umer benefits from lower aartares

in these (onnect markets could be offset by redu(ed competition in hub-to-hub nonstop

markets, and that the analysir in the papers was focused on connect market impacts, and was

not intended as an evaluation of the overall welfare imoacts ot alliances

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

and non-alliance situations, which underlay the authors'assumptions of structural barriers to

efficient non-alliance pricing, causing cooperative alliance interline fares to always be lower

than non-cooperative interline {ares

I Jan K. Bnreckner. cunerrtl) on lhe Economics facuhy at thc tlniversily ol Calitbnria-lr!inc and W. Tonr whalen.

cunently uith dre Anlitlurl Division ofthe Depanment of.luslice. Both werc at the Univefsir) of lllinois-UrbanaChanrpaign at ihe tinre ofthe original papcr

" llrucckner. i. K. and Whalen. W. 1.. (1000). -The Price EtTccrs ol lnternational Akline Alli.mces .rrc Jounul ol I'ut

./"r/ti.,trd,x.r \'.13 nl. p. 501
Horan BAAA Supplemental Comments 8 January 2010

A discussion of the authors' mathematical models of how interline carriers, alliance and nonalliance, maximized the difference between marginal revenue and marginalcosts, which were

then applied to a simplified (4 to 8 leg) airline network where there economies of network

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

structural barrie15 inherent in non-alliance pricing imposed an efficiency penalty that

imnunized airlines did not face, solving these equations (not surprisingly) demonstrated that

non-alliance interlining was always less profitable than alliance interlining

A djscussion oI the DOT DBiA data and the regression resulti which confirmed the general

hypothesis that allian(e interline fares were materiallV lower than non,alliance interline fares.

. None o{ Brueckner or Whalen'r follow-up papers made any signifi(ant (hanger to the approach or

conclusionr oIthe 2000 paper, and should not be seen as separate from the original analysis

: Brueckner-Whalen (2000) also attempted to estimate the net welfare impact of a Britiih

Airways-American Airlines immunized alliance. This wat ralculated by applying the regre5rion

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

lrom those regresrions due to redu(ed competition to traffic on BA-AA hub-to-hub flights.

The welJare losses from redu.ed hub-to-hub competition eliminated almost most gains in

connection markets, although the exactradeoff depended on price elasti(ity assumptions.

Brueckner (2001)" did not undertake any regrersion analysir, but Jleshed out the behavior

pricing theories and mathematiaal profit maxjmization model a bit. The paper introduced the

terms "double maximization" and "negative externalities" as des(riptors Jor the alleged

structural inability of non-alliance carrierr to optimize interline revenues.

E Brueckner (2003a)r3 wat the first paper to recognize multiple levels of alliance (odesharing, and

updated the original Brueckner,Whalen (2000) regressions uting 1999 data, whi(h separately

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

reductions for alliancer with antitrust immunity than {or <odesharing within alliances that did

not have antitrusl immunity.

:r Brueckner (2003b)re summarized Erueckner (2003a) results lor a more general audience, and

ettimated the benelit of Star Alliance codesharing inconnecting markett. Like the earlier 8AAA analysis, thit involved a simple appli(ation oJ regression coefficientg representing "price

benelits of alliances in connecting markets" to all Star Alliance connecting trallic. Brueckner

did not attempt to weigh the connecting market benelits (roughly $80 million) again5t

detriments Jrom lost <ompetition in overlap markets, but acknowledged these existed.

r Whalen (2007)'z0 briefly summarized Brueckner's general hypothesis and theories of pricing

behavior, and presented new regression5 using 11 year panel data instead o{ cross-section

data from a s;ngle quarter as the input to his regression. Panel data minimizes errorr or Jal5e

(orrelations in cross-section analvsis that are due to {actorsuch as lenoth oJ haul or local

route characteristics, although p;nel data can introduce problems due-to temporal factors.

Whalen also extended the database to include online connecting trips. His results confirmed

the general hypotherir but found smaller price ditlerences than Brueckner's cross'section

analysis. A separate analysis found that the existence of an "Open 5kiet" treaty was actually

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

'lllruecliner. J. K..(:001). The Econonrics of I nternational Codesharing: AnAnal)sirofAi inc Allian cc\".lntcrnntiarnt

.h tt1'. ol h'tht\ttk Ots.tni.atk t\lt).p.1171 '" Bruecknef. J. K.. (l00ia). _lnlemational Airfarcs in lhe Aee ofAlliancesi lhe Ellects ofCodesharing and Anlitrust

Inrmunit) .Rfr,!'r o/ f.rrx,niL: dnl Skttisti.! \85 nl.p105.IhepapercitcsWbalcnnsanuncrcditedco-author.and$as

aclually completed in 100 L

'' Brueckner. J. K.. (l00lb). l he Bene li ts o f Codesh aring an d Antirruslnr nr unitt lbr lntemal iona l Passcngefs. \! ilh an

Applicarion ro fhe Srar A lliance" . Jonmal o/ .l u. Tttusport lthudseme \9 n2.p83

" Whalen. W. T.. (2007) A Panel Data Analrsis ol Code Sharing. Anrirrusl ImmrlDit] and Open Slies Treatics in

InremarionalAviarion MarkclJ. Rern , oftndusknl Orsdni.dtbu vSo 2007r most analr'sis ras conducled years before

and earlier worki g paper vcrsions included Whalcn. W. T.. (100i) 'Co0srrained CoDtmcting and Quasi-Mergcrs: Price

EfTecls of Codesharins and Aniitrust I nr m un;I\ in lrlerna.ional A irline A I liances and Whalen. w. T.. (100j ) A Pan€ |

Data Anal)sis ofCode Sharing- Anriirust lmmunil) and Open S[ies Trearics in Inrernational Aviarion Markels'
Horan BAAA Supplemental Comments 8 January 2010 6

t All quantitative evidence of alliance pricinq benefits quoted in these antitfust immunity cases are

based on two regressions of data from the 1990s Brueckner's cross-section analysisof l999data,

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

the 2001 work) are summarized in the table below

publication data used in regression aLrthor's key Jindings about price

differences based on reoressions

Brueckner-Whalen

2000

3Q 97 (cross section)

international interline

connect trips in DBIA

45,620 trip5 in

16,755 0&Ds

alliance vs. non alliance interline

24% totaldataba5e

15% total US behind gateway

1 5-18% Transatlantic+Central America

52% US Canada

(8%) US-South PaciJic

0olo IJS South America/North A5ia

3Q 99 (cross section)

international interline

connect triPs in DBI A

54,687 trips in

17,518 O&Ds

ATI vs non alliance interline

17 31% totaldatabase

21-23% Transatlantic

22o/o total u5 behind gateway

non ATI codeshare vs interline

7-10% total database

7-9% Transatlantic

5% total US behind qatewav

Whalen 2007 11 year panel data

1990-2000 (3Q each)

all US-Europe connect

trips in DB 1A;

120.758 couoons

17-23% on ine v! non alliance interline

17-20% ATI vs non alliance lntefline

6-9% non-ATl codeshare vs interline

(3%) Open Skies vs. non Open Skies

grueckner, the primary author, has been a paid advocate Jor United Airlines and the Star Alliance

throughout the period when the5e pieces have been publighed", and in addition to the Brueckner

(2003b) paper estimating Star Alliance consumer benefits, has presented testimony on behal,f of the

Star Alliance in the recent antitrugt immunity cases.::

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

benefits, each of Brueckner's papers al5o raised some concerns about possible consumer detriments

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

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

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

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

positions of other parties advocating international airline consolidation.

Erueckner's papers can and should be evaluated on their own merit.. Nonetheless, there is no basis for

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

consumer benefits have been well documented by an independent "economic literature"':r. The

entire basis for the claim consists of one article plus statistical opdates, 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 case (written by paid advocates for American

Airlines), or similar paid testimony in other cases-

: Nloorman.R.(1000)rJnitedTurnsioAca.lenicsroShowAllidnccsAidConsuners.,lrnrn?,,d!*d,,/.S4r.

Ic.r,?o/'/Rr vl5: n l4 2 Ocrober:000 p. 56 Brueckners paid advocac)- role was not disclosed in an) ofthcsc papc|:r.

-' for examplc "An Evaluation oftbe Skyeani-Wings Antiirusl Imnrunity Applicalion" subnitted in docket DOT'OS I100.1- l911.1 and -An Evaluation oltlre Latest Srar Alliancc Application fof Antilrusr 1mmuniry" srbmitted in docket DO I

OSI 2005-21922. Sincc lhc AA BA anallsis in BrueckneFWhalen (2000). Whalen has not published arr) comments about

!rn) specific mer-ser. consolidalion or dntitrtrst im'nunity proposal.

_ Thc Brattle afiidavit makes the'has bccn rvclldocunenled in the economic literaturr" point at p.L Anothcr piece writen

by paid advocales for American Ai.lines cla;med: "virtuall,,- every peer-revie$,ed acadenric siud) ofnnmunizcd

international alliances has concluded that. as a resulr ofeliminatin-q carriers' incenlives to impose sLrccessive markups on

lares for connecting lickets (hc so called 'double rnarginalization problent. alliances have led to lo\.er fares and

e\panded output . Kaspcr and t-ee. Why Antitrust Immunil) Benefils Consumers GCP Arthrust Journal. Sep. 1009:
Horan BAAA Supplemental Comments 8 January 2010

B. THE ORIGINAL NORTH ATLANTIC ALLIANCES DID CREATE SIGNIFJCANT CONSUMER WELFARE BENEFITS

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

WERE FULLY EXHAUSTED BYTHE LATE 9OS

. The consumer benefits of the original North Atlantic immunized alliancer (KLM-Northwest in 1992,

Delta-swissair-Sabena in 1995, United Lufthansa'5AS 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 specific category of double connect O&Ds that prior to 1992 had Only

been served on interline tervices

: Prior to alliances 70% of transatlantic demand had nonrtop or true online connecting service via

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

full range ot discount fares; the other 30% of th€ market were required to use interline

servicet where connection5 were often poor, and discount fare5 were more limited; the

original alliancet extended the schedule and pricing benetits that had always been enjoyed

by pass€ngers in 1'9top connect markets to passengers in the 2-stop double connect markets

E The table below summarizes the competitive situation of the 1990s; certain carriers focused on

the category (1) large nonstop O&Ds 5erving the largest markets (London, New York, Chicago);

these nonstop servicet also provided capacity serving the (ategory (2) l-stop markets beyond

their hubr; the new alliances had (ompetitive advantage in the (ategory (3) double connect

markets where the non-aligned ca.rier5 could not (ompete and the only alternative was

interline connections, but they also carried signiticant traffi( in (ategory (2) l-stop markets

Mid 1990s Carrier

Competitive Advantage

by North Atlantic

Market Category

% of total

Trans-Atlantic

marKeI In

these O&Ds in

1995

Did large non-aligned

carrierS

(8A, CO,AA) have

Competitive

Advantaqe?

Did large

immunized alliances

(KL-NW, SR-DL) have

Competitive

(t) Nonstop O&Ds

<gareway-gareway>

30o/o MAJOR

ADVANTAGE-major

share of large nonstop

O&Ds

NOUNCOMPETITIVE

(2) Online l-stop O&Ds

not served by nonstops

<beyond U5-gateway EU>

<qateway US-beyond EU>

40% Could compete but no

carrier had strong

Could compete but

no carrier had

5trong advanta9e

(3) Double Connect O&Di

with no online selvi(e

<beyond U5- beyond EU>

30% N(F

UNCOMPETITIVE

MAJOR

ADVA{IAGE-only

interline service

The consumer oricino benefits oJ the new alliancer was 5ignifi(ant but was strictly limited to the price

redu(tions achieved in category (3) markets-the diflerence between interline priceg and "online"

alliance prices in these speci{ic O&Ds that had been exclu5ively served on an interline basis

! The new alliances served a significant amount o{ category (2) traffic, but these passengert in

these market5 already had online pri(ing, and thus the new alliances did not create any new

pM!!g benelits for these passengers; the overall groMh of these alliances would seriously

overstate the sjze of the true pricing benelits

r Alliance pidrg benefils were only a small part of the overall consumer bene{its realized as a result of

innovation and increased competition on the North Atlantic; evidence of consumer benefits

(so5tainable lower fares/increased service due to improved industry eJficiency) i5not always

evidence o{ alliance benelitr or pricing benefits

c Consumers benelited whenever profitable new capacity added, ar this grolr.th put downward

pressure on fares; most of this capa(ity growth o{ the 905 was due to lavorable overall

industry supplykonditions and was not alliance related. The graph below shows that seat

capacity groMh during the 90s on the North Atlantic (where alliances and.odesharing were

strong) tracks very closely to seat capacity growth on the North Pacific (where there wa5 no
Horan BAAA Supplemental Comments 8 January 2010

antitrust immunity and codesharing was extremely

the slightly Jaster growth on the Atlantic, it is clear

driven by underlying market conditions, and those

pri.ing (hangec obse.veo in the regressio-s.

rare); while alliance fadors may explain

that capacity growth was fundamentally

conditions explain a large portion of the

\*--.---'

Growth-lr.nrAtlantic vs lr.nspacltl. r990-2000 (|nllllonl of ohcway

seats ooT T100 data)

Consumer welfare was significantly increased by other non-pricing factors lnclud ng increased

market iberalization, the orlginal Open Skies treatles, thegrowth of network hubs inthe Us

kesulting {rom deregulation based changes in the 80s), major lmprovements in European

(arrier efliciency (including the privatization of British Airways. and the consolidation of the

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

information technologies, and the widespread introduction of 767 and A330 aircraft that

made it possible to operate a much wider range oJ transatlantic {lights profltably, and

dec ining fuel prices. The "quasi online" all ance network innovation was one of the benefits

of lncreased transatlantic competitlon, but lt was a small part of the overal picture.

The ability of the new alliances to generate !iqnifi(ant consumer benefits depended on the

convergen<e oJ three critiaal tactors

Aggressive market-oriented, pro-competitive policies in both Washington and Erussels,

includlng the Department of State's e{fort5 use oJ ultra-liberal Open Skies treatie5 with

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

Germany and Fran(e to remove traditiona barriers to open entry and market pricing

The lar9e, Lrntapped, Category (3) double-connect market opportunityi prior to KLM Northwe!t,

no one had re.ognized the size of this segment (individual O&Ds w€re extremely small and

highly fragmented); given the traffic potential, domination ot this niche became the central

focus of the KLfM Northw€st'5 allian.e.':i The alliance's network coverage created signifi.ant

marketing and distribution et{i(iencies, including strong market awareness in every US and

European "beyond gateway" market that KLM Northwest ol{ered a full range of flights at

competitive practi.es to every signilicantransatlantic destination. The 3Lrccess of KLM

' I rras pcrsonalh rcspofsjble tbr e\parrding alliance hub,ro-hLrb llighrs iiorrr i lo l0- rll 7.17s and DC,l0(. a I of\ hich

$cre hi-ehl) profilrblc- ls par1 ol a conscious srrares\ ro e\pk)il lhe alliance s first-nrovcr ad!antale rfd cshblish a

dorninanr posirion in rhis nich.. lh.larcr Dcha-S$ issa ir-Saben! and l-ufihansr-L Iircd rllirnces lollo$ed rlris e\acr

ncr$ork renrplate. and rcndcred \onh Allanlic inre.line sen ice alnron conrplerel\ oh{lclL'.
Horan BAAA 5uppler.ental Comments 8 lanuary 2010

Nonhwest and the other alliances in developing this category (3) niche was documented by

several DoT studies at the end o{ the decade.,:

The coincidental strongly {avorable supply/demand (onditions that made capa<ity growth

profitable; the alliances'development oI se(ondary connect markets would have been

signiticantly ri5kier in an environrnent with low demand growth and overcapacity.

r The5e incremental consumer benefits were fully exhausted by the end of the 90s; the a liances

remained competitive, but were not introducing new efficiencies or reducing prices in any markets

As in any competitive market, the introduction of new efficiency enhancing innovation spurs

some competitors to mat(h the e{ficiency gains (via additional alliances or expanded dire(t

services) and forces other capacity out of the rnarket, and interline service had become tota ly

irrelevant on the North Atlantic by I999':6. Alliances only create pricing benefitr to the extent

they introduce on ine pricing to a market previou5ly only served by high fare interline servlces

The category (3) double aonned niche that drove ali alliance pricing benefits also shrank

dramatically with the ma,or expansion of new nonstops, which shifted most category (3)

O&Ds into online 1 stop category (2) O&Ds; many <itie5 soch as sLC, CLE, PDX, MEM. BCN, VCE,

BHX received non5top transatlantic servlce for the flrst tlme, as did major destinations in India,

the Middle East and Africa that had pfeviously requlred connections via European hubs

Allidnces afe not generating any incrementalconsumer benefits in the lownegative growth

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

overexpan5ion in the late 90s, a5 carriers a55umed growth driven by the one-time early'90e

innovations and the dot-(om bubble would be sustainable; capacity and traffic ha5 only

barely returned to peak 90s levels, and much oJ thi5 may have been artlficially slrpported by

the recent financial bubble.

Capaclty Gro$.th-Tran3Atlantic vs Tranrpacltl< 199O"20O4 (mlllions of

onewby raata DOT TIOO data)

'( S I)lpartnrcnr ot lrnsponarion.Otilc!ofthcSlcretarl.(1999)-'lrtcmationirlA\ialionDe!elopnrcnrs:Global

l)ercsulation Takes Olli llS Depafnrenr ol liansponarion. Olllce ol Lhc Secret,lr'_\. (1000). -ltin\llllunric Deregulali(rr: 'lhc lllafce Net\vofk lilt-(cf' r'\\'hilenralkelscorcrlngl0oi,oll(nalderrrand$ereonl)scrvcdblinteflinescr!icespriorlolgg:.inrerlincrrips

itccounted lbr l0'liod oi totrl No.1h Arlnnlic rra\el. since sonrc passen-gers inc.rlegor\ : nrarkcrs Lrsed irte'1inc ibte.d of

a\rilrblc online orarkers l he Depannrent ol JUsrice srecenr nahsisof1008conrccringtra\elsho$cdonhT0oolrh.

eoopns in irs sanrple r\ere inrerlire tript- srsgrsting tbar illrerline tru\clprobabh accdunls tbr less rhrn 1"" ofrhe krtrl

\onh Allantic. See D.pariment oiJustice- (i, flcnt\ontheShoNCaNcOrder.I)()I-OST-1008-0lil-0119.p..19jI
Horan BAAA Supplemental Comments 8 lanuary 2010 l0

C. THE BRUECKNER-WHALEN REGRESSIONS FUNDAMENTALLY MISREPRESENT THE HISTORICAL

CONSUMER PRICING BENEFITS FROM ALLIANCE ANTITRUST IMMUNITY

elJlrnstt.all gJ _tbe pl&€ledulliqlllhe l'coooerative alliance interLine pI(]!-SI (!I

be better explained bv imoroved suooly/demand conditions and other chanoes in the lMketpllrc

Brueckner claims that antitrust immunity reduces fares by l7 to 30% and that his paper "measures the

separate impacts of codesharing and antitrust immunity on the fares charged for interline trips .'z7

He attributes all of the observed alliance benefits to pricing, specifically "the cooperative pricing of

trips by the partners puts downward pressure on lares in the interline city-pair markets-"'?3 None of

these papers are attempting to measure the overall benefits created by alliancexpansion, they are

speciJically attempting to measure alliance pricing bene{its. Whlle there is no questlon that

consumers benefited from lower {ares in transatlantic markets in the 19905, and these regressions

show a clear correlation between "alliance presence" and " lower {ares" in connecting markets,

there is nothing in the data or analysis presented in these papers ju5tifying the claim that

"cooperative alliance interline pricing" behavior was the sole and exclusive cauie of price shift5 o{

thi5 magnitude. This is an unsubstantiated theoretical argument based on claims o{ etructural

"double marginalization" barriers to efficient non-alliance pricing that will be discursed in section D,

but the fegre55ions provide absolutely no empirical data supporting the theoretical caLlsation claim.

The actual primary driver of the observed pricing changes was the highly favorable supply/demand

and competitive conditions of the mid and late 905. A5 shown in the graphs in the previous section,

transatlantic capacity grew rapldly during this period (7.4% CAGR 1990-97, 4.9% CAGR 1990-2000")

with overall 5trong growth in international trade and travel. Some of this occurred in the hub_tohub routes serving alliance connect markets, but the huge increales in nonstop and true online

(onned services would have had a much bigger impact on market price levels than the increased

connecting service in markets that had no online 5ervice.

As noted earlier, there were other important non-alliance factors that also contributed to the

observed price changes, including pricing libera ization in Europe, carrier efficiency (the expansion

of hubs serving intercontinentaL flights, marketlng and distributlon technology galns, 757 and A330

aircraft efficiencied, and declining fuel prices.

C?._Ibejcgl€lllgr C iously overstated the cgrrel_allon €I!r!b-!!cd to "<ooperatilqallilM

interline oricinq" bv Iailino to restrict inout data to the markets \4there these oricing benelits wouid hav€

actually occurred

r Alliance connecting fares were in fact lower than pre alliance interline {are5, and alliancexpansion

did create legitimate consumer bene{its, but Brueckner and Whalen seriously overstate thls benefit

by detining their data sets in a manner inconsistent with their own pricing hypotheses and

incongistent with the actual dynamics of these markets. As discussed in section B, alliance pricinq

benefits only occurred in category (3) double-connect markets that had only been served on an

interllne basis, and did not occur when alliances served (ategory (2) connect markets that already

had online service and prices. All ol Brueckner and Whalen's papers explicitly assurne that the

"online" pricing the existed in category (2) markets prior to alliances was fully e{fic;ent. But their

regresslons overstate the bene{it because the data includes avery large number ot category (2)

connect markets-r0 Category (2) is the most competitive category o{ rnarkets on the North Atlantlc

sjnce they can be served by every network carrier and all three alliances.rr 8ut "a liance prlce leve s"

rr Bruccknef (2001a) p. I 05 . Whalen (200 7 ) makes the nan o'ver. morc appropriate c la inl s that *allianccs are lbLrnd to ha! e

signitlcantl.v lorler prices'or_arc associatcd $'ilh" pricc bencfits p.19.

:3 Brueckner (2001) p.1,,175 ' DOT T-100 seat capacity data

" The regressions exchrde categola (2) traffic originating at US gaterlay citics scrved b) European canie| Donsrops (due to

inhercnt limitalions in the DBIA dara). bur include aU orher category (l) onc-srop nrarkets

'' Calegory i markels can onlt be served by the three alliances. and categoD lma.kel conrpetition is a funclion ofthe

number ofcaniers that choose to operate nonstops.
l-loran BAAA Supplemental Comments 8 January 2010 lt

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

while they should have been measured 50lely based on the (higher) category (3) obrervationr.

. Interline fares were also not properly restricted to category (3) markets, and "interline fares" were not

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

Brueckner's 1999 rample 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 Nonh Atlantic

O&D would have had actual or alliance online servi(e-any interline travel would have represented

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

account traveler going out of his way to collect trequent flyer miles. By de{inition the5e tickets

would 5how a high average fare, bot they are meanlnglers inany evaluation ot possible alliance

price bene{itg- Brueckner's primary regressions includes interline prices worldwide, including

markets where all pri<es are much higher than the North Atlantic. A legitimate ettempt to estimate

alliance price benetits would have been rtrictly limited to alliance versus interline coupons in the

North Atlantic O&Ds that had no true online service, but none of these regresrion5 were

appropriately {ocused. These would have been in(luded in Whalen's transatlantic panel data, but

his data also included large quantities of unrelated non-(ategory (2) market coupons.

. The analysis not only Iailed to limit the regression data to the appropriate markets, but the papers

made no attempt to pla(e their "l7 to 30% lower price" type contumerwel{are conalutions inany

type of meaningful context. There is nothing in any of the papers that would help readers

understand the magnitude oI the alleged (onsumer benefils relative to the size of the overall

market, or even to onderstand the rcope of the markets in the regre5sion relative to the size of the

market. Despite an analytical r<ope specifically targeting "inteiline" traJlic and markets, the

authors made no attempto show what portion of these 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 5how that these interline-only ma.kets had almo5t completely disappeared by the end of

the decade. An analysis appropriately targeted at category (3) interline markets might have found

similar price redu(tions Iollowing the introduction of alliance online pricing, but from an economi(s

and policy standpoint, itis much more important to understand what the actual historical consumer

weltare gain Jrom antitrust immunity had been, and whether there are opportunities Jor Juture

gain5 in markets that could, but do not currently enjoy "online pricing".

r Any serious, caretully designed analyris ot Nonh Atlantic competition in the 1990s would show a clear

correlation between the introduction and expansion ol immunized alliance and growing tonsumer

benetits (lower pri(es and increased capa(ity). But correlation does not equal causation. Not all of

the observed consLrmer benefits would have been caused by alliances (most were caused by capacity

growth, increaring liberalization, industry elliciency and other factors), and not all of the observed

price reductions on alliance tickets were caused by efficiencies specifically related to antitrust

immunity. A proper analysis of the North Atlantic would also show <onsumer bene{its in general,

and specific alliance pricing gains fully exhautted by the end of the decade.r'

'r See for erarnple. Robyn. J.. RcitTes.J. (2005) untir led paid anal) sis ot tfie Sk)tcam anrirrusr inr m un ir) npp lical ion

prcpared on behalfofAmerican Airlines DOT-OS-[-100.1- l9l l.l. Rob)n. J.. Reiizes.J. (1006) untitled paidanallsisoflhc

Srar AIIiance antimsr jnrrLrniq applicaiion prepared on behall of A merican Airlines DOT-OST-?oos-ll9ll
Horan EAAA Supplemental Comments 8 January 2010 12

D, DOUBLE MARGINALIZATION DOES NOT EXI5T, NEVER EXISTED, HAS ABSOLUTELY NOTHING TO DO

WITH THE EENEFITS OF IMMUNIZED ALLIANCES, AND BRUECKNER AND WHALEN'5 THEORIE5 ABOUT

DOUBLE MARGINALIZATION ARE NOT SUPPORTED BY ANY DATA OR ANALYSIS

0_1. Brueckter and Whalen spe(ific!llv claim that all of their observed reoression price c!l!qlq{9l5 AIqdue

to the abilitv of cooperative ori(ino to eliminate "Loubte MeIg!lAliz€ljSlll !l'DoublqlEltqp!1jIrd thatt

thk is the orimarv consumer benefit (reated when antitl!5t immunitv aoolications afe approvld

r Brueckner and Whalen's central "Double Marginalization" claim is repeated in each of their papers}.

They believe that all of the pri(e/alliance correlation in the regressions is caused by a "negative

externality", a structural 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 structural barrier

arises because non-aligned carrlers allegedly establish "sub{ares" (proratet for interline travel over

their routes without any consideration ofthe prorate levels ol connecting airlines, or any

consideration ofthe joint interline fares that might result from the sum o{ there two prorates. This

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

maximize joint profit"r'. The two interline <arriers are making "two separate markupJ" while

immunized alliances and online (arriers would only make oner5, Becaure alliances can eliminate the

"double marginalization", their interline fares are alwayr lower than non-alliance interline fare5r6.

Th!5 when Brueckner and Whalen tolve orofit maximization eouations for alliance and non-allian(e

interline services, the non-alliance equation incloder the efficiency penalty ot the "double

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

not just a usetul feature, but is lhe primary benefit oJ immunized airline alliances.r'

r The alleged efficiency penalty of non-alllan(e "double marginaljzation" i5claimed to add $200 to the

price of a round-trip ticket. Whalen citet an average non allianre fare of S929 in one of his

regression sets versus an average immunized alliance fare o{ $727.33 The idea that eliminating nonalliance "markups" would create a 25olo efficienry gain i5 prepo5terous on the face of it; such an

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

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

smaller regrerrion gap between allian(er and existing codesharer tohigher 2007 fares). lf t200-250

per ti(ket price redu(tions actually o(curred in the market every time airline5 received antitrust

immunity, there would be ample evidence {rom multiple source5, and immunity advocates would

not be relying exclusively on this academi( paper.

D2. The entire "Double Marqinalization" theorv is based on unsqbstantiated claims that normal

comoetitive. rationa ieral assumotions do not apply !o lltelllle plicing, and the

theoryi5 fundamer-tally (ontradi(ted by e(ua! airline oricing oractices and systems

. Brueckner and Whalen's theory ol "double marginalization" arsumes phyri(al barrie15 tooptimal non,

allian(e interline pricing that do not exkt and ignores the existence of revenue management. The

"BruecknerandWhalen(2000)p.505-6.Brueckner(2001)p. 1177. Bnreckner (200j n ) p. 106, Bruecknef (2001b) p.8l-85.

Whalen (2003) p. 2-4. Whalen (2005) p.2-4. Whalcn (2007) omils ihe behavior explanatio|r lbund in all previous papcn.

and simpl! noles thal lho$c papcrs idcntificd !Doublc Margin lizarion problern. and that rhc rcgrcssion analysis in rho\c

papcrs ibund a correspondirg pricc dillcrcncc p. l0 '' Brueckner (2001a) ibid.

:' Brucckncr. J.K.. Proost. S. ( 2009) 'Carve-outs Under Airlinc Anrilrust lmmunin CESlFO \\orting paper

:t Whalcn (1005) p. I sals thal rhc double marginalization cosr problem onlt erisrs when rhc rso carriers have markel

pot\ er on their respecrive ponions ofthe roure. and can ser price above marginal cosr. bur Whalen (1007) delelcs al1

references topricing po$er. bu otlers no ahemarexplanarion forthe altcgcd cosl problenr. ' Bru€ckner (200ib) ibid. Whalen (2007) ibid. rB Whalen (2003) p. 24. Other regression sets have slighrly lor\er overall averagc lares. bur avernge fares for ker subgroups

$ere not identified- 'o According to its l0-K. wages. salaries and benefirs accounted tbr 16% ofAnrerican Airlines' rolal 2008 opc.ating
Horan BAAA Supplemental Comments8January2010 l3

assumed independent noncooperative processes with {;xed (per roote) mileage ba5ed prorates

(derived from IATA pradices) were abandonedecades agoao. Even carriers with limited automation

were always fully capable of designing and adjusting interline fares to more profitable levels.4r.

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

interline fares are now easily linked to both carrier'r inventory 5y5tem5; prorates (an vary by

booking class, so that interline fares can be revenue managed just as effedively as online

connecting fa re5,

r The "double marginalization" theory also assumes that fares are set with reJeren(e to the marginal

cost oI Ilight legs. This ignores overwhelming historj(al evidence that fares are set with respect to

competitive "market prices" and not with resped to internal <ost measures. The entire claim ot

"double marginalization" is based on "markup5" above marginal cost, but the claim falls apart

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

evaluate pricet or prorates against marginal cost. l{ price5 were 5et on a markup basis with respect

to marginal cost-type measures, one would observe wild price {luctuations when fuel prices are

volatile, lf prices were 5et on a markup basis with resped to marginal cost-type measures, one

would rarely obterve price matching on competitive O&D5, given underlying (ost difterences

between carrierr, eir<raft and routings.

r Brueckner and Whalen's 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 focuser on revenue

contribution/dilution4'z. Using "marginal cost" logic, Brleckner and Whalen falsely assume any

"high" interline prorate 5uboptimizes joint revenue. Most KLM,Northwest alliance fares in the 90s

might have been lower than most alternative interline tares, but rational, protit-maximizing airlines

{alliance or other) will vary these levels based on tpe(ific opportunity costs and market conditions.

Carriers with "high" prorates may be maximizing profjts bared on opportunity cost ol connecting

tral{ic {rom other routes. Connections over hubs with capacity limjts and high local fareg (London,

Tokyo, New York) will have high prorates (to limit yield dilution) regardless ofwhether these are set

on an immunized alliance arms-length codeshare or traditional interline baris. Connedions over

hubs with ample capacity and low local fare5 (Bangkok, Amsterdam, lo5 Angele5) are rationally set

at lower levels. "Hi9h" prorates in very tiny interline markets may be entirely rational in the sente

that the added pri(in9 and revenue management costs needed to maximize joint tralfic in each of

the thousand5 of these markets could easily exceed the potential revenue gain. International

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

and cancel arrangements that are not profitable.

r The Brueckner^Vhalen claim that there are behavioral barriers to optimal non-alliance prorate retting

was never true, and is in fact a claim that market (ompetition does not work. They claim that nonaligned carriers are incapable ot improving or optimizing prorate levels even in the fa.e of evidence

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

'" Rrucckner (2001) claims rhat his noncooperarive process is bascd on hisioricnl IATA practiccs. bLrr then quorcs Douganis

lt985l FIrnlS! OIJ Cour'!. saling lhat (even b) I985)majorairlines almost neverLrsed lAr^-derived prorare lbrnrulas.

Brucckner (2003a)p. 108 also notcs rhat mosr irrterline l-arcs arc in fact bascd on'special prorate agrecmcnts dral do not

lbllow his nrodel ofscp rolc lcg prorales set in isolation ofwhar interlire partncrs are doing. and roralll. conlradicts thc '\nravoidable e\ternaljty claim when hc adniis rhat those agrcenlents ma]- produce fares nor nruch higher than ihose

obser!cd under anritrusl inr unit)". 'l$orkcde\rensivel!\\ilfiSNBrussclsAirlincs.lvhichber$ecn1002and2009$asnotanrembcrofantallianc

i5 dilLrenl Opes ofintcrlinc agreemeoc rvith oler 80 airlines. all adminisrcrcd nanualh- AII agreemcnrs capable ol'

gencrnting significant traffic flows werc carclull) d€signed $irh rcspect ofihe comperitive pricing situation in the inrerlinc

O&Ds. and the local demand levels and patterns (ime ofday, da) of week. scasonal) on each allected flighr leg. Pfoftfcs

\!crc nol fixed by routc. bul varied wilh lhe booking classcs Lrsed. so $at parrnefs nrainlained full lbiliiy to limit inlcrline

sales that would dilule rields. Defirult" pnxilcs were used in lo\v-!olurne cases. bul lhese rel'leclcd lle opportunil\ costs

ofcapaci$ on individual SN flighls. nor dishnce based fonnulas. ' -opponunit\ cosi is lsed in its relcnuc nranag€menr conrc\r here: rhe opponunit) cost ofan) potential nc$ traftic flo$

is the revcnue from rhe rraffrc it mi-sht displacc: carrien \yould al\vals set prorates h;ghef than the opportunil) cosr" letcl.

Wirh bw load faclors. rhis opponunity cosr approaches zero. Actual evaluations $ould be based on a range ol-l-acron.

including seasonalit) and how revenuc nranagenient s,vstems actr6lly allot invent{xy to d;fferent lare categorirs.
Horan BAAA Supplemental Comments 8 January 2010 l.l

models of dynamicompetitive markets that apply well to every other category ot airline pricing

suddenly break down at the door of the interline pricing department.

Lr Thi5 behavioral theory of competitive markel failure rests upon the unsubstantiated assertion

that at all non'alliance airlines, the procers of establishing leg prorates is completely isolated

from any consideration orpublication ot joint interline fares. "Neither carrier considers what

effect setting a high prorate would have on the other"4r The authors explicitly assume that

online fare retting is efficient, which implies they believe that online fare setting {ollows

rational prolit maximizing criteria, and is rapidly adjusted in the face of new information

about the marketplace. However they offer no explanation of why rational, profitmaximizing logic cannot be applied to interline pri(ing

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

carrier operates hubs, and its pricing statfs understand the pro.ess ol prorating thru fares

across connecting hubt, and how prorate lormulas aiJecthe profitability of the various longhaul and short-haul legs at the hob. Thus they would have a very strong onderstanding oJ

how any given prorates or joint fares would affect the profitability of a potential interline

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

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

management and route profitability systemg, airline rtafft have detailed inJormation about

leg (ontributiont, can establish the "opportunity (ost" of any potential new revenue flows,

and can readily understand how other airlines would value these interline opportunities."'

r Brueckner and Whalen'5 theory of structural barrie6 causing (ompetitive market Jailore cannot be

accepted without substantial reaLworld exampies oJ (arriert relusing to introduce or adjust

prorater to levels that would increase total revenue contribution. As noted above, the existence of

inlerline fare! that are higher than online or alliance fares does not demonstrate ruboptimality, as

there could be many rational reasons for maintaining "high" prorates in these cases. The inability of

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

many (ates where there is no jointly beneticial 50lution.

: Whalen's analysis illustrater lhat interline negotiations normally only have a limited set of

jointly beneti(ial 5olutions. He presents a detailed comparison of hypotheti(al allian(e and

non-alliance interline negotiations, 5howing the full range of possible prorates that would be

pro{itable for both carriers,a5 In Whalen's example there i9 a narrowerange of solotiong

bene{i(ial to both carriers in the non-alliance cage because of the structural "double

marginalization" costs he has assumed, but a similaresult would hold if the assumed higher

costs were due to higher "opportunity costs" oJ displacing high yield traffic, and there would

ceriainly be carer where "opportunity cost" differentiab lead to higher alliance versus nonalliance prorales. lrrational suboptimization would only oc(ur iJ there was a consastent

pattern where non-alliance carriers failed to achieve recognized opportunitie5 beneficial to

both carriers existed, consistently reducing their own pro{its. His example assumes pri<e in the

interline O&D is 3-4 times greater than <ost, while in the real world airlines evaluate traffic

options with only razor-thin margin. In that world the opportunitie5 to improve joint profitt

via lower prorates would be rare, and it would be entirely rational to turn down most

reouest5 to lower ororates,

" whalen (2003) p.i. In ccnairr situations. caniers might mtionlllr- sct del:uh proratcs in isoiation .bascd on rlre

opponunir) cosB on a rout.. USAir$n)s mighl have a defauh prorare available for ilr midda) l-os Angcles-Las Veg s

night available to trdnspacific canien \!irh moming ari!als ar Los Angeles inreresled in sclling rhe conneclion. and Si!err

Dlodern revenuc managemcnt systems rhis default proraie might bc very close to an oprimalev€1. Bul fie -double

0urginalizarion" lheory spec ificall), clainls that USAiNals $ould r€iirse to alter lhis promte. evcn if a transpacific carri€r

proposed an alternative thar would be more profitablc lbr USAirways.

" Ihe autnors make passing refcrcncc to _double narginalization" in thc literature on ncgotialion within vcnical industrics.

bul rhis is largely focuscd on llflns that have very limired irfonnation abouthe cosrs. internal operations and profitabilil)

ol conlpetiiors. condilions that do nor apply ro aviarion. lronically. thc aulhors apply thc low-corrpetitive inlbrnlation

conceptof double narginalization toan anallsis based on DBlA. a comprehensive dalabase thal providcs competilors

$ilh near-perfect information aboul pricing in eleq signi|cant marker-

" \\'halen (:00i)p. l.l-15 and Figures 1.2 p-]5
Horan BAAA Supplemental Comments 8 January 2010 15

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

prices following the approaches theorized. None of the hundreds of non-aligned airlines ln the

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

efforts to minimize or overcome the huge ($200'250 per ticket) competltive priclng disadvantaqe it

i5 alleged to create.

D3. The market issues that Brueclner atd Whalen have imoropejf eltlbqted tllMlua barriers and

"Do]]blc l4alSbaljzllja Lbe readily exolained bv factori unrelated to antitrust immunity

. Brueckner and Whalen's papers have totally mitcharacterized the actual nature oJ the efficiencies

achieved by the orlginal 9Os North Atlantic alliances. As di5cussed in section B, real consumerwelfare enhancing benefits were created, but they were strictly of function of the unusual

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

vs. interline" price benefit, but more lmportantly, there was the marketing/distribution e{ficiency

opportunity created by the large size of the category (3) nlche. The size of the market, combined

with the size of the KLM-Northwest pricing advantage created the opportunity to quickly and

cheaply establish powerful brand awareness among frequentravelers and travel agent5 in all of

these many non-gateway cities. KLM-Northwest had no efficiencies allowing them to determrne

profit-maximizing levels of connecting tares any better than code5haring ornon-aligned carrlers

on initially entering the large 5et of category (3) double-connect markets, they did exploit brand

marketing effi<iencies, but these were the same efficiencies any hub network operator would enioy

against point-to-point competitors46, and were not a unique function oJ antitrust irnmunity

. To the extent that there was a historical obstacle limiting the spread of interline fare5, it had nothing

to do with alliances, but wa9 due to the major economic diJJerences between 5horthaul and

longhaul flights. Prorate formulas-the 1960's IATA fofmulas, the formulas currently used in every

carrier's pri(lng and route profitability systems, and everything in between-all attempt to reJlect

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

shorter Jlights, rnore rapidly than unit revenues do in the vast majority of markets Prior to

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

creating structural profitability problems for local service carriert, and artiJicial advantages for trunk

carrie15 operating longhaul routes. The problem can be seen today within the route profitabillty

reports oJ hub operators, most clearly at large European hubs like Amsterdam or Frankfurt that

have a distinct mix of short 60-90 minute {lights, and longhaul intercontinental flights, where

shorthaul fights carrying signiJicant connecting traflic will appear very unprofitable, while the

longhaul connecting flights appear highly proJitable.4t The obstacle here is that it k extremely

diJJicult to find jointly beneficialjoint Jares in longhaul-shorthaul situations, where the very low

shorthaul prorate will rarely approach the opportunity cost of alternative local or short_haul

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

through this barrier becau5e o{ an ability to internalize "double markups" as Brueckner and Whalen

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

parallel network5. In each case partners had equivalent longhaul operations and equivalent

5horthaul feeding {lights, so there was no "big prorate vs. small prorate" or other type of structural

ifirbalance. Desoite the oroven suc(ess of the North Atlantic alliances, this model has not been

$ The inhial KlM-Northwest !e|sus i erlinc competirion ras analogous to a rrew hub cntering nafkers preljously ser\ed

bl- fragnrented point'to poirt ilighls. ri ln one ofrhc firsl KLM-Norrhwesr alliance nerlvork nrcetinss I attended. wc norked \vith our KLlvi counterpais lo shoN

thenl thal lhc Anisterdanr- I Ieathro$ roLrre was not the biggcst money losing route on theif s)stcnr. and $h) Lhc ctrtbacks

rhe) $.ere plaDning would be highly danaging to profitabilil). Tlreir llealhfow roure P&l- accounting dara rvas accurate.

bur did nor sbow the !aluc ol longhaul connecting revenue ihaL would be lost if llights !tere cut. Scveral years htcr. aliel

revie'ling similar route P&L dam. Sabena did elinrinarc irs B.ussels-Heathrct route. feducnr-q prulitabiliry b) tens of

millions of tJS dollars.
Horan BAAA Supplemental Comments 8 January 2010 lt)

duplicated in any other market, because the parallel market5 needed to ensure mutual benefits and

to facilitate cooperation between independent companies does not exist.as

f, ln the environment of the I990s, KlM-Northwest would have never been able to stumble onto

and figu.e out how to exploit this market opportunity without antitrust immunity,o' but

eJJective, ef{icient prorate and revenue sharing approaches for these types of parallel

alliances are now well understood, and could now be applied without immunity.50

r Codesharing at hubs between mainline and regional carriers turther illustrate5 the longhaulshorthaul prorate imbalance issues, and disproves the claim that productive international

alliances are lmpossible without {ull antitrust immonity- No regional operator could exist

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

solved with common ownership (a5 with American Aidines and Arnerlcan Eagle), but this

approach has many disadvantages and is now exceptional, and airlines have devised a range

o{ contract structures that can allocate market and financial risks in different wavs.

D4. Anticipatino the loint aooli!e!l's use o{ their regression rg5ltlts in the current ca!e, BrueckneMll

Whalen use their re9re55!q! larff(lellllg grCd efits in otjCl qilqblelllDq4ets, but d9

so ln ways that viglate the basic loqic of their "Double Maroinalization theory

Brue(kner and Whalen's theory 5ays that con5omer benefits from collusive alliance price5 will occLrr

totally independent of market and competitive conditions, beca!se every interline fare in every

market suffers from the same structural "double marginalization" cost problem, and thus any

immunity grant will internalize the problem, and will directly lead to lower fares. In Iine wlth the

presumed oniversal truth of this "immunity always lower fares l7-30%" clalm, their papers provide

two examples using their regression coefticientso predict future price changes in other markets

The Brueckner-Whalen (2000) analysis of a potential Eritish Airways'American Airlines al iance

took th€ 25% price/alliance correlation found in the original regression and then simplistica ly

claiming that the fare on every BA-AA interline ltinerary would immediately fall 25olo a5 soon

as immunity was granted, creating a direct annual conrumer welfare gain between $48 and

'b5 ml ron' .

L Brueckner (2003b) applies the same simplistic approach in reverse, taking a 2770 "benetit" rate

Jrom the later regressions, and then claiming that if the united-Lufthansa-SAS alliance

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

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

Applying coefJi(ients {rom these regre55ions tofuture cases in diffefent markets is only plausible lf

one accepts that none of the regression correlations were explained by 1990s market conditions and

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

these dubious conditions, the forecasting use of the <oefficients in these papers violated the logi< of

that theory.

" fofcramplc. a hlpolhctical inmunized alliance between LuRhansa and IhaiAir$als$ouldollifThainearl) 100

imporranl connccrins destnrations be) ond Lufihansa shub. bur Thai only operares a haDdftrl ofroutcs ar irs Banskok hut)

$here Lulihansa'Thai aUiance connections \rould bc neaninglirlly comperitive. Under a KLM-Nol1hwcsl.cvcnue sharing

approach. even with meralneLrlralit!. Ltrlthansa wotrld be saddlcd wirh a disproporlionate share oilo\ !alu. dnrlhlrul

prorates. \ hich might not only displace high-1a.c intl.l-lurcPcan shofl haul passengers, but longhaul passengcrs thar

Ltrlihansa could havc caried on its oun longhaul llights- With toda]'s sysrenrs, ajoirtl) pRrllL impro!ing s) stem could

cedainl) be designed, bLt even in the abscncc ol an) regulatory or antilrust issucs. lhe net Sains nright notjultilj thd

required in!estment.

" As with non clficienc] enhancing innovations, the inrponance of hck and the lack ofprior understanding oflhe lrLre

opportunify cannor be overcratcd.

" For discussions ofapproaches sec Ccllnran Research Associates (1991) A Stud) oi Inlernarional Airline Code Sharing.

DeDar-lment of TransDonalion Officc of Avialion and lnternational Econonr;cs 'ThedaiapresentedinlhepaperisliontheDOTDBIAtenpercentsample.andmusrbcn]trllipliedb)tentopro

fuil estimated marketplace impacl. None ol Whalcn s writirss aRer thc BA-AA anal)sis in re originaljoinl2000 papcr use

regression results as predictive ofimpacts in olhcr markcts
Horan BAAA Supplemental Comments 8 January 2010 17

. The 8A-AA forecast erroneoully assumes that every current BA-AA interline ticket is sold in a

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

made no ef{ort to determine what markets these passengers flew in, or whether they were

even paying higher fares than passengerr in other connecting markets were paying. Given the

broad market coverage of the existing KLM-Northwest, Delta-Swissair-Sabena and UnitedLufthansa-sAs alliances at the time this was written, it is safe to a15ume that the vast majority

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

alliance pricing, and the claim that all these BA-AA interline tickets were sold at rates 25%

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

. The Star Alliance (alculations assume that it the alliance lost immunity, none oI its current

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

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

incapable of establi5hing any type ol alternate (oderharing arrangement, but since they

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

prorates with markups over marginal costs, would do in isolation of th€ pricing situation on

any interline market, and would refuse to conrider any proposals lrom their former partners

to alter these prorates to levelthat would in(reare joint profits. Brueckner also calculated

transallantic consumer impacts using the 27% factor from his worldwide regression, instead

oJ the 21% factor from his transatlantic regressions, suggesting this analysis may best be

viewed as corporate advocacy, and not seriour academic research.

q5. Brue(kner and Whalen claiIDlhal "DoubLe Marginalization" is a stru(!Iali!!!qh[erent to allelqe5,

and that any and all new imqrqnitv qrants would create rimilar conrumer oains (due to the

internalization of thes€ bllfrelsli5_fu44aoentally false, and is col|l&di-c_ted by all available eviden(e

The Joint Applicanti (laim of publi< benelits in connecting markets totally depends on the claim that

"double marginalization" not only exists, but would have the powerful effect on consumer prices

(17-30% reductions, t200-250 per tiaket) any and every time a new grant of immunity was made,

regardless ofsupply or competitive conditiont in lhe rpe.ifically alJe(ted market5 at the time of the

immunity grant. Neither the Joint Appli(ationr in thi! case, or any prior appli<ants for antitrust

immunity, have submitted any proper, verifiable, non-5pe<ulative evidence oJ this alleged universal

cautalink between immunity and lower connecting fares except for citations of the

Brueckner/lvhalen articles dGcussed here. All other availablevidence directly contradictshe Joint

Aoolicants'claims.

In order to claim that the Brueckner^Vhalen regression coefficients can be used to predict price effects

in other, unrelated, markets, one must demonstrate that their regressions were able to surgically

i5olate the "cooperative alliance pricing" impad on interline prices from all other marketplace

factorr in{luencing these Jares, including supply levels, efficienq improvements, and the general

level of fares in the 70-95% of all markets 5erved by true online services. This would be an

artounding statistical caim, but it is not supported by any analysis 5howing similar pri(e effects in

any post-1999 markets, and it is not supported by analysis putting the allian(e impacts in the

(ontext oI the broader North Atlanti( (onsumer pri(ing 9ain5 that occurreduring the mid 905.

: lI one is to argue that these regression perfectly isolated the impact of "cooperative allian(e

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

benefits actually enjoyed by KLM-Northwest and Delta'Swissair passenge15 in the 90s, was not

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

concludeither that these immunity grants were the 5in9le most economically beneticial

decision in the history of aviation, or that the "double marginalization" coefficients cannot

be used in forecasts.

:, lf immunity grants really did drive these huge /.17-30%, $200-250 per ticket) type of price

reductions under any market condition, there would be ample evidence, in DBlA and other

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

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

r Neither Brueckner, Whalen, or anyone else has repli(ated these "17 30o/0" type results in any

regressions of any other markets. The analysis that hat been conducted shows absolutely no

evidence of "market-independent.ooperative alliance priaing" consumer benefits, and tends to

support the claim that conrumer benefits, if they exist, are not large enough to offset the consumer

wel{are losses due to redu(ed competition.

: James Reitzes and Dorothy Robyn of the Brallle Group, the authors of the Brattle affidavit in

this Joint Application, also submitted analysis on behalf of American Airlines in the Star I and

5kyteam I cases.t? These affidavits updated analyris oI transatlanti( market grolvth since the

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

2000.5r The new analysis found that the pro-consumer picing trendt oI 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. Prices had increased 210lo across the

entire North Atlantic {CAGR 3.5%) and 23% in category I double connect markets, despite

llat capacity. This suggested that whatever effi(iency/consumer bnefits had been generated

by the original alliances had been short-lived, and had been lully ofJset by increased pricing

power. lt also suggesled that the later Star Alliance immunity g.ants did not have the "17 to

30%" level efte(ts that the earlier alliances were alleged to have, and had no impad after

1999.

ii In the Continental/star Alliance case, The Department of Justice pretented original statistical

analysir oJ price differences in connecting North Atlantic markets based on OBl A data Jrom

2005 through 2008.5i The results directly contradicted claims of "double marginalization" and

immunity efficiencies. Interline tickets only comprised 7% of the total sample, suggesting that

interline only accounted Jor 3-4% of total North Atlantj( travel. The analysis found that

immunized allian(e fareg were 2.1% higher than online fare5 and 3.6% higher than nonimmunized aodeshare fares. This cootradicted the claim that immunized fares would be lower

than non-immunized codethare fare5 becau5e of "double marginalization" problems, and

lent further rupport to con(erns that the immunized alliances had developed market power

and were not maximizing consumer welfare.

- In the current cate the Department of Justice conducted funher new analysis of (onnecting

market fares based on 3Q2008 D81A data, with resultr {urther broken down by alliance

group.55 This confirmed the earller conclusion that current market data did not support claims

about "double marginalizatlon" and immunity efficiencier, and the DOJ specifically noted

that they "make no representation that fare dif{erences across tickets, as estimated by this

type of work, are in{ormative about causality between immunity grants and double

marginalization". The results found that Oneworld codeshare Jares were 1.6% less than

Oneworld member online Iares, undermining the Appli<antr (laim that immunity is needed to

redu(e artificially high non-immunized fares- The results also found that Skyteam immunized

fares were 7.2% higher than Skyteam non'immunized fares and that 5tar immunized Iaret

were 11.7olo higher than Star codeshare Jares.

r The argument "consumers benefit from international (ollusive pricing arrangements" is expli(itly

saying "consumers benefit whenever international competition is eliminated". It this were true, it

would require rethinking a great deal oJ antitrugt and industrial organization theory. But iJ each

new immunized alliance actually generated price cut! on the order oJ 17-30%, or $200-250 a ticket,

then the rethinking would undoubtedly be worthwhile.

r All of the availablevidence suggegtshat the two BruecknerAVhalen rgressionr failed to surgically

i50late "cooperative alliance" pricing eflects in connecting markets from the many other factors

influencing these prices. The observed correlation5 between "17-30% price reductions" and

"alliances" itnot explained by "the internalization oIdouble markups" which does not happen.

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

in section B, in(luding strong, profitable capacity growth, market liberalization, and efficiency

j: R.h)n. J.. Reiuer.J (.'0('5r :rnd. r'006rop. c r. ' DO-f, op.cii '- I)enJrlm(nr ofJu'ric(. Conrmcnrr on rh( Shor\ CdL\c Order. p .19.5 |

(.'n)nrenr, ,,frhc D(fannrenl ,,f lustiL(. p.::-r
Horan BA,AA Supplemental Comments 8lanuary 2010

grolvth. The original antitrust immunity 9rant5 undoubtedly contributed to these overall el{ects in

the mid 90s. but specific alliance pricing benetits would have been limited to one segment of the

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

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

r Since there is no demonstrated "universal market-independent cooperative alliance pricing" impact, it

is totally inappropriate to apply the coefficients oflhese two regressions to any other markets with

di{{erent supply or competitive characteristict. The Joint Applicants are specilically claiming that

regressions refleding the highly competitive, strongly profitable, high demand growth 1990s North

Atlantic can be used to predict price effects in 2010. This it the equivalent of saying that an analysi5

of the price impact ol new low cost carrier enlry onto marketsolely served by Legaq carriers in the

199os can be ured to predict the price impact of the entry o{ a low cost carrier onto a market

already served by other low cost .arriers in 2010, when the pricing and efficiency 9ap between low

cost and Legacy (arrierr wa5 substantially smaller than it had been. This is the equivalent of saying

that an analysis of the price appreciation oI Las Vegat hou5ing in the 1990s can be used to predict

the exact level ol housing appreciation in 2010. The Joint Applicants'Lrse of the5e regressions to

forecast {uture price reductionr is completely indefensible and the consumer benelit (laim5 based

on those "predictions" must be rejected,

E, THE JOINT APPLICANTS' CLAIMS OF S92 MILLION IN ANNUAL PUBTIC BENEFITS IN CONNECT MARKETS

MUST BE REIECTED. IT NOT ONLY FAILS TO MEET THE MINIMIMUM REQUIREMENTS OF THE HORIZONTAL

MERGER GUIDELINES, BUT THE CLAIM I5 DEMONSTRABLY FALSE,

E1. The Joint Applicant's Claim qf $92 million in anfual publiqbClefits in connect markcllLilentirely

based on twq demonstrably false assumotions. a|!d thus nurt be fejected in it5 entirety-

: The Joint Applicant's public benelit claim depends on the Ialte assumption that there are structural

"Double Marginalization" barriers to efficient non-alliance pricing that would be lound in any and all

non'alliance cases as there barrie15 are indeoendent of market or competitive (ondition5.

(r There have never been serious Strudural or behavior barriers preventing non-immunized

(arriers lrom setting rational, profit maximizing interline tare leveh; carriers do not set

prorates in total isolation oI interline markets and partne15 as the "double marginalization"

theory assumes, and do not refuse to consider more jointly beneficial alternative prorates

L] "Double markups" never existed becaure airline5 never price on a "(ost plos markup" ba5is;

L The general claim that "hi9h" interline prorates are evidence of structural barriers because they

are inherently suboptimal itfalse; there are many examples of rationally higher prorates, and

the theory is not based on any actual examples oJ irrationally suboptimal pri(ing;

: Etficient interline pricing can be managed at small airlines with limited aulomation, and i5 easily

managed via fare mapping at any carrier using modern revenue management tools;

: The marketing efficiency olthe original 1990s Nonh atlantic alliances had nothing to do with

pricing; the adual brand awarene55 and distribution efficiencies achieved are found in any

"hub network verrut point to-point" situation and were not uniquely caused by antitrusl

rmmunrty

. Histori(al limitations to more wid$pread interline pricing had nothing to do with the lack of

alliance5 or antitrust immunity but wa9 due to the inherent diffi(ulty oJ establishing jointly

profitable interline fares between longhaul and shorthaul operators.

r None of the statisticalnalysi5 in the Brueckner and Whalen papers demonstrates the existence

oJ "double marginalizatlon" orany related stroctural barriers or supports the claim that it is

the caute o{ higher non'alliance prices; there i! absolutely no empirical evidence that the

theorized structural barriers to efJicient interline pri(ing actually exast.

. The .,oint Applicant's public benefit claim dependg on the false assumption that non-immunized

interline fares are always higher than immunized alliance and online connecting fares in all

l9
Horan BAAA Supplemental Comments 8 January 20'10 l0

situationt, regardless oImarket or competitive conditions, and that these higher non-immunized

fares woold immediately {all to the lower immunized/online level opon grant o{ immunity

E The only legitimate histori(al case of consumer pricing benefits lrom immunity occurred in the

19909 in a specitic range oJ double connect North Atlantic markets that had no online service,

where new alliances prices were substantially lower than the previously available interline

pri(es; this benelit is only possible in cases where new allian(e servicenters an O&D solely

served on an online ba5i5; "interline-only" O&Ds 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 benefitr from this source.

E Erue(kner and Whalen's regression correlations between "alliad(es" and "lower prices" vastly

overrtate the claimed alliance pricing benefit, as their regregrions were not properly restricted

to the double'connect, interline-only marketg and included many markets that already had

online pricing. There were major consumer benefits realized on the North Atlantic following

the introduction of allian(er in the mid 90s, but mo5t were due to non-alliance {a(tors

including profitable capacity growth and hub expansion, market liberalization, increased

carrier efficien(ies due to fleet and technology improvements, and lower fuel prices. The

consomer beneJits due to alliance pricing in previously interline-only markets had been tully

exhausted by the end o{ the decade, and all of the availablemplrical evidence shows that

the consumer welfare impact oJ antilrust immunity grants since 1999 ha5 been negative.

r The Joint Applicant's' provided no evidence that their (urrent non-immunized codeshare and

interline fares in any given market are higher than competitive online and alliance tares,

mu(h lers eviden(e showing that they are 17.45% higher as their testimony <laims; Neither

the Joint Application or the Eroeckner and Whalen pricing theorier are supponed by any

empirical evidence that noo-immunized (arriers publish higher fares than online and alliance

carriers in any given market, and the claims of structurally higher non-immunized fares would

contradict all hGtorical evidence that airline5 with comparable products cannot surtain higher

than "market" fares in competitive O&Ds.

- The Joint Applicants'claim that non-aljian(e fares are stru(turally higher than allian(e fares is

based on the false assumption that all of these competitors set fares on a markup basis

relative to a marginal cort-type measure; il this were true, airline lares would fluctuate wildly

with volatile input costs such as Juel. lf a given interline fare was rationally profit maximizing

prior to an immunity grant, it would irrational to redlrce it after an immunity grant. Since

there is no evidence that current fares are irrationally 9et above profit'maximizing levels,

there is no reason to believe that an immunity grant would tystematically reduce fares.

_ There is no empirical eviden(e of any fare redu(tions dire<tly attributable to any antitrust

immunity grant in the lart decade, and certainly no evidence o{ Jare reductions of the 17 30%,

t200-250 per ticket magnitode suggested by the "double marginalization" theory and

claimed by the Joint Applicants.

t Since the Erueckner and Whalen theories and regressions donot justify the "universal marketindependent cooperative alliance pricing" impacts claimed by the Join't Applicants, there is no

basis Ior u5ing coellicients trom those regrestions as the basis ol predicting such alliance

pricing impacts in today's market.

L2. Th€-bidApp[eent'r claim 9J. S92 million in annual oublic benefits complclqly ]fails t9lleet the

evidenliarv stand?I!bg[ ]tiqlle!:izontal Mcrgglil{klelines. and must bejqielled in its entifet!

r The Joint Applicants have failed to provide proper, veritiable, non-speculative evidence that the

claimed structural "double marginalization" barriers to efficien(y actually exist

. The cited Brueckner and Whalen "double marginalization" theories do not constitute legitimate

evidence of actual barrie15 to airline efficiency

E The cited Brueckner and Whalen "double marginalization" theorie5 are not supported by their

own empirical evidence or any other independent analyti5 showing tystematic barriers to
Horan EAAA Supplemental Comments 8 January 2010 21

non-immunity pricing efficiency, all of the assumptions underlying the theory can be plausibly

challenged, and there are highly plautible alternate explanations for all ot the evidence they

cite in support of their theory

! The credibility of the theory must be questioned {urther given Brueckner's longstanding role as

a paid advocate for another airline with similar interests in reduced competition among

internataonal airlines

- The Joint Applicants'failed to provide any other evidence supporting their "double

marginalization" (laim.

. The Joint Applicants have failed to provide proper, verifiable, non-speculative evidence that the

proposed immunity grant would lower prices in the specific markets served by the applicants, under

cUrrent market Conditions.

E The Joint Applicants provided no evidence that the current interline pricing tunctions of British

Airways, American Airline5, Finnair, lberia or Royal Jordanian actually 5uffer f.om any oI the

structural inefficiencies implied by the "double marginalization" (laim

The Joint Applicants provided no evidence that their current interline pricing is <urrently above

online or alliance levels in the markets where it currently provides service

r The Joint Applicants provided no evidence ol any specitic consumerwelfare enhancing price

reductions it would make in any market it currently serves following a grant ol immunjty, and

no evidence that these mergeFspecific changes would create $92 million in annual public

benefits.

r As hat already been shown in the comments of the Department of Justices6, the .Joint Applicants

provide no proper, verifiable, non,spe(ulative evidence that it would be unable to provide the

alleged consumer pricing benefits in the absen(e of a grant of immunity, although this point il

mooted by the lack of evidence for the alleged consumer pricjng benefits.

. At the DOT has acknowledged on many o(casionr, the law places the burden of proof on the (arriers

requetting exemption from the antitrust laws; this burden has clearly not been met.

Re5pectfully submitted,

furA 2k*,^

Hubert Horan

8 January 2010

:6 DOJ conrnrenrs. DOT-OST-2008-Ol5l-ii74 p. 22-28