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. I amfiling

these comments

in response

to the Department

o'f Justice filing at DOT-OST-2008-0252-3374. These are supplemenlal

to commenl5

| originally

{iled on 15 October 2009 under DOT-O5T'2008-0252-3362
During my 25 year aviation career I have done consulting

work with over

30 airlines

andheld airline management

po5itions with Northwest,

America West, Swissair and Sabena. I have signilicant

experience in international

airline competition

and the actual

operation

and economic5

of airline

alliances.

While at Northwest

I was personally

responsible

for the original

development

oI the KLM'Northwest

Alliance network andintroduced

the intense

hub-to-hub

operations

that allowed

Northwest

to become

the most pro{itable

US (arrier on the North

Atlantic, and establjshed

thetemplate

followed

by all of the subsequent

alliance networks.

I spent four yeart at Swislair-Sabena.

including

thetransition

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 theyears

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 bythis (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 staldlldsof the Hotizontal

MergerGuidelines

demons:rating

ao!\sumer

benelits in nonstop

and connectingl[l!le$ tioniJicantly

greater thanany

ri5k5 of reduced

comoetitjon

in nongtoo

or(onnectinq

markets

. Applicants

for antitrost

immunity

murtprove

that immunity

"is necessary...to

achieve important public benetitr"

that "cannot

beachieved

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

MergerGuidelines

defines the evidentiary

standards

that must be met: ! "[the applicants]

must substantiate

efficiency

claims o that theAgency

can verify by reasonable

means the likelihood

andmagnitude

of each asserted efficiency,

how and when each would beachieved

(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 IHoran

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 NorthAtlantic 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 bytheJoint

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 verifiable

vidence

presented

bythe Joint

Applications

in delense

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 theWillig/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 theWillig/Compass

Lexecon (laims, the only eviden(e supponing

theJoint Appli(ants

competition

claimr. d My O(tober

testimonyro

demonstrated

thatthe 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 theWillig/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% fareincreare

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 theWillio/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 this su bnr iss ions refer to public vers ions : pagiDar ion mar- van sl igh l l) liornconildentia

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,

results upported

the DOI lindings of <onsumer

rGks, and no longer supported

theJoint Applicants'claims.

The DOJ submission

altopretented

HerfindahlHirrchman

Index ("HHl") measures

oI competition

5howing thatthege

nonstop markets are afready highly<on(entrated,

and that under

the Horizontal

Meryer Gurdel,nes

turther reductions

in competition

(ouldbe presumed

to create

additional

market power.

. The Joint Applicantr'

(laim that immunity

would lead to increased

capacity inthese markets does not meet Horizortal Meryer Guidelines standards

as it is purely

speculative

(the Joint Appli(ants

ay they would look

seriously at capacity

increases

but have made no (ommitments),

butthe 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' $92milliq! ]PlrUljqBcl€lf]1llaimt arethe 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 theJoint Applicant's

claim that immunity

would (reate $92 million in publia benelit', but argued

more narrowly thatthese

benefitt could beachieved

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

of any 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 farereductions

ot 17.45o/d;

tl',is magnitude

oJ farereduction

would occur in any market, independent

o{ any other factors. These price reductions

can beassumed

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 allAA-BA"/AA'lB

interline passengers

identiJied

in the 2007

DB lA data, and further increasing

' 1he Joinl Application

shows (Supplelnental

Conrnenrs

p.5) that he Dallas-Fl.Worlh"l-ondon nurkel alread) has 8 tinies
asnlan! 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. butthese 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

beeroded

or competed

away bythe 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. Thelater

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

thatthe DOT

murtcompletely

reject heJoint

Applicants'

claim of $92 million in public benefits in (onnecting

markets as it not only

fails to meet the evidentiary

standards

of the Horizontal

MergerGuidelines

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 andmarket

studies, but also based on myexperience

as one of the key

people responsible

tor the development

of the original

KLM-Northwest

alliance network,

my subsequent

srategic andnetwork

alliance workat 5wi55air

and other carrier5, and other work throughout

my 25 year career directly relevant to the competitive

issues raised bythis 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

beemphasized

that, while these comments

will lo(us

heavily on the Brueckner/Whalen theories andpapers,

the issue at hand is claims made bytheJoint

Appli(ants,

not by Brue(kner

or Whalen perronally,

neither of whomhar

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 of one journal arti(le published

by Brueckner

and Whalen in 2000'6,

and several follow-up

pieces bythe same

authors offering minor updates on the original

paper. That original paper outlined the material

thatwas repeated,

with minor

modifi<ations,

in allsubrequent

papers, including E A statement

ot the general

hypothesis

thatthe "cooperative

pricing" lowers airfares in connecting

markets; each paper specifically

noted that con5umer

benefits from lower

aartares in these (onnect markets could beoffset

by redu(ed

competition

in hub-to-hub

nonstop markets, and thatthe 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 andnon-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 uithdre 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 andnonalliance, maximized

the difference

between marginal

revenue andmarginalcosts,

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 notface,

solving these equations

(not surprisingly)

demonstrated

that non-alliance

interlining

was always less profitable

thanalliance

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

oI the 2000

paper, and should not beseen

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 coefficients

o 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 exact

radeoff depended

on price elasti(ity assumptions. Brueckner

(2001)" did not undertake

any regrersion

analysir, butJleshed

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 thefirst

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

in connecting

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 {actors

uch as lenoth oJhaul or local route characteristics,

although

p;neldata

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 Antirrusl

nr nr unitt lbr lntemal

iona l Passcngefs.

\! ilh an Applicarion

ro fheSrar

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 SliesTreatics

in InremarionalAviarion

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

years before and earlier workig 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

antitfustimmunity

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 thetable

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

behindgateway 1 5-18% Transatlantic+Central America 52% US Canada (8%) US-South

PaciJic 0olo IJS South America/North

A5ia 3Q99 (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% totaldatabase 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, andBrueckner

har argued thatthe 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 arenot 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

bytheJoint

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'OSI100.1- 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

BY THE 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

andpricing

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 hadnonrtop

or trueonline

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 oftenpoor,

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 alsoprovided

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

butwas 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 hadbeen

exclu5ively

served on an interline

basis ! The new alliances served a significant

amount o{ category

(2) traffic, butthese

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

andincreased

competition

on the North

Atlantic; evidence of consumer

benefits (so5tainable

lower fares/increased

service due to improved

industry eJficiency)

i5 not 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

wasdue to lavorable

overall industry supplykonditions

and was not alliance

related. Thegraph 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 wa5noHoran

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 wasfundamentally 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 hubsinthe Us kesulting

{rom deregulation

based changes

in the 80s),

major lmprovements

in European (arrierefliciency

(including

the privatization

of British

Airways.

and the consolidation of the Air France-UTA

ir Inter hub in Parit, major improvements in distribution

and other information

technologies,

and the widespread

introduction

of 767 and A330aircraft

that made it possible

to operate

a much wider range

oJtransatlantic

{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(antconsumer

benefits

depended

on the convergen<e

oJthree 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

likethe 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

marketopportunityi

prior to KLM Northwe!t,

no one had re.ognized the size of this segment

(individual

O&Ds w€reextremely

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

strongmarketawareness in every US and European

"beyondgateway" market that KLM Northwest

ol{ered a full range

of flightsat competitive

practi.es

to every

signilicant

ransatlantic

destination.

The 3Lrccess

of KLM

' I rras pcrsonalh

rcspofsjble

tbr e\parrding

alliance hub,ro-hLrb

llighrs iiorrr i lo l0- rll 7.17s

andDC,l0(. a I of\ hich $cre hi-ehl)

profilrblc-

ls par1 ol a conscious

srrares\ ro e\pk)illhe 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.

andrcndcred

\onh Allanlic

inre.line senice 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 (viaadditional

alliances

or expanded

dire(t services)

and forces

other capacity

out of the rnarket,

and interline

service had become

tota ly irrelevant

on the NorthAtlantic 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,

whichshifted

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 haltedby 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 oJthi5 may havebeenartlficially slrpported

by the recent

financial

bubble.

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

in c.rlegor\ : nrarkcrs

Lrsed irte'1inc ibte.d of a\rilrblc online

orarkers

l he Depannrent

ol JUsrice

s recenr 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 alliance

xpansion,

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 inthe 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, butthe fegre55ions

provide absolutely

no empirical

data supporting

thetheoretical

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 inthe graphs

in the previous

section, transatlantic

capacity grewrapldly

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, butthe huge

increales

in nonstop

and trueonline (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 alliance xpansion 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 andprices.

All ol Brueckner

and Whalen's

papers explicitly assurne thatthe "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 a very large number ot category

(2) connect markets-r0

Category

(2) is the most

competitive

category o{ rnarkets

on the North

Atlantlc sjnce they can beserved

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 thenan 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 ' DOTT-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).

burinclude

aU orher category (l) onc-srop

nrarkets '' Calegory

i markels

can onlt be served

bythe three alliances.

and categoD l ma.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

arebeing

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 alsonot 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, botthey aremeanlnglers

in any 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 trueonline

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, butthe papers made no attempt

to pla(e their "l7 to 30% lower price" type contumerwel{are

conalutions

in any type of meaningful

context. There is nothing

in any of the papers

thatwould 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 andmarkets,

the authors made no attempt

o 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

bythe 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, butfrom an economi(s and policy

standpoint,

it is much

more important

to understand

what the actual

historical

consumer weltare gain Jrom antitrust immunity

hadbeen,

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.

Notall 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

bythe end

of the decade.r'

'r See for erarnple.

Robyn. J.. RcitTes.J.

(2005) untir

ledpaid anal) sis ot tfieSk)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

OFIMMUNIZED

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 wouldbe intheir

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

of the prorate

levels ol connecting

airlines, or any consideration

of the 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(hdoes

not maximize

joint profit"r'.

The two interline

<arriers aremaking

"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

andnon-allian(e interline services, the non-alliance

equation

incloder the efficiency

penalty ot the "double marginalization"

and is always less profitable.

The internalization

of this "negative

externality",

is not just a usetul feature, but is lhe primary

benefit oJimmunized

airline alliances.r'
r The alleged efficiency

penalty of non-alllan(e

"double marginaljzation"

i5 claimed 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

allwage and benefit expenset.re

The Joint Applicants

are claiming benefits of $257 per ticket in this case (applying

the smaller regrerrion

gapbetween

allian(er and existing codesharer

to higher

2007 fares). lf t200-250 per ti(ket price

redu(tions

actually o(curred

in the market

every timeairline5

received antitrust immunity,

there would be ample

evidence {rommultiple

source5, andimmunity

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 to optimal

non, allian(e interline pricing that do not exkt andignores 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 allprevious

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 salsthalrhc

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. burWhalen

(1007) delelcs al1 references

to pricing

po$er. bu otlers

no ahemare

xplanarion

forthealtcgcd

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.atingHoran

BAAA Supplemental

Comments8January2010 l3
assumed independent

noncooperative

processes

with {;xed

(per roote) mileage ba5ed prorates (derived from IATA

pradices)

were abandoned

ecades 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 arenow easily

linked to both carrier'r inventory

5y5tem5; prorates (anvary 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 thatfares

are set with respect

to competitive

"market prices" andnotwith resped

to internal

<ost measures.

The entire claim ot "double marginalization"

is based on "markup5"

above marginal cost, butthe 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 androutings.
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 andhighlocal

fareg (London, Tokyo, New York) will have

highprorates

(to limit yield dilution) regardless

of whether

these are set on an immunized

alliance arms-length

codeshare

or traditional

interline baris. Connedions

over hubs with ample

capacity andlow local

fare5 (Bangkok,

Amsterdam,

lo5 Angele5) are rationally

set at lower levels. "Hi9h" prorates

in very tiny interline

markets may beentirely

rational in the sente thatthe added

pri(in9 andrevenue

management

costs needed to maximize

joint tralfic in each of thethousand5

of these markets could easily exceed the potential

revenue gain. International codesharing

andinterline

prorate arrangements

have always been highly dynamic,

as carriers adjust and cancel arrangements

that arenot profitable.

r The Brueckner^Vhalen

claim thatthere

arebehavioral

barriers to optimal

non-alliance

prorate retting
was never true, andis in fact

a claim that market

(ompetition

does notwork.

They claim that nonaligned carriers are incapable

ot improving

or optimizing

prorate levels even in thefa.e of evidence that existing

prorates do not maximize

joint revenue.

Thus thetheory

agsumes thatthe 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 arcin 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$asnotanrembcrofantallianceburhnd
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 thelocal 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 howrevenuc

nranagenient

s,vstems actr6lly allot invent{xy

to d;fferent

lare categorirs.Horan

BAAA Supplemental

Comments

8 January

2010 l.l
models of dynamic

ompetitive

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

or publication

ot joint interline

fares. "Neither carrier considers

what effect setting a highprorate

would have

on the other"4r

The authors explicitly assume that online fare retting is efficient, which implies theybelieve

that online

fare setting {ollows rational prolit maximizing

criteria, and israpidly

adjusted in the face

of newinformation about the marketplace. However they offer no explanation of why rational,

profitmaximizing

logic cannot be applied

to interline

pri(ing

c Hub complexity

cannot he source

of the alleged

structural

problem;

every large international carrier operates

hubs, anditspricing

statfs understand

the pro.ess

ol prorating

thru fares
across connecting

hubt, andhow prorate

lormulas aiJect he 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 orjoint fares would affect the profitability

of a potential

interline partner, and could negotiate

jointfares

within ranges

thatwouldbe proJitable for both carriers. Information

cannot bea serious

issue; thanks to highly

sophisticated

yield management

androute

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 arehigher

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 onjoint 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.

Hepresents

a detailed

comparison

of hypotheti(al

allian(e and non-alliance

interline negotiations,

5howing the full range

of possible

prorates thatwould

be pro{itable

for both carriers,a5

InWhalen's

example there i9 a narrower

ange 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 similar

esult would holdif the assumed

higher costs were due to higher

"opportunity

costs" oJ displacing

high yield traffic, and there would ceriainly becarer where "opportunity

cost" differentiab

lead to higher

alliance versusnonalliance 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. Inthatworld

the opportunitie5

to improve

joint profitt via lower

prorates would be rare, andit would

beentirely

rational to turn down most reouest5 to lower ororates,

" whalen

(2003) p.i. In ccnairr

situations.

caniers might mtionlllr-

sct del:uh proratcsin 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 oprimal ev€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

about he 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 orjoint 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, realconsumerwelfare enhancing

benefits were created, butthey 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 frequent ravelers and travel agent5 in all of these many non-gateway

cities. KLM-Northwest

hadno efficiencies

allowing them to determrne profit-maximizing

levels of connecting

tares any better than code5haring

or non-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

thatthere

was a historical

obstacle limiting the spread

of interline

fare5, it hadnothing
to do with alliances,

but wa9 due to the major

economic

diJJerences

between 5horthaul

and longhaul flights. Prorate formulas-the

1960's IATA fofmulas,

theformulas

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 reflect

he underlying

cost curves, creating structural

profitability

problems

for local service carriert, and artiJicial advantages

for trunk carrie15 operating

longhaul

routes. The problem can beseen today within the route

profitabillty reports oJhub 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 thevery 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 notthe biggcst money losing route ontheifs)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

!terecut. 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 havenever

beenable

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 hubsbetween

mainline

and regional

carriers turther illustrate5

the longhaulshorthaul

prorateimbalance

issues, and disproves

the claim

that productive

international alliances

are lmpossible

without {ull antitrust immonity-

No regional

operator

couldexist 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 canallocate

marketand 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 fromcollusive

alliance price5 will occLrr totally independent

of market

and competitive

conditions,

beca!se every interline farein 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 theirregression

coefticients

o predict

future price changes in other markets The Brueckner-Whalen

(2000) analysis of a potential

Eritish Airways'American

Airlines al iance tookth€ 25% price/alliance

correlation

found in the original

regression

and then simplistica

ly claiming thatthe fare

on every BA-AA interline ltinerary would immediately

fall25olo a5 soon as immunity

was granted, creating a direct annual conrumer

welfare gainbetween

$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 to future cases

in diffefent markets

is only plausible

lf

one accepts

that none of the regression correlations

were explained

by 1990s

marketconditions

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

s hub. bur Thaionly operares

a haDdftrl ofroutcs ar irs Banskok

hut) $here Lulihansa'Thai

aUiance connections

\rould bcneaninglirlly

comperitive.

Under a KLM-Nol1hwcsl.cvcnue sharing approach.

even with meralneLrlralit!.

Ltrlthansa

wotrld be saddlcd

wirh a disproporlionate

share oilo\ !alu. dnrlhlrul prorates. \ hichmight

not only displace

high-1a.c intl.l-lurcPcan

shofl haul passengers,

but longhaul

passengcrs

thar Ltrlihansa

could havc caried onits 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 netSains

nright notjultilj thd required in!estment. " As with non clficienc] enhancing

innovations,

the inrponance

of hck and

thelack ofprior understanding

oflhe lrLre opportunify

cannor be overcratcd. " Fordiscussions

ofapproaches

sec Ccllnran Research Associates

(1991) A Stud) oi Inlernarional

AirlineCode

Sharing. DeDar-lment

of TransDonalion

Officc of Avialion

and lnternational

Econonr;cs 'ThedaiapresentedinlhepaperisliontheDOTDBIAtenpercentsample.andmusrbcn]trllipliedb)tentoproducethc fuilestimated

marketplace

impacl. None ol Whalcn

s writirss

aRer thc BA-AA anal)sis in re originaljoinl2000

papcr use regression

results aspredictive

ofimpacts

in olhcr markctsHoran

BAAA Supplemental

Comments

8 January

2010 17

. The 8A-AA forecast erroneoully

assumes that every

current BA-AA interline ticket is sold in a market hat has no existing

online or alliance

interline service. Infact 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 thetime

this was written, it is safe to a15ume

that thevast

majority of this traflic, perhaps over 90% was in markets

that already

had the benefit

on online

or alliance pricing, and the claim

that allthese

BA-AA interline tickets were sold at rates 25% higher thanones

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 onlybe

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 levelt hat 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,

andnot 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 timea new

grant of immunity

was made, regardless

of supply

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 cautal ink between

immunity

andlower

connecting

fares except for citations

of the Brueckner/lvhalen

articles dGcussed

here. All other available

vidence directly contradicts

heJoint Aoolicants'claims. In order to claim thatthe Brueckner^Vhalen regression

coefficients

can be used to predict

price effects in other, unrelated,

markets, onemust

demonstrate

thattheir 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 bytrueonline

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 occurred

uring the mid905.

: lI one is

to argue thatthese

regression

perfectly isolated the impact

of "cooperative

allian(e pricing" from all other possible factors, then onemust

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 conclude

ither that these

immunity

grants were the 5in9le

most economically

beneticial decision in the history

of aviation,

or thatthe "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 wouldbeample

evidence,

in DBlA and other industry databases,

that one could use to support

he 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"

typeresults

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 hadbeen

performed

bythe DOT

in 1999 and 2000.5r The new analysis found thatthe pro-consumer

picing trendt oI the 1990s

hadbeen reversed,

and that the greatest

1999-2005

price increased

had come in the connect

markets predominately

served by carriers with antitrust

immunity.

Prices hadincreased

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 bythe original

alliances hadbeen

short-lived,

and hadbeen

lullyofJset

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 thatthe 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 oJprice 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 thetotalsample, 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 thanonline

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

thatthe immunized

alliances had developed

market power and were not maximizing

consumer

welfare.

- Inthe current

cate the Department

of Justice

conducted

funhernew

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

bythis type of work, arein{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

theAppli<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 thanSkyteam

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 newimmunized

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 available

vidence suggegts hatthe 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"

it not explained

by "the internalization

oI double

markups"

which does not happen. The correlations

arelikely

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

onrh( Shor\

CdL\c Order. p .19.5 | (.'n)nrenr,

,,frhc D(fannrenl

,,flustiL(.

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 fullyexhausted

by the tate 90s, as"online"

schedule and pricing options expanded

from60-70%

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

of lhese 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 growth1990s

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 markets

olely served by Legaq

carriers in the 199os can be ured to predict

the price

impact of the entry

o{ a low cost

carrier ontoa market already served by other low cost .arriers in 2010, when the pricing

and efficiency

9ap between

low cost andLegacy

(arrierr wa5 substantially

smaller than it hadbeen.

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

INCONNECT

MARKETS MUST BE REIECTED.

ITNOT 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

thatthere

are structural "Double Marginalization"

barriers to efficient

non-alliance

pricing thatwouldbe 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 tareleveh;

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

it false; there are many examples

of rationally

higher prorates, and thetheory

is not based

on any actual examples

oJ irrationally

suboptimal

pri(ing;

: Etficient

interline pricing can be managed

at small airlines with limited

aulomation,

andi5 easily managed

via faremapping

at any carrier using modern revenue management

tools;

: The marketing

efficiency

olthe original

1990s Nonhatlantic

alliances hadnothing

to do with pricing; the adual brand

awarene55

and distribution

efficiencies

achieved

are foundin 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

butwa9 due to the inherent

diffi(ulty

oJ establishing

jointly profitable

interline fares between

longhaul and shorthaul

operators.

r None of the statistical

nalysi5 in the Brueckner

and Whalen papers demonstrates

the existence oJ "double

marginalizatlon"

or any related stroctural

barriers or supports

the claim

that it is the caute

o{ higher

non'alliance

prices; there i! absolutely

no empirical

evidence thatthe theorized

structural

barriers to efJicient

interline pri(ing actually exast.

. The .,oint Applicant's

public benefit claim dependg on thefalse

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

oI market

or competitive

conditions,

and thatthese

higher non-immunized fares woold immediately

{all to the lower

immunized/online

level opon grant o{ immunity E The onlylegitimate

histori(al

case of consumer

pricing benefits lrom immunity

occurred

in the 19909 in a specitic

range oJ double connect North Atlantic markets that hadno 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 service nters an O&D solely served on anonline

ba5i5; "interline-only"

O&Ds hadbeen

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 andincluded

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 mid90s,

but mo5t were due to non-alliance

{a(tors including

profitable

capacity growth andhub expansion,

market liberalization,

increased carrier efficien(ies

due to fleet and technology

improvements,

andlower

fuel prices.

The
consomer

beneJits due to alliance

pricing in previously

interline-only

markets hadbeen

tully exhausted

bythe end

o{ the decade,

and all of the available

mplrical

evidence shows that the consumer

welfare impact oJ antilrust immunity

grants since 1999 ha5 been negative.

r The Joint Applicant's'

provided

no evidence

thattheir

(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 thatthey

are 17.45%

higher as their testimony

<laims; Neither theJoint

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 thefalse

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 areirrationally

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 fareredu(tions

dire<tly attributable

to any antitrust immunity

grant in the lart

decade, and certainly no evidence

o{ Jare reductions

of the 1730%, t200-250

per ticket magnitode

suggested

bythe "double

marginalization"

theory and claimed by the Joint

Applicants. t Since the Erueckner

and Whalen theories and regressions

do not justify the "universal

marketindependent

cooperative

alliance pricing" impacts claimed bytheJoin'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

oublicbenefits

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 thatthe 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 arenot supported

by their

own empirical

evidence or any other independent

analyti5 showing tystematic

barriers toHoran

EAAA Supplemental

Comments

8 January

2010 21 non-immunity

pricing efficiency,

all of the assumptions

underlying

thetheory

can be plausibly challenged,

and there arehighly

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 thatthe 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

thatthe current

interline pricing tunctions

of British Airways, American

Airline5, Finnair, lberia or Royal Jordanian

actually 5uffer f.om any

oI the structural

inefficiencies

implied bythe "double

marginalization"

(laim The Joint Applicants

provided

no evidence

thattheir

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