Airline Industry Collusion

Overview of Airline Industry❏ Highly regulated and competitive industry (Airline Deregulation Act, 1979)

❏ Historically, industry has been highly unprofitable, but has been supported and thus highly regulated

by U.S. government as it is deemed “fundamental to existence of a sound economy”

❏ Relatively low barriers to entry/exit -- operational structuring reduces the capital intensity of industry

(e.g., wet-lease/lease buy-back programs)

❏ Industry has grown ~300% since Deregulation Act, (~1,300 new carriers)

❏ Airline industry driven by 3 key metrics: a) Supply, b) Demand, c) Fuel prices

❏ a) Available Seat Miles (ASMs), b) GDP, c) Brent/WTI Crude → Jet A Fuel

❏ Volatile revenue stream and cost structure

Background of Investigation❏ 2015: DOJ opens investigation into the 4 largest domestic carriers (American, United, Delta,

Southwest) about possible pricing collusion

❏ American, United, Delta, and Southwest control nearly 80% of the domestic market

❏ Colluding with Institutional ownership → benefitting shareholders, not consumers

❏ Indirect price coordination across airlines → openly discussing “capacity discipline”

Airline Industry History❏ From the time of airline deregulation in 1978 through the early 1990s, the airline industry was in a state of

nearly constant upheaval.

❏ At the time of deregulation, the U.S. domestic jet air travel market included about 20 competitors ranging from small regional carriers to the largest national and international airlines.

❏ Immediately following deregulation, many startup airlines entered the domestic market. Concentration at both the national and the route level fell in the first five years following deregulation.

❏ Most of the startups were small regional airlines. Under the financial pressure of competition, few were ever able to turn a profit.

❏ By the mid-1980s, airlines were folding faster than new ones were entering, and many were disappearing through merger. A merger wave in the middle and late 1980s, along with more exits during that time, raised the Herfindahl index for domestic air travel from 854 at the beginning of 1985 to 1074 at the beginning of 1990.

Why we think they are colluding ❏ “Justice Department doesn’t need to demonstrate fantastic profitability to prove collusion”, i.e. collusion

may be present in forms other than price differentiation. Also, with less players in the market the

potential for collusion is much higher, according to the Department of Justice

❏ Airline executives could be refraining from engaging in price competition: either by expanding capacity

(Available Seat Miles) or by lowering ticket costs, which would lead to them cutting each other’s necks

(airline industry historically subsisting off debt at little to no profit). This is bad news for shareholders.

❏ Looking at changes that happen in Airline industry (such as reduction of space per each seat, or

complimentary services, such as checked baggage and inflight snacks getting an extra price tag), it can be

argued that these specific changes among the airlines are a consequence of collusive behaviour

Why we think they are colluding (continued)❏ Airline industry services are very important to American consumers and having a small amount of

market participants allows the airlines to collude not only tacitly, but also explicitly, with simultaneous

quality deterioration and route cuts

❏ Airline consolidation - smaller airlines have filed for bankruptcy, or were absorbed by larger ones, while

other larger groups decided to merge. The last merger between American and US Air already saw a

government lawsuit against them, however with minor adjustments, the merger was approved.

Based on this graph which

takes inflation into account,

airline prices have been

steadily rising (with the

exception of the recent

recession), and are exceeding

prices from the previous

decade.

So what's the significance of

the recent prices and the the

prices in the last decade?

A small comparison

Statistical Evidence of Rising Prices❏ Domestic airfare rose on average of 1.9% percent from 2012 to 2013 and by 2014 it had gone up by

another 2.5%.

❏ Meanwhile, fuel costs (the largest expense for airlines -- ~⅓ of total operating costs) have been plunging (nearly 41% in the last 12 months).

❏ U.S. airlines enjoying collectively strong profits for the first period in history, as as result of consolidation, bankruptcy restructuring and the fuel benefit: U.S. carriers have earned nearly $25 billion since YE2012.

Colluding with Shareholders- Department of Justice has asked for records of meetings with shareholders whose stakes exceed 2% - “Product prices are 3 percent to 11 percent higher because of common ownership” a study by Martin

Schmalz of the University of Michigan’s Ross School of Business and José Azar and Isabel Tecu of consulting firm Charles River Associates revealed

- Shareholders want the airlines to not compete as aggressively with other airlines in their portfolio- BlackRock is among the five largest shareholders for the 4 largest airlines

More StatisticsIn April 2015, U.S. airlines paid nearly $1.50 less per gallon for jet fuel oil than they did the prior year. Moody’s, one of the major rating agencies, estimates U.S. airlines will spend $15 billion less on fuel in 2015 relative to 2014, net of hedging.

With the decrease in fuel costs and the growing economy, economists expect rational market participants to increase capacity, resulting in lower fares. However, capacity of the largest airlines has stalled while fares are increasing.

They Are Not Colluding❏ 4 companies hold 80% of market, so higher possibility of Collusion

❏ Benefitting shareholders, not consumers

❏ Jet fuel prices decreasing but the price of airfare still remains high

However, we believe they are not colluding because

❏ Profit margins have been dropping over the long-term (before 2009)

❏ Current “capacity discipline” is largely to recoup losses (2009 onwards)

❏ Airlines still do not really have pricing power

Long-Term Trend: Airlines have been losing money❏Profit margins have been dropping

❏ Nearly the least-profitable industry in the US

❏ Accumulated losses in the airline industry from 2000-2009 totaled $60B

Long-Term Trend: Airlines have been losing money❏ Airfare price increases have historically been in tandem with fuel price increases

Capacity discipline is good management❏Low-cost carriers increase capacity to gain market share

❏ Do not have past losses to make up for

❏Major carriers are practicing capacity discipline to recoup past losses❏ Not proof of tacit collusion❏ Too much capacity drives down prices and profits❏ It is proof of good management

❏Wall Street pressure❏ “There have been about two years of conference calls in which Wall Street analysts have browbeat

airline executives to either have [capacity] discipline, or they will bust their recommendations on

their stock” - Robert W. Mann Jr., aviation analyst.

They do not have pricing power❏Airline industry highly transparent

❏ Federally: Significantly more government oversight than most all other industries (even after Airline Deregulation Act)

❏ Publicly: All ticket prices and schedules are publicly available and consistently updated

❏Successful fare hikes are rare❏ 21 attempted fare hikes in year 2014 according to Farecompare.com. Only 5 succeeded.

Our Sources:1. http://skift.com/2015/07/18/what-it-will-take-to-prove-airline-industry-collusion/2. http://www.theguardian.com/business/2015/jul/03/us-airline-collusion-investigation-prices-seat-capacity3. http://www.nytimes.com/2015/07/02/business/airlines-under-justice-dept-investigation-over-possible-

collusion.html4. http://www.economist.com/blogs/gulliver/2015/07/airline-competition5. http://www.ajc.com/news/business/airlines-were-not-colluding-were-competing/nm4NL/6. http://www.bloomberg.com/news/articles/2015-07-16/what-does-it-take-to-prove-airline-collusion-7. http://faculty.haas.berkeley.edu/borenste/download/atpcase1.pdf8. http://aviationblog.dallasnews.com/2015/07/doj-investigation-prompts-lawsuits-alleging-that-airlines-are-fixing-

airfaresa.html/9. http://www.forbes.com/sites/danielreed/2015/08/21/if-airlines-are-reporting-record-profits-they-must-be-colluding-

right-probably-not-and-heres-why/2/10. http://www.chicagotribune.com/news/opinion/chapman/ct-airlines-justice-department-anti-trust-prices-perspec-

0709-20150708-column.html11. https://www.washingtonpost.com/posteverything/wp/2015/07/09/the-government-says-airlines-prey-on-

consumers-thats-the-governments-fault/

Our group (in order of talking)❏Blake R Barritt blake.baritt@nyu.edu

❏Won-Jang Joo wjj217@nyu.edu

❏Egor Molchanov em2527@nyu.edu

❏Talha Naeem tn656@nyu.edu

❏Vladislav Lee vl671@nyu.edu

❏Rishabh R Shah rrs364@nyu.edu

❏Hisu Kim hk1308@nyu.edu

❏Andrea Ng Wen-Xin anx200@nyu.edu