A federal judge recently blocked the proposed merger of JetBlue and Spirit airlines on antitrust grounds, reversing antitrust enforcers’ recent history of waving through airline industry consolidation. However, while this decision affirms that mergers designed to reduce competition and raise prices violate antitrust law, it comes too late to undo the damage from 15 years of lax enforcement that allowed radical consolidation in the airline industry.
The United States airline industry has seen dramatic consolidation in the last fifteen years. A series of mergers between the largest competitors (Delta/Northwest, United/Continental, Southwest/Airtran, American/USAirways, Alaska/Virgin) increased the market share of the top four carriers from 56% to 80%. The previous industry, with more competitors, was much more responsive to market forces and could reasonably cope with periodic crises. Today’s industry is dominated by too-big-to-fail companies that can demand huge taxpayer subsidies when they fail to anticipate problems.
But on January 16, a federal judge blocked the proposed $3.8 billion merger of JetBlue, the sixth largest U.S. carrier with a 5% market share, and Spirit, the seventh largest with a 4% share. This was the first time that a U.S. airline merger had been rejected on antitrust grounds. While the Department of Justice (DOJ) had filed suits against numerous previous mergers, it had never mounted a serious, credible effort to prevent a merger from occurring.
Was the decision a proper application of antitrust law? Will blocking the merger strengthen the industry or make things worse? How will it affect the industry consolidation process? Answering these questions requires some context about airline competition in the US, and this particular merger application.
Competition Between Different Airline Business Models
U.S. airlines fall into three major categories based on the business models they follow and their operating/marketing economics: megahub network, quasi-network, and ultra-low cost.
Delta, United and American, the three largest U.S. airlines, follow megahub network models. This model entails large diverse fleets (widebodies, narrowbodies, regional aircraft) operating through extremely large connecting hubs (e.g. Atlanta, Chicago, Dallas-Ft.Worth) that serve a very large and diverse set of origin and destination markets (longhaul intercontinental routes plus hundreds of domestic markets). These are often referred to as “legacy” airlines, since they date back to the decades of Civil Aeronautics Board (CAB) regulation when all trunk airlines followed this business model. The high cost of their operating and marketing complexity is offset by significant scale and network economies.
After deregulation, new business models emerged with a narrower focus on markets where they could establish major cost and pricing advantage and expand total industry demand. The pioneers here were carriers such as PSA, Southwest, and People Express and were originally known as low-cost carriers (“LCCs”). They narrowly focused on large volume point-to-point routes and achieved huge cost advantages through much higher aircraft and staff utilization while avoiding the costs of serving diverse markets through large hubs. Their aggressive pricing drove rapid growth.
Today these are better seen as “quasi-network” airlines. Southwest migrated from high-frequency point-to-point operations to one based on smaller scale hubs. This allowed them to expand into many more U.S. cities (while still avoiding small regional cities or intercontinental markets) although it narrowed their cost advantage over the megahub carriers. America West, JetBlue, Alaska, and Virgin America also followed the “quasi-network” model, and the product gap versus Delta, United and American on narrowbody jets became fairly small.
As the product and costs of the quasi-network carriers evolved, airlines following an ultra-low cost (ULCC) model entered the market. This model, pioneered by Ryanair in Europe, eliminated all network connectivity and unbundled charges for each product component (e.g. baggage, seat assignments, on-board food). By offering the lowest possible bare-bone fares, they could capture highly price-sensitive traffic from the megahub and quasi-network carriers and stimulate new demand. U.S. ULCCs included Valujet, Airtran, Frontier, Spirit, Allegiant, Sun Country, Avelo and Breeze.
Airlines with lower-cost business models are, by definition, more focused on price competition as they attempt to capture share from higher cost operators and attempt to grow the overall market. As more recent entrants facing entrenched incumbents, they must also work harder to develop innovative new approaches to pricing and operations. A major issue in this case is that by acquiring a lower-cost ULCC like Spirit and converting them into a quasi-network airline, JetBlue is eliminating an important source of price competition and innovation.
While technically JetBlue-Spirit was the first airline merger blocked on antitrust grounds, last year’s rejection of the proposed American Airlines-JetBlue Northeast Alliance raised many of the issues JetBlue-Spirit raised and that decision explains why many outsiders expected the JetBlue-Spirit to fail. The Northeast Alliance was a merger in all but name since it would have created a common bottom-line for the two carriers’ Northeast services, which requires significant operational and pricing collusion. This would have neutered JetBlue as a significant price competitor against American and the other megahub network carriers in Northeast markets. While blocking the alliance achieved the same end, the case failed to fully focus on the degree of pricing collusion an alliance P&L would have required, something that should have constituted a prima facie Clayton Act violation.
What Drove JetBlue and Spirit to Pursue a Merger?
At the time they applied to merge, both Jetblue and Spirit were struggling with serious strategic challenges.
The foundation for JetBlue’s early growth was a 1999 Department of Transportation (DOT) award of 75 landing/takeoff slots at New York City’s Kennedy Airport, enough to establish both meaningful network and operating efficiencies and a competitive presence in the New York market. Its innovative product offerings aggressive pricing made it popular with consumers and its lower costs allowed it to profitably make competitive gains against incumbent carriers. But the longstanding infrastructure constraints in New York seriously limited its long-term growth potential.
JetBlue has had moderate success developing a couple of new network bases (Boston, Fort Lauderdale) but most other domestic expansion efforts (Philadelphia, Raleigh, Newark, Los Angeles) have done poorly. As intended, the consolidation of the megahub network sector from six to three carriers made it much more difficult for smaller quasi-network carriers like JetBlue to compete effectively in domestic markets. The North Atlantic cartel (United/Lufthansa, Delta/Air France and American/British Airways) has been able to effectively stymie JetBlue’s plan to build a European network from New York and Boston.
Spirit had been strongly profitable prior to the pandemic but lost nearly $1 billion in 2020 and another $1 billion since. Its balance sheet has become much more leveraged. After the pandemic destroyed business demand, the higher-cost carriers rapidly entered leisure markets served by the ULCCs. These were markets that they could not profitably serve in normal times, but predatorily poaching leisure revenue generated more cash than parking planes. As demand recovered, the megahub carriers more aggressively marketed “basic economy” fares that limited the ULCCs ability to recapture highly price-sensitive traffic. Labor market conditions have tightened significantly since the pandemic, and the ULCC cost advantage shrank due to the need to remain competitive for pilots and other staff. The growing inability of airframe and engine manufacturers to deliver reliable products on promised schedules has hurt the entire industry but has disproportionately hurt smaller carriers like Spirit which will have an average of 26 of its A320s grounded in 2024 due to engine issues.
Spirit and Frontier announced a plan to merge in February 2022. JetBlue, which began eyeing Spirit as a potential acquisition target prior to the pandemic, realized it did not have a good alternative merger opportunity and initiated a hostile counteroffer. Spirit’s board initially rejected JetBlue’s advances, believing that a merger designed to eliminate ULCC competition and raise fares was much more likely to be rejected on antitrust grounds than a merger that would have created a larger ULCC that could compete more effectively with higher cost carriers. By July, JetBlue had increased its takeover bid to $3.8 billion, promising Spirit a 50% premium over their current stock price and guaranteeing them a $470 million breakup fee if it was blocked on antitrust grounds.
Spirit’s board walked away from Frontier and accepted the JetBlue bid they had previously attacked under the (not unrealistic) belief that shareholder lawsuits would look narrowly at the size of the JetBlue bid and would ignore management’s analysis that it was not in the company’s best interests.
Since JetBlue’s profit and loss performance was increasingly problematic, its pitch to Wall Street became focused on deals to reduce competition, including both the Northeast Alliance and the Spirit acquisition. Wall Street knew that no airline merger had ever been seriously challenged on antitrust grounds and was usually enthusiastic when companies used mergers to reduce competition and raise prices. Wall Street’s love of mergers meant that it valued Spirit as a takeover target and largely overlooked the growing ULCC competitive issues. JetBlue had good reason to believe that its equity value would be based on the perceived value of eliminating competition and raising prices and that Wall Street would largely overlook the antitrust risk, the magnitude of the takeover premium, and JetBlue’s recent difficulties finding profitable growth opportunities.
Attacks on the JetBlue/Spirit Decision
Judge William Young’s decision to block the JetBlue/ Spirit merger has been attacked from a variety of different angles. Most recognize that Spirit is now likely to face years of additional losses, that it has no obvious way to restore its previous corporate value, and may need to consider a chapter 11 bankruptcy filing.
One line of attack blames the court for failing to base the decision on the potential problems a weakened Spirit might face if it failed to approve the merger. The decision “sent shudders through some of Spirit’s key constituencies” (leisure travelers, airports used by Spirit) and will “add cost and stress to travel across America.” By “undermining Spirit,” the court has seriously damaged low-cost flying. These attacks make the category error of assuming that a judge in an antitrust case is supposed to focus on the near-term interests of a specific company (or employees, or cities served) rather than determining whether the gains investors are seeking from a proposed merger are based on undermining market competition.
These attacks also falsely claim that consumers would have been better off if Spirit’s aircraft had been moved to JetBlue. There is no evidence in the case that JetBlue is a more efficient operator than Spirit. JetBlue did not present evidence showing that despite the failure of recent network development plans it had (absent fare increases) abundant profitable ways to deploy Spirit’s aircraft. Judge Young went to considerable lengths to demonstrate that the merger applicants had failed to document consumer or efficiency gains large enough to offset the competitive harms the DOJ had documented or that actions by other carriers would be timely, likely and sufficient to counteract these harms.One issue in the case is that the current ability of airframe and engine manufacturers to deliver reliable products on promised schedules means that it would be take many years before the ULCC capacity this merger is eliminating could be replaced.
While acknowledging Spirit’s financial challenges, Young correctly noted that the merger application did not claim that the DOJ’s competition concerns should have been overlooked on the basis that Spirit was a “failing company” whose liquidation would create a greater loss of competition. Spirit did not claim it was a failing company, positively argued that Spirit had a plan to restore profitability, and Young explained that Spirit would have not met the standards of the failing company doctrine.
A second category of attack actually tries to blame the DOJ’s antitrust enforcement for the potential financial harm to Spirits’ operations as a result of decisions that its shareholders freely made. Spirit’s shareholders were explicitly warned of the antitrust risks that could leave them holding a very empty bag. Spirit shareholders explicitly instructed management to abandon its efforts to build a stronger ULCC with Frontier in the hope that JetBlue’s $3.8 billion offer could be realized.
A Wall Street Journal editorial provides a prime example, saying “Justice has essentially set Spirit up for failure” and that “the Administration’s trust busters are reducing competition.” The Journal’s editorial board, which would normally be a diehard defender of the right of shareholders to do whatever they thought was the best way to maximize shareholder value, is attacking the court for failing to overturn the Spirit shareholders’ freely made decision to reject management’s analysis and pursue the merger. The Journal’s editorial board is not fighting for the prerogatives of shareholders, it is fighting to ensure shareholders will not be held accountable when they make bad decisions.
The Journal’s editorial should also be seen as part of its ongoing, obsessive attacks on current efforts to enforce existing antitrust law. It has published 80 attacks to date, roughly one every 11 days, including attacks on Federal Trade Commission Chair Lina Khan and the leadership of the DOJ’s Antitrust Division. The Journal’s editorial board is entitled to its political/ideological belief that antitrust enforcement should be entirely focused on rigging markets in order to maximize the returns of capital accumulators — shareholders and large investment firms that take an active role influencing management — and should ignore any laws limiting the preeminence of such capital accumulators. But this editorial attack should not be seen as a credible claim about the merits of the JetBlue-Spirit decision or an honest depiction of what the Clayton Act says.
A third category of attack on Young’s decision claims “the fundamental problem in air travel today is not lack of competition; it’s the lack of sensible regulation to channel competition to public purposes.” This author claims there is too much competition, fueling a “race to the bottom” producing, among other things, the bare-bones Spirit product that he doesn’t personally like. The author correctly observes that antitrust is just one piece of government oversight, but makes no effort to explain what might be wrong with Young’s decision in a case properly focused on the antitrust issues with this particular merger. He also makes no effort to explain how reestablishing route, product and pricing regulations would have maximized pricing and service options for consumers and produced stronger airlines that would have avoided JetBlue and Spirit’s current problems, or how Congress would have established a much more enlightened regulatory system than ever existed before. The pro-reregulation pieces are not as bad as the Wall Street Journal editorial, but they are also political/ideological claims that don’t constitute either a legitimate critical review of this specific Court decision or a useful analysis on the entirely separate (and much broader) issue of airline regulation.
Reduced Competition Was the Predominant Expected Source of Returns from This Merger
Did Judge Young apply the Clayton Act correctly? In my view, yes. He correctly identified the competitive dynamics between airlines following different business models, and the importance of aggressive price competition from airlines with lower costs as critical to consumer welfare. He correctly identified robust competition was not just a question of pricing but as key to driving ongoing innovation. He appropriately evaluated whether the JetBlue/Spirit claims of merger benefits offset the competitive problems. He correctly noted that the many airframe/engine manufacturing problems would make it impossible for future expansion by other carriers to discipline any anticompetitive behavior by the merged carrier.
All airline mergers have huge implementation costs and risks. Maintenance, marketing and financial IT systems need to be integrated. Case testimony indicated it would take five years to fully convert Spirit’s aircraft to JetBlue configurations. Overcoming cultural and training differences is especially challenging when the carriers follow different business models. A simple way to focus on the antitrust issues is to ask where the investors in the merger expected to find returns large enough to overcome these implementation costs and risks, and in this case justify the 50% premium over an already rich corporate valuation. If there is verifiable evidence of operational synergies and scale/network economies large enough to cover these costs and risks, antitrust concerns go away.
In this case that verifiable evidence does not exist and thus the predominant expected source of returns had to come from higher fares and the elimination of competition. This merger was not shifting assets from Spirit’s weak network to a much stronger JetBlue network. The merger would have done nothing to solve JetBlue’s recent difficulty finding profitable network expansion opportunities. JetBlue had offered gate/slot divestitures in south Florida, the one area where both carriers had meaningful market positions. JetBlue failed to present objective evidence of billions in synergies that could be realized independently of the potential impacts of reduced competition. Scale economy synergies would have been achieved but these are relatively small when carriers do not have very large hubs and could not have possibly covered the implementation costs and acquisition premiums.
Airline Industry Consolidation Would Not Have Happened If the Antitrust Standards of This Case Had Been Applied
The radical consolidation of the airlines serving intercontinental and megahub domestic markets would not have occurred if Judge Young’s straightforward reading of the Clayton Act had been applied. The comments below are based on extensive published analysis of mine about the anti-competitive economics that drove airline industry consolidation.
Almost all of the major airline mergers that drove industry consolidation were designed to eliminate a more aggressive price competitor with lower costs. Air France paid a 40% share price premium to acquire KLM in 2004, a merger that neutralized the lowest cost longhaul carrier in Continental Europe and directly triggered the consolidation of the North Atlantic into a three player-cartel. By design, this forced the subsequent consolidation of the U.S. megahub sector from six competitors to three. In each megahub merger a higher-cost carrier eliminated a lower-cost rival. Each merged megahub carrier had a major artificial advantage over quasi-network and ULCC competitors thanks to supra-competitive international fares. If one accepts the court’s finding that a JetBlue-Spirit merger would have harmed consumers and market competition Southwest’s 2010 $3.2 billion bid for Airtran (that DOJ quickly rubber-stamped) would have been much worse since Airtran was larger than Spirit, and Southwest achieved few (if any) of its claimed offsetting merger synergies. Southwest claimed it wanted to incorporate and expand Airtran’s large Atlanta operation which had significantly lowered fares at Delta’s megahub, but quickly downsized Atlanta and reduced price competition. Southwest claimed that Airtran’s 717 aircraft would give it a ready-made second fleet type that would allow it to grow into markets its 737s were too large for. But Southwest quickly abandoned the second-fleet type idea and sold the Airtran 717s to Delta at bargain-basement prices.
Airline consolidation was always designed to reallocate capital from more efficient uses to less efficient uses and entrench the power of the airlines that fought to reduce competition.
In these cases, regulators never scrutinized where investor returns might be coming from and took unsubstantiated claims about huge synergies (which never materialized) as definitive evidence. In the critical North Atlantic cases U.S. regulators used willfully fraudulent claims to evade Clayton Act requirements. In these cases the fact that an initial merger (Delta-Northwest) would inevitably trigger a round of additional mergers was ignored so the overall impact of consolidation on consumers and market competition was never considered. In these cases the existence of different airline business models was ignored so the fact that these mergers weakened price competition from lower cost operators to consumers was never considered.
How Will the JetBlue-Spirit Decision Affect Airline Consolidation Going Forward?
Will Judge Young’s decision create a strong precedent for future U.S. merger cases? I would like to think so, and most observers see little likelihood that this decision will be overturned. The effective nullification of the Clayton Act has been reversed for at least the time being. In terms of overall progress towards effective antitrust enforcement, Matt Stoller summarized the situation with Churchill’s quote: “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” One medium-term concern is that a future Trump administration could replace current antitrust officials with ones following policies that the Wall Street Journal editorial board would enthusiastically support.
In the near term, I think Young’s decision will make competition marginally healthier than it would have been had the merger been approved, but the key word here is marginal. A positive first step would be getting JetBlue and Spirit and other airlines to stop seeing the pursuit of artificial market power as the key driver of corporate value and refocus on their serious competitive and operational issues.
But a reaffirmation of Clayton Act protections for market competition comes far too late to help the airline industry. This decision can’t undo the last fifteen years of damage. That horse escaped the barn a long time ago. The current Alaska-Hawaiian proposal is unlikely to raise huge DOJ concerns since it doesn’t raise any of the issues JetBlue/Spirit or the Northeast Alliance case raised. It is not clear what other airline merger opportunities might be left, even in the complete absence of antitrust enforcement.
This decision appears to reflect a growing awareness in some quarters that radical airline consolidation may not only not have been a good thing for consumers or industry efficiency or for the economy as a whole but may have depended on suspending enforcement of antitrust laws. It is difficult to imagine an open acknowledgement of regulatory and policy error ever occurring but perhaps this awareness might make it a bit more difficult to roll back antitrust enforcement in the future.Â
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
