Delta-Northwest Merger

Olivia Aldinger

Introduction-Merger announced April 14, 2008

-Merge between 2 out of 6 remaining large legacy airlines

-Delta was the 3rd largest airline and Northwest was the 6th largest

-Merge would create what was then the worlds largest airline

Background-The domestic airline industry as a whole was struggling financially.

-Between 2001-2008, the domestic airline industry reported negative net income in every year, this loss as a whole was totaled at $29 billion.

-Both Delta and Northwest had filed for bankruptcy protection prior to the merge.

Pre-merger

DeltaHubs-Atlanta, Cincinnati, and Salt Lake City. Carried 47 million passengers, 149 domestic destinations and 136 international, 10 billion in revenue.

NorthwestHubs-Minneapolis, Detroit, and Memphis. Carried 29 Million passengers, 132 domestic destinations and 48 international, 7 billion in revenue.

Combined Carrier

-Covers most of the United States

-390 destinations and 786 aircraft

Arguments for Merger

-Generate up to 1 billion in annual cost synergies

-Substantial consumer benefits due to the positive network effects of combining their complementary networks.

DOJ Investigation-The DOJ raised a number of potentially significant competitive concerns.

-Both merging parties and the DOJ analyzed the merger in the context of markets for air travel between specific origins and destinations.

-The theories of harm focused on weakening competition on those specific routes where there were overlaps between Delta and Northwest post merger.

Key Issues-Overlapping nonstop service on 12 domestic city-pairs

-accounted for 6.6 million passengers and 1.1 billion in revenue.

-Overlapping connecting service on 702 domestic city-pairs -accounting for 7.8 million passengers and 1.8 billion in revenue.

-These overlapping routes were primarily in the southeast over Deltas hub in Atlanta and Northwests hub in Memphis.

Key Issues

Of these 12 overlaps, no other carriers flew nonstop on 4 routes, 1 other carrier flew nonstop on 3 routes, and 2 carriers flew nonstop on 3 routes.

Type Competitor Change

Number of Routes

Total Passengers (mil)`

Total Revenue (mil)

Nonstop 2-1 4 0.25 $66.69

3-2 3 1.17 $180.64

4-3 3 1.99 $391.84

4+ 2 3.21 $457.39

Nonstop Total 12 6.62 $1096.56

Connecting 2-1 83 0.82 $188.20

3-2 395 4.08 $956.40

4-3 224 2.91 $653.50

Connecting Total 702 7.81 $1807.10

Overview of Key Issues

Delta/Northwest and the DOJ focused their investigations on how the merger was likely to raise nominal fares due to the decrease in competition in certain areas and how the improvements in the quality of service could offset the increase in prices.

Overview of Key Issues

-Reducing the number of carriers from 2-1 is a 4-5% increase

-In 2001, reducing the number of carriers from 2-1 resulted in a 12% increase.

-Reducing the number of carriers from 3-2 is statistically indistinguishable at zero

Overview of Key Issues-The DOJ concluded that nonstop service constituted a relevant market

-The consolidation of carriers on nonstop overlaps would increase fares

-Remaining non-stop competition from a LCC on a route would lower considerably the potential anticompetitive effect in a non-stop market.

-Therefore, non-stop overlaps were minor enough that the DOJ concluded that the potential harm on these routes was likely to be modest at most.

Overview of Key Issues-The nominal fare effects estimate: $40-$100 million.

-Without including the quality benefits, the merger was expected to cause a small but significant upward pressure on prices.

-The merger was expected to generate $1 billion in annual synergies that would arise from more effective aircraft utilization, a more comprehensive and diversified route system and cost synergies from reduced overhead and improved operational efficiency.

Overview of Key Issues-Quality benefits played a huge role in why the DOJ decided not to challenge this merger.

-However, the idea of evaluating quality benefits in the context of merger analysis was new at that time.

-The DOJ had to come up with methodologies that would be appropriate to quantify these benefits.

Modeling Quality Benefits

1. Reduce numbers of connections on itineraries.2. More connecting itineraries on a single carrier.3. Reduced average travel times due to better connections of less circuitous

routes.4. Richer and better coordinated schedules of flights on given routes.5. More efficient fleet utilization that improves connections, increases the. number of passengers that fly on larger aircraft, and/or allows more passengers to be accommodated on their preferred flights.

Modeling Quality Benefits

-Improvements in scheduling would provide consumers with more options for connecting itineraries and flight times.

-Ex. Consider a case where both delta and northwest had 3 options for an inbound flight and 3 options for an outbound flight. Pre-merger, If a consumer decided to use Northwest, they would have 9 different round-trip itinerary options. However, post-merger, a consumer would be able to choose among 6 flights in each direction, which would give them 36 different round-trip itinerary options.

Modeling Quality Benefits

-A merger between complementary networks expands the set of destinations that a carrier serves from any particular airport.

Increases value of frequent flyer miles.

-The greater density of traffic induces carriers to increase flight frequencies or serve locations that it would not otherwise serve.

How to Quantify Benefits1. Quantify the changes in product characteristics that were expected to

result from the merger

2. Quantify the value to consumers of those changes in product characteristics.

Quantifying Merger Related Changes-Using schedule data from the OAG. The DOJ combined Delta and Northwests networks into a single network to show any merger related change.

-Network planners can model changes in frequencies and routes that would likely be in the post-merger network.

-When evaluating the merger, the DOJ put more of an emphasis on scheduling adjustments and ordinary course methods.

Quantifying the Consumer Benefits

The dollar value to consumers of a change in a nonprice characteristic is equivalent to the value of the change in price that is required to generate the same change in quantity demanded. (Q=a+bP)

Quantifying the Consumer Benefits1. Use the parties planning models to measure the expected merger-related

shift in the demand curve and then translate this shift into quantity equivalent changes in price.

2. Estimate a demand model from the ground up to assess the value of each individual characteristic and then apply these values to merger-induced changes in these characteristics.

Using QSI Models

-QSI Models are based on econometric models of demand.

-QSI models take flight schedule as an input and forecasts market share for each flight.

-It takes into account itinerary type, equipment type, convenience of schedule.

QSI Model Results-The QSI models of Delta and Northwest predicted that demand for the merged carrier would increase by 3.4% and traffic would increase by 1.8%.

-These increases in output imply benefits for consumers ranging from $150-300 million/year.

Estimating Demand Models-The empirical evidence was derived from an econometric analysis of the consumer demand for specific itineraries on specific airlines.

-The results show that product quality, in addition to price, is an important consideration to consumers with respect to their choices among different travel options.

Demand Model Results-The results of this model show that consumers value the services from higher quality networks on particular routes and at particular airports.

-Based on this model, it was estimated that consumer benefits would be $700 Million/year.

-This estimate is much greater than the estimate made by the QSI Model.

Conclusion-The DOJ closed its investigation without challenging the merger.

-In 2009, Delta estimated that it achieved $700 Million in merger synergy benefits and anticipated $600 Million in 2010.

Conclusion-However, due to changes that affected both supply and demand in the airline industry after the merger, made it impossible to assess empirically the realized marketplace effects of the merger on prices and outputs.

-The general conclusion of this case is that consumer benefits from airline network effects should not be ignored in the formulation of policy towards the airline industry.