Senator Kohl on Antitrust, Part I — Airline Mergers

Thom Lambert —  8 May 2007

One nice thing about being a legal academic is that you can diversify your political portfolio. By that, I mean that you become somewhat indifferent to who’s in office. If it’s folks you agree with, then you’re happy because your preferred policies are being implemented. If it’s folks with whom you disagree, then you’re happy because your job (criticizing bad policy) becomes easier.

I was reminded of this ability to “make lemonade” as I perused the latest issue of Antitrust, the magazine of the ABA’s Antitrust Section. That issue, which is dedicated to “Antitrust in the New Congress,” is chock full of interesting stuff. Among the most intriguing pieces is an interview with Senator Herb Kohl (D-WI), the new chairman of the Judiciary Committee’s Antitrust Subcommittee.

Senator Kohl, it seems, is going to make my job easier.

Over the next few days, I’ll highlight a few of Senator Kohl’s thoughts on antitrust policy. (There’s too much here for a single blog post.) We begin with airline mergers.

Orlando-based AirTran, a discount airline, has been trying for quite some time to acquire Midwest Airlines, a Milwaukee-based airline known for its fantastic service. Midwest has repeatedly rebuffed AirTran’s offers, so AirTran has made a tender offer for Midwest stock. (The current offer expires on May 16.)

Senator Kohl is opposed to the merger and plans to use his antitrust influence to try and thwart it. He explains:

In the case of AirTran’s acquisition plans, I think we have been very clear that if they follow through with their intent to purchase Midwest, they will face hearings in our committee. Midwest is my home state’s local airline. It is headquartered and has its main hub in Milwaukee. And the quality of service they offer to travelers is superior. Their service are [sic] considered to be among the very best in the industry and they have devoted customers like you rarely see in most businesses and certainly not in the airline business. People who use Midwest Airlines truly appreciate the quality of their service in every way — from the type of airplane that they use with only two seats across to the frequency and numbers of destinations they serve from their hubs, which is so important to those of us who live in Milwaukee, to their competitively priced air fares.

So here we have an airline that offers reasonable prices, excellent service in terms of the pilots and the attendants, and gives Wisconsin residents like me excellent connections to the major business centers around the country. Most important to Wisconsin’s economy, Midwest Airlines is a local business, employing thousands of people in high quality jobs, so this airline is really appreciated by all of us in our state.

And now AirTran wants to buy it. And so, we wrote a letter to AirTran, just a couple of days ago. I wrote not only as a Senator, but also as a consumer. We think this would be a bad deal for consumers. We understand it might be good for AirTran’s own business interests and bottom line, but it would harm many thousands of travelers in Wisconsin and elsewhere in terms of quality of service. And in fact, the merger is being opposed by Midwest management.

So as the head of the Antitrust Subcommittee, you can be sure that I’m going to be looking at this deal very carefully should it go forward, including having hearings at our Subcommittee regarding what this deal would mean for consumers and the thousands of people that rely on this excellent airline.

In general, we care about competition in aviation because this industry is so critical to our country’s economy. Airlines are America. America is airlines. Of course, you can say that about other industries, too. But, with respect to airlines, in our modern economy and society, people have to travel. In today’s modern times, the airlines are the lifeblood for our nation’s commerce and our citizen’s [sic] travel.

And therefore, those of us who regulate the industry or have oversight over the industry have to do everything we can to see to it that there is sufficient competition in this industry.

Sen. Kohl’s comments sound like the sort of thing I hear from my non-lawyer friends when I tell them I teach antitrust law. The remarks demonstrate almost no understanding of antitrust’s role and purpose and instead treat antitrust as a just another tool for protectionism.

Sen. Kohl never says a word about the only real point of competition between Midwest and AirTran — i.e., the routes served by both airlines. That’s probably because the airlines compete on so few routes. Comparing the Midwest route map (click on “Midwest Airlines Route Map”) with the AirTran route map (run your cursor over the cities to see the routes from each) reveals minimal competition between these two airlines. Almost all Midwest flights originate or terminate in Milwaukee or Kansas City. AirTran, which has dozens of routes from Atlanta and Orlando, appears to offer only six flights from Milwaukee and four from Kansas City. Midwest flies one Atlanta route and two Orlando routes. Because the two airlines serve different areas (and the areas where there’s significant overlap are subject to intense competition from other airlines), a combined AirTran/Midwest would not have the power to reduce output and raise price above competitive levels. That is all antitrust cares about.

It is not, however, the only concern of politicians who would use antitrust law to achieve non-antitrust ends. Sen. Kohl emphasizes a number of other concerns. For example:

The merger might result in a change to Midwest’s fancy service. Sen. Kohl is exactly right that Midwest offers superior service — e.g., all business class seats, warm chocolate chip cookies, etc. Midwest has become a takeover target, though, because its stock price appears to be low relative to what it could be if it were run differently. In other words, the current service/price combination is not squeezing the maximum amount of value out of Midwest’s assets. AirTran believes, and is willing to bet money on the fact, that it can generate more profit from Midwest’s assets. Absent some ability to charge supracompetitive prices (and, for reasons stated above, this merger would not create such ability), AirTran could do this only if it offered a service/price combination that is more desirable to consumers than that being offered by Midwest. So, while the level of service on Midwest flights might fall post-merger, the total consumer surplus (including that which would be created by eliminating the all-business seating and thereby increasing the number of consumers on each flight) would increase. Antitrust law should not bar this expansion of overall consumer surplus.

The merger might reduce jobs in the Milwaukee area. At least Sen. Kohl is frank about his real concern: “Most important to Wisconsin’s economy, Midwest Airlines is a local business, employing thousands of people in high quality jobs….” The problem is that antitrust is not aimed at protecting jobs. It is an incredibly blunt job-protection tool. Moreover, if antitrust recognized potential job losses as grounds for blocking a merger, practically every merger could be barred. After all, it is the elimination of redundancies that creates the efficiencies that make mergers attractive in the first place.

The merger is opposed by Midwest’s management. Duh. AirTran wants to buy Midwest because it perceives Midwest’s stock price to be low relative to the value that could be produced if the firm were managed differently. That means that AirTran believes Midwest management is doing a bad job, and that current Midwest management will almost certainly be replaced in the merged company. Of course Midwest management opposes this merger! Opposition by a laggard management, though, provides no reason for antitrust authorities to block a corporate combination.

The merger involves a crucial industry. This is the argument of last resort for antitrust interventionists: Even if antitrust intervention would not normally be appropriate here, we must step in in this case because the industry at issue is just so important! We’ve recently seen the argument in connection with oil and gas mergers, but I’ve never seen it applied to airlines — especially in such dramatic terms: “[W]e care about competition in aviation because this industry is so critical to our country’s economy. Airlines are America. America is airlines.” C’mon.

Just imagine what Sen. Kohl will have to say about this.

Thom Lambert

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I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

9 responses to Senator Kohl on Antitrust, Part I — Airline Mergers

  1. 

    Hey Thom,

    I don’t dispute the claim about the concern of antitrust law being consumer surplus, or anything else you said. I think my use of the phrase “begs for the type of interference” was poorly worded. What I meant was that the *subjectivity* inherent in determining consumer surplus invites political speculation and interference.

  2. 

    Marc–

    I don’t think anyone seriously disputes my (and Keith’s) claim that antitrust is ultimately concerned with consumer surplus rather than with shareholder wealth-maximization. If shareholder interests were paramount, antitrust would embrace mergers to monopoly and collusion-facilitating combinations, both of which benefit the shareholders of the surviving firm.

    I do not believe, though, that a desire to maximize consumer surplus “begs for the sort of interference that Kohl is proposing.” Kohl seems to be saying that he (or someone similarly situated) can tell that this merger would reduce consumer surplus, because it will lead to a reduction in service levels. I don’t think he’s in a position to make that call (nor is any apolitical economist from GMU or Mizzou). Like you, I believe the market will tell us which business models produce the most consumer surplus. Assuming competition among firms (and thus no ability to produce supracompetitive profits), those business models will be the ones that generate the most profit. Thus, if AirTran can produce more profit by eliminating Midwest’s wide seats, and if there’s no reason to believe AirTran’s profit enhancement is due to an exercise of market power, consumer surplus is enhanced by having AirTran buy Midwest and eliminate the wide seats.

    For these reasons, I believe the analysis here boils down to two questions: (1) Is AirTran willing to pay a significant control premium for Midwest? [Yes--which suggests that AirTran believes it can wring more value out of Midwest's assets.] and (2) Is this merger likely to substantially increase the surviving firm’s ability to reap supracompetitive profits? [No--which suggests that the profit-enhancement that's attracting AirTran is the result of giving consumers more of what they want.]

  3. 

    “consumer surplus, not shareholder wealth-maximization, is the ultimate goal”

    That statement bothers me. It may be the law, as the courts have interpreted it, but it begs for the type of interference that Kohl is proposing.

    Who can objectively decide if a trade-off reducing particular consumer benefits in favor of shareholders is also reducing aggregate consumer welfare in an anti-competitive manner? In other words, would ATA going cold Nabisco instead of warm Famous Amos be anti-consumer or good business? I would say that the people in the best position to weigh that are, in order:

    1) God
    2) ATA’s management
    3) A competing airline’s management (if they’re really good)
    4) The fine people at the DOJ (with the help of apolitical economists from GMU, Mizzou, etc.)
    5) Just about anyone else with a college degree
    6) A U.S. Congressman or Senator

    Next question: If Midwest decides, as a result of this takeover threat, to end the cookies as part of its takeover defense, should ATA be liable for consumer harm under a similar anti-trust theory?

    Final question: Can a consumer sue someone with the market power to do so for better service? Or does one get to use the government to challenge only what is visible instead of what is not?

  4. 

    Yes, Thom, I do agree about Senate hearings being unusual and unnecessary.

    Re market power, it seems to me that the airline industry is oligopolistic enough that pretty much every firm possesses market power to some degree. No one is entirely a price taker. And Midwest is the leading firm in the Milwaukee market and therefore surely possesses some market power.

    One other point to bear in mind: the Milwaukee airport is only about an hour away from Chicago’s northern suburbs and therefore is a realistic alternative to O’Hare for many travelers (particularly those who live in between the two in places like Glenview and Kenosha), just as Newark and JFK (which are more than an hour apart, though closer in miles) compete in the same New York metro market broadly defined. If you think of the two firms in this way, then Air Tran’s LaGuardia – Chicago route competes with Midwest’s Newark – Milwaukee route, which suggests much more overlap than your original post assumes.

    At any rate, I have confidence in the fine people working at DOJ to analyze all of this very carefully. If the deal is ultimately permitted, perhaps it might be conditioned on the preservation of Midwest’s “big arm chair product” or on a reduction in prices charged on Midwest’s routes.

  5. 

    Keith,

    Is there enough overlap to “invite some scrutiny”? Sure. Senate hearings? No way. (Your last paragraph suggests you agree with that.)

    As for your point about AirTran’s reduction of services, I think the key point is that absent some evidence that this merger will notably enhance the merged company’s market power, the likely cutting of services doesn’t raise antitrust concerns. AirTran is almost certain to reduce the level of service (and the price) because it believes that’s the best way to maximize profits. If it does so and there’s no reason to believe its profit enhancement is due to an exercise of market power but is instead the result of better responding to consumer desires, then the service reduction is, from an antitrust standpoint, irrelevant. Absent an exercise of market power, the only way the merged company could increase profits would be to enhance efficiency — that is, to provide more of what consumers want at a lower price. You’re absolutely right that consumer surplus, not shareholder wealth-maximization, is the ultimate goal. But if there’s no chance of supracompetitive profits occasioned by this merger (as there seems not to be, given the minimal competition between the two firms), then shareholders’ and consumers’ interests are perfectly aligned.

    My point, I guess, is that it’s not enough to say that services will be reduced. If service-reduction occurs as a result of profit-seeking and there’s no reason to believe the service-reducing firm is exercising market power, then antitrust assumes the service-reduction is a good thing.

  6. 

    Nice post Thom. My reaction to reading the piece when I first saw it, similar to yours, was that it was at least refreshingly honest with respect to the reasons for objecting to the merger — protecting the local job market! What could be more telling than the line:

    “We understand it might be good for AirTran’s own business interests and bottom line, but ….”

  7. 

    Thom–you’ve identified 12 routes on which the two airlines do compete. Might that not be enough to invite at least some scrutiny?

    Moreover, if it’s true (as both you and Senator Kohl seem to agree) that the deal would mean an end to Midwest’s comfy seats and fresh-baked cookies, then doesn’t that mean the deal is potentially anti-consumer (assuming prices aren’t reduced)? The possibility of producing higher short-run profits for Air Tran isn’t a reason to ignore the effects on consumers. If Midwest’s management could do better for shareholders by reducing amenities and/or raising prices, then shareholders could sue derivatively to make that happen. But so long as Midwest’s consumers are benefitting from these policies, it seems proper for them to invoke antitrust as a way to block a deal that could harm consumers even if it would benefit shareholders.

    A further complication may be the subsidies (if any) that Wisconsin or Milwaukee have given to Midwest in (perhaps implicit) exchange for the high level of service that Midwest offers. Assuming the federal effort to block the deal fails, perhaps the deal might be challenged (either ex ante or ex post) as a matter of Wisconsin antitrust law.

    That said, it is fairly unusual for deals of this sort to be reviewed by the Senate Judiciary Committee rather than the antitrust specialists at DOJ. In its Hart-Scott filings, Air Tran will have to make the case to DOJ that the merger is in the interest not only of Midwest’s shareholders but also of its consumers, which means it must show either how prices will drop, or how flight choices and/or other amenities will increase.

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