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Hearing of the Subcommittee on Antitrust, Competition Policy and Consumer Rights of the Senate Judiciary Committee - An Examination of the Delta-Northwest Merger

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Location: Washington, DC


Hearing of the Subcommittee on Antitrust, Competition Policy and Consumer Rights of the Senate Judiciary Committee - An Examination of the Delta-Northwest Merger

SEN. KOHL: Good afternoon.

Our hearing today will examine the $3.7 billion merger between Delta and Northwest Airlines -- a merger that will create the world's largest airline. Many predict this merger will just be the beginning in a wave of mergers in our nation's airline industry.

We recognize the tremendous pressures that the airline industry has endured in recent years. After recovering from the horrible tragedy of 9/11, the industry now faces skyrocketing fuel costs, and many of our major airlines -- including both Northwest and Delta -- have undergone the painless (sic) process of bankruptcy filings. Yet while it has been the worst of times for the airline industry, it has been no better for the flying public. We all complain about airline service. Uncomfortable flights, frequent delays and mysterious prices are a staple of air travel. Now the airlines suggest that they will be able to merge their way out of their troubles in a way that will benefit customers.

As we analyze their claim we will confront the crucial question of how this merger will affect air competition and whether it will lead to higher prices and reduced services for customers. And we need to very carefully examine the impact of this deal -- and others that well may follow -- on air service offered to small and medium-size cities that depend on frequent and inexpensive air service for their economic health. We expect to hear from the airline executives here today about their plans to maintain service to these communities. While there may always be ample competition between New York and Los Angeles, what does this deal tell us about the future of competition for the rest of us?

Of equally vital interest to me is that this merger do no harm to the independence of Midwest Airlines of Milwaukee, Wisconsin, which is in fact regarded as our hometown airline. Midwest Airlines is a unique company in the airline industry -- an airline that offers the highest quality of service and is actually beloved by its customers. In the last year Midwest Airlines was acquired by an investment firm that partnered with Northwest Airlines. If the merger before us today is completed, Delta will acquire Northwest's stake in that airline. I will expect today to hear from Delta that this will not harm the independence, the quality and the frequency of service or competitive viability of Midwest Airlines.

Both Delta and Northwest defend this merger by arguing that they operate largely complementary route structures that overlap only occasionally. Whatever the merits of that claim -- and we expect the Justice Department to scrutinize it carefully -- our inquiry cannot end merely with an examination of overlapping routes. These two airlines are competing national networks. Each airline takes passengers from small and medium-sized cities through their gigantic hubs and then on to the travelers' final destinations.

There are now six of these national networks. This merger will reduce it to five, and many analysts expect even more mergers soon to reduce the number to four or even three. As we go from six to five to four and maybe even three or even less, we need to stop and ask the question, what will be the impact of the loss of competition on price and service? Are the few smaller low-cost airlines really sufficient for competition, or will the remaining dominant airlines gain a stranglehold on our air transportation system?

Other important issues are implicated by this merger, such as the hard-won rights of employees of both airlines. We are concerned that this merger not lead to any loss of labor protections enjoyed by the airlines' employees. While no union is testifying here today in person, we are including in the record submissions from any union concerned about this merger.

In closing, the executives who lead these airlines have a responsibility to their shareholders to create the strongest airline. But we on this subcommittee have a different and perhaps more important responsibility. Our responsibility is to the public -- to protect consumers and to ensure that no airline or small group of airlines gains a stranglehold on the market. We need to be sure that the announcement that we've all heard flight attendants say at the end of a flight -- quote, "we know that you have a choice," unquote -- "among airlines" -- "we know that you have a choice among airlines" -- does not become as obsolete as airlines like TWA, Pan Am, Eastern, Braniff, ATA and now perhaps Northwest.

Senator Hatch, the ranking member of this committee, is with us today, and we turn to him for his comments.

BREAK IN TRANSCRIPT

SEN. KOHL: The hearing will continue.

We'd now like to introduce our second (sic) panel of witnesses.

Our first witness on that panel today will be Douglas Steenland. Mr. Steenland is the president and CEO of Northwest Airlines, where he has served in various capacities since 1994. Before joining Northwest, Mr. Steenland worked as senior partner at the law firm Verner, Liipfert in Washington, D.C.

Following him will be Richard Anderson. Mr. Anderson is the CEO of Delta Air Lines, where he has served since September of 2007. Prior to joining Delta, Mr. Anderson was the executive vice president of United Health Group from 2004 until 2007. He worked at Northwest Airlines from 1990 to 2004, where he was the CEO from 2001 to 2004.

Following will be Kevin Mitchell. Mr. Mitchell is the founder and chairman of the Business Travel Coalition, where he writes and speaks on airline competition and other aviation issues. Prior to founding BTC, Mr. Mitchell was the vice president of human resources and services at CIGNA.

Finally, we'll be hearing from Darren Bush. Dr. Bush is an associate professor of law at the University of Houston Law Center, where his primary research interests are antitrust and regulated industries, energy, as well as intellectual property. Dr. Bush also served in the Transportation, Energy and Agriculture Sector of the Antitrust Division at the Department of Justice.

We thank you all for appearing at the subcommittee's hearing today, and we ask you all to stand and raise your right hand. Do you affirm that the testimony you are about to give will be the truth, the whole truth and nothing but the truth, so help you God?

MR. STEENLAND: I do.

MR. ANDERSON: I do.

MR. MITCHELL: I do.

MR. BUSH: I do.

SEN. KOHL: Thank you.

Mr. Steenland, we'll hear from you first.

BREAK IN TRANSCRIPT

SEN. KOHL: Thank you, Dr. Bush.

Mr. Anderson, as we discussed in our meeting yesterday in my office, the future of Milwaukee's hometown airline -- Midwest Airlines -- is a major concern to me. I believe it is crucial to our economy that Midwest remains independent and locally owned and operated.

As part of a deal that closed earlier this year, Northwest Airlines owns 47 percent, as you know, but has no operational control of the partnership that owns Midwest. We also understand that as part of that transaction Northwest has an option to purchase the rest of Midwest. If the Delta-Northwest deal is completed, we presume that Delta will own that share and control that option.

Can you assure us that you will not exercise that option, Mr. Anderson?

MR. ANDERSON: Well, the entities aren't merged yet, so I'm not perfectly familiar with the terms of that transaction. But I can tell you that it would be our intention to keep them independent. The original transaction -- as I understand it -- contemplated that Northwest would be a purely passive investor, that they don't have any membership on the board of directors and the two firms act independently. And that was the whole idea behind the investment. And it would be our intention to maintain that position with respect to Midwest.

SEN. KOHL: So I can take that as something of a near certainty?

MR. ANDERSON: Yes.

SEN. KOHL: Thank you.

Mr. Anderson, will you pledge, as a major shareholder in Midwest, that Delta will do everything it can to maintain the independence of operations of Midwest and not take any action to interfere with the route structure, frequency and quality of service of Midwest Airlines from its Milwaukee hub?

MR. ANDERSON: Yes.

SEN. KOHL: After the merger with Northwest, will it be Delta's business interest to have Midwest remain as an independent and strong airline based in Milwaukee?

MR. ANDERSON: Yes, because the whole transaction is predicated upon a domestic alliance with Northwest, with a shared frequent flier program, connecting passenger exchanges through code sharing, and that was an important part of the transaction for Northwest, as I understand it. And that sort of alliance relationship is important to Northwest's service patterns in the Upper Midwest, because they flow traffic on each other, particularly international traffic, since Midwest doesn't have an international network.

So I think the original agreement that Doug put together contemplated that it would remain an independent airline. It's got a great service reputation. It bakes cookies and does other special passenger amenities on its flights, and I think it's a very well run and -- a very well run hometown airline. And it would be our intention that it would remain that way.

SEN. KOHL: Finally, gentlemen, Mr. Steenland and Mr. Anderson, what is it about Midwest that generates such strong approval from customers that I don't think you find in too many other airline businesses across the country? What is it about their business that you feel cannot or should not be emulated in your business?

MR. ANDERSON: Well, if it's good customer service we want to emulate it.

SEN. KOHL: Well, their ratings, you know --

MR. ANDERSON: Right.

SEN. KOHL: -- the things that characterize them in the competitive market in which it plays, from time to time those things come out and Midwest seems to be somewhere close to the very top.

What about you, Mr. Steenland, what do you think?

MR. STEENLAND: Well, I think Midwest has done an excellent job in terms of fashioning itself as the hometown airline. Milwaukee travelers are very familiar with it. It has strong local roots. It had -- it still has members of the Milwaukee community on its board. It was a good civic supporter. And I think that developed a loyalty and a responsiveness that is admirable.

SEN. KOHL: Thank you so much.

Ms. Klobuchar?

BREAK IN TRANSCRIPT

SEN. KOHL: Thank you very much, Senator Feingold.

Mr. Anderson and Mr. Steenland, many airline analysts expect that the Delta-Northwest deal is just the first merger in a massive wave of consolidation in your industry. Indeed it has been widely reported in the press that other major airlines are in merger discussions as we speak. What are now six major networked airline competitors may soon be down to four or even three legacy carriers dominating our skies. And so consumers may be left with little or no competition on many routes, with the remaining large airlines carving up the country.

In your view, Mr. Anderson, what's the minimum of number of legacy airlines necessary for a competitive market? Would three be enough? Would two? Would you like to have it all to yourself?

MR. ANDERSON: (Laughs.) I'm not that optimistic. (Laughter.)

You know, that's a really hard question to answer. You know, I've just been focused on this one, and I've been -- we've been focused on this one because in a classic analysis, a classic combination analysis under the U.S. antitrust laws when you just look at the Herfindahl-Hirschman Index and you look at the overlap and the lack of overlap, this transaction is a transaction that should be approved.

And I note the good point that was made by the professor down at the end of the table that the legal analysis is to look at each of these on a standalone basis. And I think Mr. Schumer may have had it right, which is this is the right transaction. It passes antitrust muster. That doesn't necessarily mean anything that follows on would pass antitrust muster. So focusing on this one, this one should be approved.

MR. STEENLAND: I also think, Senator, we can't forget Southwest Airlines is out there. They remain the largest airline in the United States. They have 20 percent market share. In addition to Southwest, we have JetBlue. We have Air Tran. We have a recent new entrant in the form of Virgin America. And entry in this industry historically has not been a problem. There is ample access to gates, facilities. Aircraft historically, particularly in times when the manufacturers have been wanting to keep their assembly lines going, have been easy to finance. And so it's an industry where entry is available and historically there has been no lack of it.

SEN. KOHL: Okay.

Yes, Mr. Mitchell, and then Dr. Bush, would you respond?

MR. MITCHELL: Well, I think the main point here is that this transaction's going to lead to additional transactions, which will not solve the airline industry's problems at all, will cause tremendous difficulties for consumers, not just on the pricing side but on the customer service side. Republic-Northwest took close to eight years after that merger to get customer service levels back to an acceptable level.

Most consumers today would say we've hit the floor in terms of customer service, very broadly defined -- cancellations, delays, no middle seats, employees looking over their shoulders for the next shoe to drop, et cetera, et cetera, et cetera. If we see the industry collapse from six carriers down to three virtually all at the same time, this will make the Republic-Northwest merger look like a walk in the park, and we will go below the floor. We'll go into the basement. And it will not be for eight years. It will be for a long time after.

I do not buy into the benefits of this merger at all. The evidence has not been put forth in any kind of quantitative way. And the structure of the industry will be forever changed, to the detriment of the consumer and our economy.

SEN. KOHL: Yes, sir, Dr. Bush?

MR. BUSH: The interesting thing about mergers is they're much like marriages. It's very interesting that in times of trouble it's always nice to have someone to go along in those times of trouble with, but it doesn't necessarily make sense. And when you look back at the history of the airline mergers and you look at the economic literature, the history of the -- that literature demonstrates that they are typically bad marriages for both consumers and they do not present the synergies -- or, as we call them, efficiencies -- that the companies purport. Rather, what they tend to do is they tend to cause consumer injury.

So when we are looking to save our companies by getting them bigger to face international competition -- which I find ironic given that they also said that they're having their lunch handed to them by LCCs, which are not big companies -- I think they are really tilting at windmills -- or perhaps airline turbines. Because in fact they aren't going to receive those synergies. What you're going to have is increased consolidation, follow-on mergers because of that consolidation, whether or not those mergers make sense. So you will be left with something like maybe three systems.

And that's problematic, because I'm not convinced that this merger -- we don't have enough evidence that this merger is pro- competitive. We don't have any evidence this merger is pro- competitive. We have no evidence of efficiencies. We have serious problems with respect to overlap. This is not necessarily an end-to- end. There are systems-based competition issues here. And therefore this merger requires deeper analysis.

SEN. KOHL: Now, if I understand the two of you, it's your judgment that this merger as well as others that are contemplated -- the two primary things that are likely to occur is that prices are going to go up and service is going to go down.

Now, I'm sure that Mr. Anderson and Mr. Steenland would not see that as the two major characteristics of this merger. Is that right?

MR. STEENLAND: That's correct.

MR. ANDERSON: That's correct.

SEN. KOHL: We're not going to resolve that today, are we?

MR. ANDERSON: No.

SEN. KOHL: But you both have pretty strong opinions on this, don't you?

MR. ANDERSON: Yes. (Laughter.)

SEN. KOHL: You're an expressive person. I appreciate that, Mr. Anderson. We all do.

Yes, Ms. Klobuchar?

BREAK IN TRANSCRIPT

SEN. KOHL: Thank you very much, Senator Klobuchar.

Before we end the hearing, just on the cost of fuel, you think about it all the time, gentlemen. It's the primary thing in your business. Why is the price of oil -- the price of fuel -- going through the roof, other than China and India, which of course is a part of it? But there must be a lot more. What's going on? Can you tell us?

MR. ANDERSON: Well, I think there are two factors. One, part of that increase is refining capacity in the United States. We haven't added any refining capacity in the United States, and in fact I saw some statistics recently that our refining capacity -- actual capacity -- has been going down.

The second thing is there's an enormous of financial speculation. Because of the issues in the bond and stock market a lot of investment has moved to commodity markets. So you see it with corn prices, wheat prices, gold prices, oil prices. And oil has been -- has had a flood of just -- not people like airlines that are buying it, but people -- people that are just commodity traders.

SEN. KOHL: Some people are making a ton of money.

MR. ANDERSON: Yes.

MR. STEENLAND: A third factor, Senator, is the weak U.S. dollar. So oil is priced in dollars.

SEN. KOHL: Right.

MR. STEENLAND: And oil-producing countries do not want to bear the devaluation risk -- or face it -- that they would face if prices had historically stayed in supply-demand limits with them taking dollars at the weaker international level that they're now at. So there is a clear correlation between how the dollar trades and how oil trades.

SEN. KOHL: And isn't it also true that you can speculate in this market with very small amounts of money -- 5, 6 or 7 percent margin?

MR. STEENLAND: Margin requirements are clearly less than what they would if you play in the equity markets or --

MR. ANDERSON: Right. Because we do that. I mean, we hedge. Delta in the past six months, we've had to spend a fair amount of money to hedge fuel. And the margin calls are a lot less than the margin calls if you're in a bond or a stock --

SEN. KOHL: Well, if we really want to do something about this -- not that this is the only thing -- but one thing that we know is that if the margin calls were much, much bigger than they are now that would reduce speculation by a ton, wouldn't it?

MR. STEENLAND: I think you'd want to make sure that that was done across all markets. Because if the United States just took that position, oil trades in Singapore, oil trades in London.

SEN. KOHL: Absolutely.

MR. STEENLAND: But if it was across the board it would have a very positive impact on reducing oil prices.

SEN. KOHL: So would it benefit our collective societies around the world if people at the top of ladder in government would get together and do just that?

MR. STEENLAND: Yes.

MR. ANDERSON: Yes.

SEN. KOHL: And they should.

MR. STEENLAND: We agree.

SEN. KOHL: All right.

MR. ANDERSON: Are we optimistic about that?

SEN. KOHL: That it will happen? I don't know. But you're being very clear on --

MR. ANDERSON: We'll work with you to try to bring that about. (Light laughter.)

SEN. KOHL: Well, I mean, why would people at the top of government collectively not want to do that?

MR. STEENLAND: If you look at what -- I think it's called the paper trades, which is basically people not actually taking delivery but simply trading as a trading mechanism, the volume of that has skyrocketed over the course of the last 12 to 24 months.

SEN. KOHL: Huge.

MR. STEENLAND: Yes.

SEN. KOHL: Senator, would you like to make another comment?

SEN. : (Off mike.)

SEN. KOHL: Well, we want to thank you all for being here today. It's been very useful, very helpful. I'm sure we've not heard the last word on this.

Before I close the hearing, very briefly I'd like to enter into the record statements from the Association of Flight Attendants, Memphis and Minneapolis Chambers of Commerce and the International Association of Machinists and Aerospace Workers.

We thank you one and all for being here, and this hearing is concluded.


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