Since the airline industry was deregulated in 1978, its earnings have been  extremely volatile. U.S. Airlines’ Financial Condition Has Improved, but It Appears to Be Short- lived

The U.S. passenger airline industry has generally improved its financial  condition in recent years, but its recovery appears short-lived because of  rapidly increasing fuel prices. The U.S. airline industry recorded a net  operating profit of $2.2 billion and $2.8 billion in 2006 and 2007,  respectively, the first time since 2000 that it had earned a profit. Since 2004, legacy airlines have shifted portions of their domestic capacity  to more profitable international routes. For example,  Northwest Airlines pilots agreed to two pay cuts—15 percent in 2004 and  an additional 23.9 percent in 2006, while in bankruptcy—to help the airline  dramatically reduce operating expenses. Although the industry saw profits  in 2007 and some were predicting even larger profits in 2008, experts and  industry analysts now estimate that the industry could incur significant  losses in 2008. Domestic Airline Competition Increased from 1998 through 2006, as Low- Cost Airlines Expanded

Competition within the U.S. domestic airline market increased from 1998  through 2006 as reflected by an increase in the average number of  competitors in the top 5,000 city-pair markets, the presence of low-cost  airlines in more of these markets, lower fares, fewer dominated city-pair  markets, and a shrinking dominance by a single airline at some of the  nation’s largest airports. Overall, the average number of effective  competitors—any airline that carries at least 5 percent of the traffic in that  market—in the top 5,000 markets rose from 2.9 in 1998 to 3.3 in 2006. In all, the growth of low-cost airlines into more markets and providing  service to more passengers contributed to the shift in passenger traffic  between legacy and low-cost airlines. Of the 16 airports dominated by a single airline,  14 were dominated by legacy airlines. Airlines Seek to Combine to Increase Profits and Improve Financial Viability, but Challenges Exist

Airlines seek mergers and acquisitions as a means to increase profitability  and long-term financial viability, but must weigh those potential benefits  against the operational and regulatory costs and challenges posed by  combinations. Airline Mergers and Acquisitions Aim to Increase Profitability by Reducing Costs and Increasing Revenues

A merger or acquisition may produce cost savings by enabling an airline to  reduce or eliminate duplicative operating costs. Airlines may also seek to merge with or acquire an airline as a way to  generate greater revenues from an expanded network, which serves more  city-pair markets, better serves passengers, and thus enhances  competition. The integration of two disparate aircraft fleets may also be costly. The Department of Justice’s Antitrust Review Is a Critical Step in the Airline Merger and Acquisition Process

The DOJ’s review of airline mergers and acquisitions is a key step for  airlines hoping to consummate a merger. Additionally, the Guidelines have evolved to provide clarity as to the  consideration of efficiencies, an important factor in airline mergers. The Department of Justice Uses the Guidelines to Identify Antitrust Concerns

Most proposed mergers or acquisitions must be reviewed by DOJ. DOJ estimated that  the merger would have resulted in higher air fares for businesses and  millions of customers. In making its decision as to whether the proposed merger is likely  anticompetitive—whether it is likely to create or enhance market power  or facilitate its exercise—DOJ considers the particular circumstances of  the merger as it relates to the Guidelines’ five-part inquiry. Increased Competition Indicates That Airline Entry May Be More Likely than in the Past

A variety of characteristics of the current airline marketplace indicate that  airline entry into markets vacated by a merger partner may be more likely  than in the past, unless higher fuel prices substantially alter recent  competitive trends in the industry. Both DOT and DOJ officials provided some clarifying and  technical comments that we incorporated where appropriate. Appendix I: Scope and Methodology

To review the financial condition of the U.S. airline industry, we analyzed  financial and operational data, reviewed relevant studies, and interviewed  industry experts. To identify the key factors that airlines consider in deciding whether to  merge with or acquire another airline, we reviewed relevant studies and  interviewed industry experts. Related GAO Products

Airline Deregulation: Reregulating the Airline Industry Would Likely  Reverse Consumer Benefits and Not Save Airline Pensions.
Why GAO Did This Study

The airline industry is vital to the U.S. economy, generating operating revenues of nearly $172 billion in 2007, amounting to over 1 percent of the U.S. gross domestic product. It serves as an important engine for economic growth and a critical link in the nation's transportation infrastructure, carrying more than 700 million passengers in 2007. Airline deregulation in 1978, led, at least in part, to increasingly volatile airline profitability, resulting in periods of significant losses and bankruptcies. In response, some airlines have proposed or are considering merging with or acquiring another airline. GAO was asked to help prepare Congress for possible airline mergers or acquisitions. This report describes (1) the financial condition of the U.S. passenger airline industry, (2) whether the industry is becoming more or less competitive, (3) why airlines seek to merge with or acquire other airlines, and (4) the role of federal authorities in reviewing proposed airline mergers and acquisitions. To answer these objectives, we analyzed Department of Transportation (DOT) financial and operating data; interviewed agency officials, airline managers, and industry experts; and reviewed Horizontal Merger Guidelines and spoke with antitrust experts. DOT and the Department of Justice (DOJ) provided technical comments, which were incorporated as appropriate.

What GAO Found

The U.S. passenger airline industry was profitable in 2006 and 2007 for the first time since 2000, but this recovery appears short-lived because of rapidly increasing fuel costs. Legacy airlines (airlines that predate deregulation in 1978) generally returned to modest profitability in 2006 and 2007 by reducing domestic capacity, focusing on more profitable markets, and reducing long-term debt. Low-cost airlines (airlines that entered after deregulation), meanwhile, continued to be profitable. Airlines, particularly legacy airlines, were also able to reduce costs, especially through bankruptcy- and near-bankruptcy-related employee contract, pay, and pension plan changes. Recent industry forecasts indicate that the industry is likely to incur substantial losses in 2008 owing to high fuel prices. Competition within the U.S. domestic airline industry increased from 1998 through 2006, as reflected by an increase in the number of competitors in city-to-city (city-pair) markets, the presence of low-cost airlines in more of those markets, lower air fares, fewer dominated markets, and a shrinking dominance by a single airline at some of the nation's largest airports. The average number of competitors in the largest 5,000 city-pair markets rose to 3.3 in 2006 from 2.9 in 1998. This growth is attributable to the increased presence of low-cost airlines, which increased nearly 60 percent. In addition, the number of largest 5,000 markets dominated by a single airline declined by 15 percent. Airlines seek to merge with or acquire other airlines with the intention of increasing their profitability and financial sustainability, but must weigh these potential benefits against operational and regulatory costs and challenges. The principal benefits airlines consider are cost reductions--by combining complementary assets, eliminating duplicate activities, and reducing capacity--and increased revenues from higher fares in existing markets and increased demand for more seamless travel to more destinations. Balanced against these potential benefits are operational costs of integrating workforces, aircraft fleets, and systems. In addition, because most airline mergers and acquisitions are reviewed by DOJ, the relevant antitrust enforcement agency, airlines must consider the risks of DOJ opposition. Both DOJ and DOT play a role in reviewing airline mergers and acquisitions, but DOJ's determination as to whether a proposed merger is likely substantially to lessen competition is key. DOJ uses an integrated analytical framework set forth in the Horizontal Merger Guidelines to make its determination. Under that process, DOJ assesses the extent of likely anticompetitive effects in the relevant markets, in this case, airline city-pair markets. DOJ further considers the likelihood that airlines entering these markets would counteract any anticompetitive effects. It also considers any efficiencies that a merger or acquisition could bring--for example, consumer benefits from an expanded route network. Our analysis of changes in the airline industry, such as increased competition and the growth of low-cost airlines, indicates that airline entry may be more likely now than in the past provided recent increases in fuel costs do not reverse these conditions. Additionally, the Horizontal Merger Guidelines have evolved to provide clarity as to the consideration of efficiencies, an important factor in airline mergers.