The Delta-Northwest Merger: Consumer Benefits from Airline Network Effects

On April 14, 2008, Delta Air Lines Inc. and Northwest Airlines Corp. announced a merger, which would combine two of the six remaining large “legacy” airlines and create what was then the world’s largest airline. The move to consolidate was no surprise, in view of the well-documented financial struggles of Delta, Northwest, and the U.S. airline industry as a whole. Between 2002 and 2005, both Delta and Northwest had filed for bankruptcy protection, as had United Air Lines Inc. (United) and U.S. Airways. Between 2001 and 2008, the domestic airline industry reported negative net income in every year and lost more than $29 million in total, with the number of airplanes and seats declining on average by 1.7 percent and 1.4 percent, respectively, each year. In the second half of the decade, aviation fuel costs (the single greatest component of the short-run variable cost of operating an airline) increased sharply, with the largest increase (more than 100 percent) occurring between February 2007 and July 2008, when prices rose from $1.74 per gallon to $3.69 per gallon. As of 2008, Delta and Northwest were the third and sixth largest domestic carriers in the United States. Delta maintained hubs in Atlanta, Cincinnati, and Salt Lake City and served 149 domestic destinations and 136 international destinations. In total, Delta carried 47 million passengers in the 12 months ending September 2008, generating $10 billion in revenue. Northwest maintained hubs in Minneapolis, Detroit, and Memphis and served 132 domestic destinations and 48 international destinations. In total, Northwest carried 29 million passengers in the 12 months ending September 2008, accounting for $7 billion in revenue. The merger was an appealing one from the perspectives of Delta and Northwest, each of which hoped to improve its financial performance. The parties projected that the merger would generate up to $1 billion in annual cost synergies and substantial consumer benefits due to the positive network effects that would arise from the combination of their complementary networks. The combined carrier would serve 390 destination worldwide with a mainline fleet of nearly 800 aircraft. More important, Delta and Northwest’s networks were largely complementary. As shown in Figure 18-1, the combined carrier’s network covers most of the United States. Delta’s network was particularly strong domestically in the South, Mountain West, and Northeast and internationally on flights to and from Europe and Latin America. Northwest’s network was focused domestically on the Midwest and internationally on flights to and from Canada and Asia. Prior to the merger, Delta and Northwest had been operating a domestic codeshare arrangement (along with Continental Airlines), and both carriers were members of the SkyTeam alliance, which also included Alitalia, Czech Airlines, and KLM Royal Dutch Airlines. Despite the largely complementary nature of the networks of the two airlines, the Department of Justice’s Antitrust Division (DOJ) raised a number of potentially significant competitive concerns with regard to the transaction. Although one might speculate about different theories of harm based on different market definitions, both the merging parties and DOJ analyzed the merger in the context of markets for air travel between specific origins and destinations. The theories of harms focused on the possible weakening or loss of competition on those routes where there were overlaps between Delta and Northwest before the proposed merger. Delta (DL) and Northwest (NW) overlapped with nonstop service on 12 (nondirectional) domestic “city-pairs”: a rout from an airport in one city (the “origin”) to an airport in another (the “destination”). Table 18-1 shows that of these 12 overlaps, no other carriers flew nonstop on four routes, one other carrier flew nonstop on three routes, and two other carriers flew nonstop on three routes. Combined, the 12 nonstop overlaps annually accounted for 6.6 million passengers and $1.1 billion in revenue for the parties. In addition, Delta and Northwest both offered connecting service (with no more than two other competitors) on 702 city-pairs that accounted for 7.8 million passengers and $1.8 billion in revenue. Of the connecting overlaps, 478 (that accounted for 409 million passengers) had either no or one other competitor. These connecting overlap routes were concentrated primarily in the Southeast, connecting over Delta’s hub in Atlanta and Northwest’s hub in Memphis.

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