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

Northwest
Hubs-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

0.25

$66.69

3-2

1.17

$180.64

4-3

1.99

$391.84

4+

3.21

$457.39

12

6.62

$1096.56

2-1

83

0.82

$188.20

3-2

395

4.08

$956.40

4-3

224

2.91

$653.50

702

7.81

$1807.10

Nonstop Total
Connecting

Connecting Total

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 Benefits

1.

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 Benefits

1.

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 mergerinduced 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.