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Why Continental and United Chose Southwest to Curry Favor with the Feds

Last Friday, Continental (CAL) and United (UAUA) said they'd give Southwest 18 pairs of slots in Newark. Then shortly after, word was out that the Department of Justice was no longer concerned about antitrust implications of the United/Continental merger. Obviously, there were some back room deals going on here, and Continental and United chose their poison... Southwest (LUV). Though that might seem like a death wish on the surface, I would argue that it's a smart move.

The Department of Justice (DOJ) explained it this way:

The proposed merger would combine the airlines' largely complementary networks, which would result in overlap on a limited number of routes where United and Continental offer competing nonstop service. The largest such routes are between United's hub airports and Continental's hub at Newark airport, where Continental has a high share of service and where there is limited availability of slots, making entry by other airlines particularly difficult.
With United and Continental combining to form the world's largest airline, the DOJ had centered its investigation on the highly-congested and slot-controlled Newark Airport outside New York. It's true that United and Continental have remarkably little overlap between their networks, and even in Newark there isn't much overlap. But Continental runs about three-fourths of the flights in the highly-desirable airport, so it's natural to look at that as an issue.

The solution? Continental just has to take United's 18 daily flights and give those slots (or others like them) to Southwest. It's clean and simple, but why would Continental want to give a fair chunk of slots to Southwest, the largest domestic airline and formidable competitor to all?

It's probably because it was the best choice available. The government has made it clear that it wants to get more low cost carriers (LCCs) into the highly-congested airports in this country. And Southwest is king of the LCCs.

What Southwest brings to the table is an enormous presence in the US and the ability to connect passengers from all around. What do United and Continental like about it? Probably more than you'd think.

See, Southwest is a low fare carrier by reputation, but that doesn't mean the airline hasn't taken significant fare increases over the last couple years. Many booking in advance know that other airlines are quite frequently less expensive. It's the last minute business traveler that gets a real break under Southwest's fare structure, but it's also that last minute business traveler that is less likely to flip over to Southwest.

Remember, the DOJ is concerned about hub-to-hub operations for Continental and United. With the exception of Denver, Southwest is unlikely to serve any of those routes directly. In addition to Denver, I fully expect we'll see flights to Chicago/Midway, Houston/Hobby, and maybe Baltimore. But those are not substitutes for Chicago/O'Hare, Houston/Intercontinental, and Washington/Dulles, especially not for the last minute business traveler who is less price-sensitive and more time-sensitive.

The DOJ, however, can sit there and happily say that it has brought a large low cost carrier into the market with connecting options around the US. Even though the Department of Transportation made it clear that it doesn't think that different airports in a single city should be considered the same market (at least not in Washington with US Airways/Delta or London with American/British Airways), it looks like something is being done that's very pro-consumer.

So why Southwest and not any of the other low cost carriers in town? Surely Frontier would put those Newark slots to good use from Denver. And we know that Virgin America wants to get into Newark as well. So why not? Well, that's a good question.

Virgin America doesn't bring much to the party in terms of reach. So yes, giving slots to that airline would bring down fares to LA and San Francisco, but that's about it. My guess is that Virgin America could have been included, but the lesser public utility means that more slots would have to have been given up as part of the deal. Besides, why would United and Continental want to give slots to an airline that loses a lot of money? I imagine they'd rather not help it in its bid for survival.

If you're United and Continental, the fewer slots the better. And even though the feds will want to point out that Southwest is going to be the savior of low fares in Newark, Continental and United probably don't feel quite the same way. Besides, they've been competing with each other for years and years. The devil you know is better than the devil you don't.

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Photo via Flickr user Hunter-Desportes, CC 2.0