MERGING TO OBLIVION
By Joe Brancatelli
May 3, 2010 -- Even before the ink was dry on the announcement of Monday's $29 billion "merger of equals" between United and Continental airlines, the talking-head "experts" were out among us offering sage bits of conventional wisdom.
Here's one talking to Reuters: The merger would be good, oft-quoted Bob Mann explained, because "consolidation provides pricing power and the opportunity for pricing power for the entire industry." Various iterations of the same themesófewer airlines meant fewer airline seats, thus more ability for the remaining carriers to charge higher faresóappeared in stories moved by the Associated Press, Dow Jones, Bloomberg, and all the other disseminators of the same old same old.
The problem is that the conventional wisdom is wrongóand it has been spectacularly wrong for a generation.
The so-called "legacy" carriers have been merging since the dawn of airline deregulation in 1978, and it has been a fruitless search for consolidation, pricing power, and profit. As a CNN business reporter claimed in her early-morning coverage of the merger, the airline industry has lost an average of $16 million a day since deregulation began. I don't know how that particular figure of airline impotence was calculated, but the bottom line on the bottom line isn't hard to understand: The United-Continental merger isn't likely to be any more successful in the long run than the dozens of airline mergers that preceded it.
All that's really happened since 1978 is that famous old airline names have disappeared and the merged and remade survivors have continued to shrink, destroy capital, and lose market share. And while the legacy carriers merge toward oblivion, newer, smarter, and more disciplined competitorsócan you say Southwest, JetBlue, or AirTran?ódrive the pricing, decide the industry's capacity, and earn what little profit there is to be made in the airline business.
The five remaining legacy linesóDelta, American, United, Continental, and US Airwaysócontrol just 70 percent of the market today. Since they represent the DNA of virtually every carrier that existed in 1978, that means they've lost about a point of market share each year since. None have been cumulatively profitable since 1978, and all of them except American Airlines have been bankrupt, several more than once.
The current prospective merger partners, United and Continental, are reflective of the syndrome. Today's United is essentially the pre-deregulation United buttressed by the Pacific and London routes of defunct Pan Am. Continental has pieces of a long list of dead carriers: Eastern, the original Frontier, and once-trendy startups with names like Texas International, PeoplExpress, and New York Air. If Monday's merger passes regulatory muster, the combined carrier would represent about 24 percent of the U.S. industry's "revenue passenger miles," a key indicator of size.
That would leapfrog it over Delta Air Lines, the current market leader with about 21.5 percent share. The carrier now known as Delta was created last year when it absorbed Northwest Airlines. But that is an almost laughable "fact" since Delta actually has the blood of more than a dozen pre-deregulation carriers coursing through its corporate body. Do the names Republic, Hughes Airwest, Southern, Western, or North Central mean anything to you? Delta also has what used to be the European and Latin American networks of Pan Am. And every one of those transactions was touted as a way to speed consolidation of the industry, restore pricing power to the airlines, and pave the way to a profitable future.
If you read the initial tranche of articles about the United-Continental merger, you've undoubtedly absorbed the talking-head expert opinion that AMR Corp.'s American Airlines, which represents about 16 percent of the market, will now have to bulk up to compete. Its logical target? US Airways, the smallest of the remaining legacy carriers, with just 7.6 percent of the market.
But neither of those airlines have had great luck (or any profit) with their post-deregulation mergers. Over the years American has purchased AirCal, Reno Air, and TWA. Today it flies almost none of the routes it inherited from those carriers. US Airways' merger history is even worse. One part of its family tree, US Air, was created by a mid-1980s merger of Piedmont, PSA, and Allegheny. Its East Coast Shuttle routes and Philadelphia hub are built on the bones of Eastern Airlines and several intermediate carriers. The other part of the family, America West, came in a 2005 merger.
I don't speak of these ghosts of airlines past to suggest that no airline merger can work. But the truth is unavoidable: None has ever created long-term market stability, medium-term profit or even short-term pricing power. Legacy airlines merge not to create strength, but to mask weakness. .
Consider United, which I wrote about two years ago in a Portfolio.com story with this catchy headline: "Worst. Airline. Ever." The airline, owned by UAL Corp., endured the longest, most expensive bankruptcy in airline history. Yet after its nearly four-year stay in Chapter 11, it emerged in 2006 with 26 separate in-flight seat configurations. It dabbled in everything from an upmarket service (available only on the carrier's transcontinental routes between New York, Los Angeles, and San Francisco) to Ted, a downmarket, all-coach concept. It slapped its name and logo on five types of narrow-body planes, four types of wide-body jets and eight flavors of regional aircraft. It befuddled buyers with an ever-shifting combination of one, two, three, and even four classes of in-flight service and hundreds of thousands of fares.
The airline subsequently rationalized itself a bitóthe all-coach Ted service was dropped and some fleet types eliminatedóbut United has never been more than sporadically profitable, and chief executive Glenn Tilton has been shopping it since the day the wounded behemoth exited bankruptcy.
Compare that to Southwest Airlines. It didn't fly outside Texas at the dawn of deregulation, but it now carries more passengers [north of 100 million] than any other U.S. airline and has gobbled up 10.3 percent of the market. It grew by a full market share point last year alone. And it has done it with a fanatical dedication to simplicity: It flies one type of plane (the Boeing 737 family), it offers one seat configuration, provides one type of service, and sells just a few one-way fares per route. It is the same airline every seat, every route, every flight, every day. Passengers understand what they are buying. And Southwest has made money every year for 37 consecutive years.
JetBlue Airways has grabbed almost four percent of the market in its 10 years of mostly profitable flying. It operates just two types of aircraft, has three seating configurations, and one type of in-flight service. Its fares are all sold one-way in a narrow band of prices. And it has successfully positioned itself as the Target to Southwest's Wal-Mart. AirTran Airways, now the nation's ninth-largest carrier with 2.7 percent of the market, also operates simply and sells passengers a fairly consistent, easy-to-understand product via a one-way fare structure.
Of course, I shouldn't dismiss airline mergers out of hand. After all, as the legacy carriers combine and contract, it means they are getting too small to be too big to fail.
The Fine PrintÖ
It almost always flies under the radar because it is headquartered in Seattle and operates mostly in the West, but Alaska Airlines has quietly grown to 2.5 percent of the market. By the standards of the airline business, it is a relatively profitable player too. And while Alaska Airlines has successfully avoided earlier rounds of industry consolidation, it might not survive independently this time. After the markets closed last Friday, the parent corporation's board of directors adopted a four-year-old proposal to allow shareholders who own a collective 10 percent of the company's stock to call a special meeting.
ABOUT JOE BRANCATELLI Joe Brancatelli is a publication consultant, which means that he helps media companies start, fix and reposition newspapers, magazines and Web sites. He's also the former executive editor of Frequent Flyer and has been a consultant to or columnist for more business-travel and leisure-travel publishing operations than he can remember. He started his career as a business journalist and created JoeSentMe in the dark days after 9/11 while he was stranded in a hotel room in San Francisco. He lives on the Hudson River in the tourist town of Cold Spring.
THE FINE PRINT This column is Copyright © 2010 American City Business Journals. All rights reserved. Reprinted with permission. JoeSentMe.com is Copyright © 2010 by Joe Brancatelli. All rights reserved.