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US airline mergers: some things never change

28-May-2010

"If the major airlines pare down to three, as industry analysts predict,...Americans would face fewer choices, worse service and higher prices."

Congressman James Oberstar, Chairman, House Transportation and Infrastructure Committee

Stuck in a theoretical time warp

The full quote from Rep Oberstar in fact includes the words “…should the United/US Airways merger fly…”.

It was not said this year.

The Congressman’s comments were made in Jun-2000. Perhaps on the basis that if you forecast something for long enough, it will eventually be right, the Chairman of the House Transportation and Infrastructure Committee holds exactly the same views today, almost exactly 10 years on. This would suggest a view of the world that has remained unaffected by both events and reality.

In 2000, US carriers were still flying high, able to charge last minute fares that could induce shortness of breath. JetBlue was not yet challenging the network carriers with transcontinental service and the year actually saw black ink on many balance sheets. And another outsider, Southwest, has since grown to become the US’ largest domestic airline.

But the face of the industry has meanwhile changed dramatically

Largely in the absence of comprehensive mergers the US majors have managed to decay comprehensively, with no help from outside. Were it not for the questionable process of Chapter 11 bankruptcy, Rep Oberstar would undoubtedly have been right about the number of the genre still flying – but not for the reason he suggested.

And today the legacy airline industry is widely despised by its customers, fed up with poor performance and fees for everything from seat selection to hand baggage. The only airlines which receive regular positive wraps are the low fare brands.

All but one of the network carriers have sat in the bankruptcy penalty box, some more than once, and the lone hold-out may be headed for a similar fate in the long term.  Meanwhile, as a group, the network airlines have managed to contract substantially since that summer of 2000 – a remarkable occurrence in a growing market. Unsurprisingly too, the legacy industry also employs fewer people than it did back then.

As new entrants have expanded, a variety of new service and routings has ensured that any shortfall from legacy withdrawals was quickly compensated, and more.

The cure becomes the malady

One interpretation of this evolution is that, by failing to allow mergers for doctrinaire reasons, the growth of the full service airline has actually been stunted. That is, the cure has actually been the malady. There are of course many other possibilities, for example that the legacy model for short haul point to point operations is seriously challenged by aggressively lower cost operations.

This is a phenomenon seen outside America too. But, outside the comfortable single jurisdiction of the US, mergers are even more difficult to achieve, characterised by rare exceptions, such as Air France-KLM.

Over this same period, global alliances have become ubiquitous, allowing US carriers to “serve” far more destinations than would be possible without such affiliations. Increasingly, for many regular international travelers, their loyalty is to the alliance which supplies the links, rather than to a single carrier brand. Today, any expansion, real or virtual, being undertaken by the US majors is international.

Is the threat of a downside from here realistic? Can things get a lot worse?

Most Americans have seen increased choice as the non-legacy carriers extend their reach. Places like Pittsburgh and St. Louis, shunned by their hub carriers, now depend on Southwest to fill the gaps that the legacy carriers have created.

Some smaller cities have undoubtedly been badly hurt by the past 10 years, but most of those cutbacks have been rooted in the fact that some routes simply fail to carry their financial weight. Temporary artificially supported services will always be at risk. The result is that most non-hub cities now have service that is commensurate with their market O & D demand.

Similarly, the decline in service quality cannot be attributed to mergers and acquisitions but has been the result of cost cutting measures and poor labour relations that have soured employee attitudes. (Also entwined with service dissatisfaction is a government agency, the TSA, dedicated to making the process of air travel as expensive and uncomfortable as possible.)

Have the few mergers led to higher prices (apart from government charges)?

This is a constant debate that will not be resolved in a few lines – which at least suggests a shortage of comprehensive evidence to suggest that fares have actually increased as a result of eg the Delta-Northwest merger.

It is true that USD99 transcontinental fares have disappeared. And the USD29-39 fares up and down the east and west coasts have also disappeared. But air transportation still ranks as one of the more affordable consumer products, priced well below 1978 inflation-adjusted fares.

Europe an still be visited for around USD500 in the off season – plus taxes and fees, many of which have continued to increase. And, in a stunning display of hypocrisy, most of those collections go to the governments and regulatory authorities that decry fare increases as being anti-competitive.

Furthermore, much of the red ink that has flowed in recent times has come from delays that are due to a combination of airline overscheduling and antiquated air traffic control equipment. Remember, Mr Oberstar, new entrants which can’t get slots at popular airports are not really competitors.

“Those who don’t learn from history….”

Back to Jun-2000: “The way airline competition works today, when established carriers control markets, the tendency is for the carriers to follow each other's fare changes so that the fares are identical, and passenger choice is limited. These tendencies would be magnified if there were only a few major airlines.”

And fast forward to May-2010: “If this merger is approved”, the Congressman told the Department of Justice, “the pressure will be immense for further consolidation, leaving passengers with still fewer options. I caution against an overreliance on the theoretical mitigating effects of low-cost carriers. Low-cost carriers do not serve many of the same markets served by large network carriers.”

Well, low cost airlines generally do not hub there services, so there might be some differences in service patterns there – but otherwise?

Again, these two statements indicate just how little updating there has been in Rep Oberstar’s thinking. In 2000, legacy carriers dominated the US aviation scene, but ten years later the three (possible) remaining carriers will carry barely half of the nation’s travellers.

The trickle-down effect of bad policy

Take Cincinnati for example; there the Delta brand claims a hub but regional carriers operate the vast majority of its flights under contract. The 2010 reality is that the legacy carriers no longer serve many markets but instead hire somebody else to do it, using their logo.

And that arrangement, unchallenged by the Chairman, has its own shortcomings and weaknesses as shown by the Colgan Air crash in Buffalo last year. That is not an issue that deserves to be reviewed in the narrow context of legacy/regional relations, but in the operation of the broader industry.

Mr. Oberstar was around at the inception of US deregulation and fully absorbed its intent. Much of what was intended has occurred since, as the market and its constituents have evolved. For all the worry about fare increases, the industry still finds that most pricing is determined by the lowest bidder – that is, there is insufficient concentration of market power to allow price distortions from that source.

Part of the inherent weakness in the system is however attributable to the fact that costs vary far more than prices. Many players simply cannot be profitable at the fares set by the likes of AirTran, Southwest and JetBlue.

Time for (de-)Regulation 2.0

Like bell-bottoms and discos, some 1978 ideas and structures need to be discarded and replaced by thinking (and fashions) that are more appropriate to the time. For those who would influence the course of history, there is a serious responsibility to recognise and adapt to the changes that have occurred.

Deregulation was designed to create a new aviation environment. Now that much has been achieved, surely it is time to rethink the basics and move on to deregulation 2.0?

One place to start could be to look back at the forecasts of a decade ago and work out why the legacy airlines have nonetheless managed to become so unpopular, unprofitable and generally unsuccessful.


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