United and Continental's Mega-Merger

Loyal Airline Bulletin readers know that I have been posting very infrequently over the last few months. I was out of the country traveling, but am now back in the States and should be able to post on a more regular basis. And although this is a bit belated, I feel it is somewhat pertinent to add my voice to the chorus of industry-watchers discussing the ramifications of the proposed United-Continental deal. So below is a summary of how I feel the deal is likely to pan out, and what some of the consequences could be.

What is likely to happen:

All hubs stay, bar Cleveland: Between them, United and Continental have eight hubs in the mainland United States: San Francisco, Los Angeles, Denver, Chicago O'Hare, Washington Dulles, Houston, Newark, and Cleveland. The smallest and weakest of these hubs is Cleveland. The city generates little origin and destination traffic, especially from business customers. While the city is not a complete dead zone for businesses, it is a far weaker market than all of the other hubs. Southwest is also present, which helps to keep yields down. Like many industry-watchers, while I don't believe it is a certainty, I seriously question the continued viability of Cleveland as a hubsite. A lot of traffic at Cleveland is on higher-cost regional jets, which are likely to see reductions in usage as fuel prices climb. Moreover, much of Cleveland's traffic can be re-routed through Chicago or DC, and maintaining the hub really provides little benefit to the combined airline.

Moreover, the company also has two hubsites off the US mainland, Continental's Guam mini-hub, and United's Tokyo Narita operations (which are hub-like, but technically not classified as a hub). Both of these are likely to be viable in the near future. Guam is a small operation, and serves as a niche hub functioning primarily to transport Japanese and other Asians to various Pacific island destinations. It has a stable market, and very high yields. Narita helps to funnel very profitable US traffic to various Asian destinations. However, it's continued success is in slightly greater doubt, though for reasons not having to do with the merger. An increasing number of US airlines are being provided traffic rights to overfly Japan and fly nonstop from China and other Asian destinations to the US. And many of these markets where traffic rights were available but not utilized are finally becoming strong enough to support non-stop service to the US. Moreover, as Tokyo opens up its airport at Haneda to more intercontinental flights, some of United's nonstop traffic to Tokyo may get routed through Haneda (though the airline did not gain any slots in the first round of applications, announced recently). This may impact the profitability of flights to Narita, and limit the airport's effectiveness as a connection site. However Delta, which inherited a Narita hub from Northwest when they merged a couple years back, is also likely to face similar challenges in maintaining a hub there.

The merged entity is also likely to be strong in markets where one carrier already has significant, non-hub operations, including Seattle, New York JFK, and Hawaii, creating focus cities with the possibility of further expansion.

Some fleet consolidation: Both United and Continental have done a very good job of trimming capacity on domestic routes, and barring further spikes in jet fuel prices (which are not at all out of the realm of possibility), their fleets are not likely to be radically altered anytime soon. That being said, Continental has a fleet of smaller, high-CASM 737-500s that could be removed from service if further capacity cuts were necessary. Given that United operates a primarily Airbus narrowbody fleet, and Continental, an all-Boeing narrowbody fleet, the cost-saving synergies here are minimal.

The Boeing widebody fleets of these companies is an important synergy, however, that suggests prospects for further Boeing orders. United has ordered 25 A350 planes in addition to 25 787s, and Continental has ordered an additional 25 787s. As a result, the combined carrier may find it more advantageous to scrap United's A350 order and replace them with the larger 787 variant, the 787-9. But given that the A350 is somewhat larger than the 787, giving it a slightly better CASM, and that United probably got a good price from Airbus to order their first Airbus widebody, it is also quite possible that this order will remain intact.

Going forward, both carriers will soon be looking to replace their 757-200 fleets, and given that a new generation high-capacity narrowbody is still years away from delivery, the combined carrier is likely to place an order of existing models. If they can negotiate a good deal, the company may do a split order, with some possibly re-engined A320s or A321s (the latter being a new type), being ordered, along with additional 737-900s, which, seat just two fewer passengers than the older 757 in Continental's configuration.

Leadership in domestic business travel: Both United and Continental have very large and very loyal bases of business customers who fly frequently with these carriers, often at considerable expense. Continental has consistently delivered some of the best customer service in the industry, and United, with its large presence in key business markets like San Francisco, Los Angeles, Chicago, and DC, has been able to win countless corporate travel contracts. A combined United/Continental will be the team to beat, and will be a very strong competitor for business contracts as the combined company draws upon the customer base of both carriers while creating prospects for future growth with an expanded network and additional amenities. While Southwest and other LCCs are vying for this market, the truth of the matter is that many large companies, even in an era of trimmed-back business travel, are likely to choose service providers that offer comprehensive domestic and international service, as well as provide the loyalty and amenity benefits that many companies expect. JetBlue's extra-legroom seating and Southwest's credit-based frequent flyer program simply won't cut it with many businesses.

Bumpy, but not catastrophic labor integration: It appears that while there may be challenges to integrating the two workforces totaling roughly 87,000 employees, the obstacles these present will not alone present a problem. Fortunately for management, both pilots and mechanics at the two airlines share a union. Flight attendant integration may be a difficult issue, but can likely be overcome. This is not my area of expertise, so I suggest looking at this recent article from Reuters about the issue, on the Airwise website.

But perhaps an even more significant question is whether this deal will go through. Many analysts have questioned the prospects for this deal, given that the Obama Administration is likely to take a tougher line on industry consolidation than the Bush Administration did when the Delta-Northwest deal was up for consideration. While the United-Continental deal would create the world's largest airline, it would also provide a key counterweight to Delta, which is now the largest airline in the United States by far.

While the Obama Administration is likely to spend a lot of time examining the ramifications of the deal, I ultimately believe that it will be approved, potentially with some conditions. If this deal went through, I imagine that the combined carrier would be required to give up slots at Newark and/or O'Hare, where low-cost carriers have been eagerly attempting to add more service. It is true that Continental has a minor presence at O'Hare, and United a minor presence at Newark, meaning that the combined airline would not have significantly larger market share than the individual hubbing carrier currently does. However given that the merger will help stifle competition within the industry, opening up slots at these two airports to low-cost competitors would be a nod to critics who worry about the competitive effects of the deal. Such stipulations would further competition in two key business markets but still enable the deal to go ahead because of the important benefits it offers for the industry as a whole.

Who loses from this deal? The biggest loser with this deal is the traveling public. The aim of industry consolidation is to maximize efficiencies and take seats out of the sky that are sold at a heavy discount to keep them filled. This deal will help to raise fares. And with fewer competitors, it also means that the industry has less of an incentive to excel, and service standards may slip since customers have fewer choices if they are dissatisfied with their experience. That being said, while the deal is likely to hurt customers with higher fares, it is also likely to help preserve the long-run health of the industry by increasing fares to a more sustainable level.

One concern I have is that if the industry continues to suffer, it may be the recipient in the not-too-distant future of a government bailout, much as it was after the 9/11 attacks. Not because I think every industry in trouble is going to be bailed-out, but because legacy airlines help provide air service to America's small and mid-size communities, which low-cost carriers for the most part do not do. Without such service, businesses in those communities would be far less competitive, as employees would be forced to drive hours to access a major airport, an expensive hassle for many firms, and an important reason why many firms would opt not to locate in smaller communities. While America could well survive without air service to the couple hundred small airports around the country that depend on regional air service to legacy hubs, some federal legislators, particularly from rural states, could not. As the U.S. Senate illustrates, just a few senators from small states have the capability to hold the nation hostage and demand specific pet projects. Because of the vital national service that it provides, I suspect that the airline industry will be protected from its own failures, as it is currently being protected from foreign ownership or competition on domestic routes. While I think these policies hinder the viability of the supposedly "deregulated" free-market of the commercial airline industry, it seems to be the way this is viewed by those in Washington, for better or worse.

The other big loser in this deal is US Airways, which was courted by United initially to help spur Continental to the bargaining table. While US Airways CEO Doug Parker is disappointed but seemingly unconcerned about the prospect of this merger, he should be worried. US Airways has been pounded by LCC competition along the East Coast. It is the smallest legacy carrier, with some of the highest costs, and lingering labor and organizational issues left over from the America West merger. US Airways probably will not find a merger partner anytime soon, but even if it did, that partner may not want to take on all the baggage attached to the company (no pun intended). Although US Airways is engaging in some international expansion, it is inadequate, and the company still faces LCC competition on most of its routes that helps decimate yields. While its competitors are drastically expanding their route networks and trimming their costs, US Airways has been slow to act.

I have not been positive about this company for a long time, and this merger only reinforces my negative view. However, US does have one advantage in this situation. They, like United and Continental, are partners in Star Alliance. If US Airways chooses to stay in Star, it is still likely to benefit from some of the increased traffic flows and network expansions that will eventually happen due to this merger. But that may be little consolation for the company which, just a few weeks ago, was touted as a potential merger partner of United, and has now been relegated to the status of "ugly girl". Obviously in the months to come, more will come out about this proposed deal, and we will get a better sense of whether it is likely to come to fruition. I will work to update Airline Bulletin more frequently now that I am back in the States, and look forward to your comments and feedback.

May 17, 2010 in Continental Airlines, Delta Air Lines, JetBlue Airways, Low Cost Carriers, Southwest Airlines, United Airlines , US Airways | Permalink

Comments

It is the smallest legacy carrier, with some of the highest costs, and lingering labor and organizational issues left over from the America West merger.

Posted by: London escorts | Nov 12, 2010 9:59:56 PM

This deal will help to raise fares. And with fewer competitors, it also means that the industry has less of an incentive to excel, and service standards may slip since customers have fewer choices if they are dissatisfied with their experience.

Posted by: Pet Carriers | Nov 22, 2010 9:28:18 PM

This deal will help to raise fares. And with fewer competitors, it also means that the industry has less of an incentive to excel, and service standards may slip since customers have fewer choices if they are dissatisfied with their experience.

Posted by: Canadian Pharmacy | Nov 30, 2010 10:21:27 PM

The other big loser in this deal is US Airways, which was courted by United initially to help spur Continental to the bargaining table. These all are great to know about it.

Posted by: abendkleid | Dec 9, 2010 8:47:16 PM

The smallest and weakest of these hubs is Cleveland. The city generates little origin and destination traffic, especially from business customers. While the city is not a complete dead zone for businesses, it is a far weaker market than all of the other hubs.

Posted by: wedding photographers bristol | Dec 17, 2010 2:25:38 AM

It can generates the origin of destination of the traffic. It can be use for the business customers these all things are great to know about it.

Posted by: Live roulette | Dec 22, 2010 8:44:31 PM

I suspect that the airline industry will be protected from its own failures, as it is currently being protected from foreign ownership or competition on domestic routes.

Posted by: Canada Drugs | Dec 26, 2010 8:19:52 PM

Now a days most of all people like to have new and latest things so that they can get something change. The post you have made over here is really nice and it is interesting as well. I have gone through it and found it really interesting.

Posted by: online payments | Dec 27, 2010 4:04:40 AM

In these blog there are several things can be done it is one of the continental bargaining table it looks really very awesome to know about it. These all are great to know about it.

Posted by: virility ex | Dec 28, 2010 1:46:02 AM

These all are really very protected with its own failure it can provide so many things which is great to know about it. These all are origin destination of the traffic.

Posted by: lax airport hotels | Dec 29, 2010 2:23:58 AM

Eu só quería comentar e dicir que manter a calidade work.Thanks moito para compartir. Vostede ten feito un traballo brillante. O seu artigo é realmente relevante para o meu estudo neste momento, e estou moi feliz de lelo.

Posted by: Generic Cialis | Sep 6, 2011 10:31:10 PM

"Hi...

Nice post, I would like to request you to one more post about that ****

Keep it up"

Posted by: china wholesale products | Oct 27, 2011 6:52:20 PM

The comments to this entry are closed.