Decommoditization as a Solution to the Airlines' Problems

The recent push to "unbundle" services airlines has hid the more fundamental problems facing the industry, regarding airline business models, and how these businesses treat their customers. All airlines need to do a better job of presenting themselves to travelers. If a consumer is going to pay, say $500 for a flight, even if most of that cost is out of the airline's direct control, the airline still needs to deliver a service that the customer values at that level. Most customers in this country will gladly pay $510 or $520 for the same flight, but with a superior experience attached. As ticket prices rise, so will consumers' expectations. Wealthier customers typically expect more of the services they purchase, and airlines must live up to that. That carrier will lose some business, but the tradeoff is worthwhile, and with capacity cuts, many seats at higher prices will inevitably be filled. Unbundling is the wrong way to retain customers who value airline travel most, and who have already contributed more than their fare share to the airline's bottom line.

There is a proverbial race to the bottom in the airline industry, and this is only magnified when the industry faces difficulty. Airline tickets have, for the most part (excepting first and business class seats) become commoditized. If a product (or service) is a commodity, the business offering that must either adjust to that reality and reduce costs as much as possible, embracing low fares in order to lure customers, or it must create a brand. Airline managers are certainly at fault for failing to create enough of a customer experience that retains customers and allows the companies to generate higher yields. Branding isn't easy, and is risky. Publicized mistakes can seriously damage good airline brands, as shown with the JetBlue Valentine's Day fiasco last year. But brands have been the most successful companies in this country, including in the airline industry. It's why Proctor and Gamble products, while being virtually identical to store brand products, but at a far higher price (and in my experience, a lower quality than store brand goods), generate more sales. Customers believe that P&G offers a better product, even if that's not really true. To accomplish this, the company carefully targets its customer base, and responds to their needs by constantly innovating and improving the product.

Marketing, and market research, is something sorely lacking in aviation. In the airline industry, companies will have to work a bit harder than P&G, because seeing is believing when one is trapped in a flying tube for seemingly endless hours. Southwest, JetBlue, Virgin America, and to some extent, Continental, have all built strong brands and generated marginally higher yields as a result. They're also the carriers doing the most innovation with their products, responding to the increasing needs of customers. While they struggle, as all US airlines do today, their problems are less severe because they have loyal customers that will pay higher fares.

Industries often suffer reputation damage in times of financial insecurity. Companies that don't work quickly enough to turnaround their downward spiral of bad press lose even more market share (aka, US automakers). At a time when the airlines need the public on their side, to help fight oil speculation and push for a better air traffic control system, they're alienating their clientele. Charging for snacks and beverages on planes is incredibly short-sided, and will deliver minimal cost savings, while delivering long-term reputation damage. With Southwest working to lure more and more business travelers, this is exactly the wrong approach to keeping the highest-yielding travelers flying with legacies.

US carriers are starting to recognize that foreign carriers may soon enter the domestic market, and have far more innovative products and services. Already, US carriers are losing ground to foreign carriers on international routes, the very routes that US airlines need to succeed on to make money, even as foreign carriers charge higher average fares than US carriers. Customers notice that most foreign carriers offer a far superior experience with free food, alcohol, pillows/blankets, and extensive entertainment. Perhaps most importantly for many travelers, foreign carriers more frequently offer nonstop flights to the destinations business travelers need to visit.

Some limited spurts of product improvement have occurred on domestic routes. United's premium service routes (offering international standards of service on domestic flights between NYC and Los Angeles/San Francisco) are some of its most profitable, attracting a large portion of the carrier's business travelers. Neither JetBlue nor Virgin America can top United in terms of passenger comfort on these routes. Sadly however, on most other domestic routes, United, nor any of its legacy competitors, offer similar service standards.

Creating brands, ones that customers will pay for, must be the goal of every airline manager. Service standards need to be improved, both in terms of amenities and employee helpfulness to customers. Managers create company cultures, and cultures turn into brands. At many legacy carriers, company culture is all but dead, and management needs to make a good faith effort to improve it. How the company treats its employees, and the kinds of tools it gives them to improve customers' experiences, determine a brand. Management needs to start innovating and create better cultures that create unique airlines. In turn, they will create more profitable companies.

How Short-Sighted Management has Seriously Damaged the Industry (and some solutions on how to remedy this).

Editor's Note: I've been a bad blogger lately, and I apologize to my loyal readers. I haven't had a substantive post since May, and now we've reached August. How time flies! While I hope to post more often, the nice weather might prevent me from getting more work done on the computer, so posts may be less frequent than desired for the next few weeks. Also, I hope to post selected pictures of my Ecuador trip soon.

The airline industry has problems that no other industry does. For some reason, the airline industry has difficulty adequately matching capacity with demand, and as a result, business cycles and unexpected turns of events seem to hit the airlines much harder than other sectors. There are many reasons for why this may be true. But first and foremost, airlines offer a product that is both essential to the economy, and is one that is constantly in greater demand. Low-fare carriers have succeeded because they have been able to reduce the cost of air travel for those who otherwise couldn't afford it. Ryanair, which has succeeded in reducing fares more than any other carrier, has seen extraordinary growth, because people simply cannot get enough of air travel. After purchasing one car or cell phone, a consumer may have all he or she needs of those products for several years. It's much harder to increase milk sales by lowering prices than it is for airline tickets.

Consumers have limitless opportunities to fly, and airlines have succeeded in convincing them that it's a good use of money, partly because it's more convenient and comfortable than other forms of transport. Nevertheless, as costs rise, this myth will be shattered. Americans will still want to fly, but it will require more and more money. What airlines will hopefully realize is that they will be more profitable companies by offering fewer flights, targeting business travelers and those who are willing to pay for it. Capacity reductions are already starting to come into place that would help achieve this, but it could be too little, too late. Fuel prices have reached such stratospheric levels that most major US airlines will likely burn through their cash reserves in the next few years.

As legacies are at a substantial cost disadvantage with the hedging Southwest, instead of targeting their core customer base, their most frequent flyers, and improving their service, legacies have eliminated many of the perks that these travelers have come to expect, in the name of revenue generation. Known as "unbundling" it's a strategy that Ryanair has perfected (to the ire of much of Europe's flying public), by charging for many services that airlines offer, aside from the flight itself. Charging for checked bags, food, pillows and blankets, and anything else that isn't bolted to the cabin, seems to be the trend. In fact US Airways' new policy is to charge for all beverages onboard. This will even keep free water out of the hands of passengers, except in cases of medical emergency; bottled water and sodas onboard now cost $2.

Yet the fact of the matter is, some of these charges are overreaching, offering airlines far more in bad press than new revenues. Airlines need to maintain their reputations, and they need to maintain low fares. This is the dilemma that carriers face. Yet if carriers adopted a better yield management system, I suspect it could generate just as much, if not more than some of these extra charges. That means offering more deals at the last-minute to fill seats (but making them restrictive enough to prevent their usage by business travelers, whom the airlines need to pay full fare). If airlines aggressively move to fill seats on less popular flights, targeting flights individually, and ensuring that the plane will be as full as possible, additional revenues can be created. It also means further reducing frequent flyer award seats on popular flights, to allow more room for paying clientele. Moreover, increased overbooking, when possible, should be practiced to better fill seats. All these moves will likely be bad for passengers, but they won't deliver the continuous negative publicity that these fees seem to generate. They also will not interrupt the onboard service experience that passengers demand. Airlines are already working these angles, but let's face it, filling one additional seat on a plane at $100 could cover 50 $2 soda sales; they can do more.

Some might argue that the "unbundled" strategy airlines are adopting is what customers want. I don't buy that. Skybus' demise proved that the completely unbundled model cannot work in the US, at least with the high fixed costs that airlines currently face. Yet that seems to be the model many legacies are now replicating. There are services many airlines used to offer (and that a few still do) that weren't being effectively utilized by customers, and there was a great deal of waste. Some examples were airline meals and restrictions enabling customers to check two or even three pieces of checked luggage free of charge. Everyone was paying hidden costs in their ticket prices for services that a select group of customers was taking full advantage of. These are services that should be charged for. By most accounts, after US carriers started offering buy-on-board meals, fewer people ate onboard, but the food was of a better quality.

However, other services, including one free checked bag, snacks and drinks onboard, and free booking of award tickets (without some of the surcharges that certain carriers have recently imposed) should be things that all US legacies offer. These are basic comfort and service amenities that airlines need to retain loyal customers. Frequent flyer award tickets are hardly free if customers must pay to redeem the miles. Spirit and Allegiant will always be the deep-discounters in their respective markets, and charge for everything, but those carriers that are shooting for higher yields need to offer more services included within the ticket price.

True, airlines have yet to impose many of these charges on their most loyal customers, with high elite status or those paying full-fare. But it's not merely the charges themselves, but rather the impression they create to customers, that may hurt loyalty, even with customers unaffected by the charges. Continental, for instance, has resisted adding fees for a number of services. This is in part because of the company's concerns that they could disrupt operations, both on the ground, and in the air, as those passengers affected by the fees resist the changes, causing potential delays or turmoil in the cabin, affecting everyone's experience.

The ability of airlines to cut costs in this environment is rather minimal, without shrinking the size of their businesses. Instead, airlines need to focus on better yield generation. That does include some of the charges being proposed, but it also includes fare increases, and a concentrated effort to fill planes during less-traveled periods. The unbundled strategy has gone too far, and the reputation damage has been done. Airlines need to be extremely cautious going forward about adding additional charges, because discretionary air travel will decrease if the experience becomes too painful, and business travelers will be more willing to consider other options of transport (or conducting meetings).

Potential 2008 Merger: United and US Airways

After Continental spurned United, the latter carrier's best hope of a merger is with US Airways. This merger was attempted back in 2002 before United backed out. But, with fuel costs at such high levels, United and US Airways could make a good pairing. Some fleet and service issues would need to be sorted out, but it could be done. And apparently, it is being done, as merger negotiations are said to be in a "very advanced state".

To start off, I don't think this merger would be as good as the United/Continental deal. United and US Airways have fewer commonalities, and a greater amount of overlap in their systems (in terms of redundant hubs and routes, creating difficulties in network integration). That could make it harder for regulators to accept, but easier when it comes to trimming capacity. I think it would be challenging for the labor groups of both airlines to come together, both of which have been abused by management with substantial pay cuts, and in the case of US Airways, botched attempts at seniority integration. The labor force of a combined carrier would likely be one with lowered morale, and I seriously question their ability to deliver the high levels of customer service that customers expect from United.

The combination of routes and hubs of the two carriers would be a big mess. US Airways has large hubs in Phoenix and Las Vegas, near United's Los Angeles hub, though admittedly, the traffic flows are somewhat different, Los Angeles serving as a jumping off point for a lot of Asian and Latin American services, unlike the mostly domestic focus of Phoenix and Las Vegas. These hubs would have to be consolidated somehow, as it makes no sense for this carrier to operate three separate hubs within a very small radius. What will probably happen is that Las Vegas will receive the bulk of the flight cuts. Any regional/international service, as well as many of its lower-yielding domestic routes could be cut. Las Vegas would be retained mostly as a point-to-point destination, and the combined carrier's operations there would compete mainly against Southwest's point-to-point service to/from the city. Some of the capacity cut from Vegas could get shifted to Los Angeles or Phoenix.

The other primary US Airways hubs are Philadelphia and Charlotte. US Airways has strong market positions in both these cities, and I expect that these would be tougher to consolidate. Because of the functioning of international traffic flows, some regional service in the South could get shifted from Charlotte to United's Washington Dulles hub, and longer-distance domestic routes (such as to the West Coast) from Charlotte could be cut in the face of high fuel costs, with much of that traffic getting rerouted through another hub like Chicago O'Hare. Philadelphia will probably keep most of its current assortment of flights in a merger because of its scale and advantageous position for European flights.

There are some narrowbody fleet synergies, as both United and US Airways operate A319s and A320s, as well as some older variant 737-300s. But, these advantages are mitigated by the fact that United has committed to a Boeing widebody fleet, and US Airways to an Airbus fleet. While this is certainly not a show stopper, it could be a problem, especially if the carrier focuses on international growth. Things could be complicated by the fact that US Airways has orders for Airbus A350s, Airbus's answer to the 787, but the combined carrier will not see those planes for several years, and by that time, the company may have decided that although the A350 is economically beneficial, it's not worthwhile keeping the relatively small subfleet of Airbus widebodies in the overall fleet.

The key is that this merger needs to exploit United's advantages on high-yielding Asia-Pacific and European routes and combine that with US Airways' presence in some key small markets. There are travelers willing to pay $2500 to get from Scranton to Kuwait City, and the combined carrier can make a lot of money off of them. Of course, the combined carrier will need to be prudent about which regional routes it keeps, since much of US Airways' regional network is operated by 50-seat or less jets, which are very uneconomical at current fuel prices. But if the combined carrier can get the right balance of connectivity to an array of smaller destinations with nonstop international flights to destinations few other carriers serve from the US, this carrier will have a winning formula. Hub-and-spoke carriers will survive because they can fill so many different roles. They can't be all things to all people, and US Airways may find that Southwest will continue to gain more market share on Philly to Fort Lauderdale routes. But hub-and-spoke carriers can be in places where there are strong yields, and provided the cost to obtain those yields isn't too high (like it very well may be with some small cities served with 50-seat aircraft or below), hub-and-spoke carriers can be very profitable.

In addition to making sure that capacity is in the right place, and that there is an attractive network for customers, balanced between small, regional, national, and international destinations, the new carrier must also institute systemwide capacity reductions. The combined carrier will have planes that it can easily remove from its fleet (older 737-300s, -400s, and -500s), but whether the company will have the courage to make the necessary decisions is another matter altogether.

United needs to reduce flights to and from its hubs and consolidate its remaining capacity. Because United is merging with US Airways, a legacy carrier billing itself as "low-cost" that offers relatively few amenities compared to its legacy or low-cost competitors, United may decide that it's best to downgrade its own operations and brand. This may not be a smart strategic decision, as business travelers who appreciate comfort and service are likely to be the biggest profit generators for the company, but they may have to begrudgingly accept the financial realities that United faces and put up with a diminished product. By eliminating its Economy Plus section, United could add several rows of coach seating to its narrowbody aircraft, enabling the company to reduce CASMs and consolidate its existing capacity. Seven flights a day between two major cities could be made into five. Overall capacity will decrease, though it will be mitigated by adding additional seats onto each aircraft. It doesn't sound sexy or exciting, but it has the potential to save the company a tremendous amount of money in the long run.

A merger between any two carriers must be used to consolidate the tremendous amount of capacity in the domestic market. Serious cuts will need to be made. The ridiculous proposal that Delta and Northwest made several weeks ago doesn't do this, instead, it tries to keep everyone happy by promising that all hubs will remain intact (the validity of this promise is yet to be determined). All that will do will make investment banks happy, executives rich, and leave our air transportation system in even deeper excrement. While United and Continental had the potential to create a world-class airline, with high standards of service focused on business travelers, the combination would likely have had minimal capacity cuts. US Airways and United have real overlap. Cuts can and should be made. Cuts, made strategically and with an eye towards customer needs, will result in fewer flights, but higher yields, and in the long run, more profits. If it's going to cost hundreds of millions of dollars to put these carriers together, there better be a tangible plan for long-term savings. Getting those hundreds of millions of dollars in savings doesn't result from combining management, it results from company-wide modifications. In a world of $120 oil, no amount of hedging, seat pitch tightening, or aircraft modifications will be sufficient to generate the savings that investors are looking for. Capacity must be cut on mainline domestic routes, as well as on small regional routes (particularly with 50-seat jets). That is the only path to profitability. 

Creating a brand attractive to business travelers, with high levels of service, an expansion of international routes (particularly in the Asia-Pacific region, where United is currently dominant), and frequent flight schedules is also critical. The combined carrier won't survive without loyal customers and those customers won't be loyal without the benefits to keep them there. The combined carrier needs to take seriously its frequent flyer benefits, onboard amenities, and service standards, and make these things a priority in a merger deal. But the airline won't thrive without actively managing its capacity, and that's the key to any merger, not just to a potential United/US Airways deal.

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What a United/Continental Merger Would Look Like...

With the recent Delta/Northwest merger proposal being made official, it appears that United and Continental may announce a deal within the coming days in order to help the two carriers compete in the changed marketplace. Both United and Continental released statements this morning expressing their desire to be proactive about consolidation opportunities. In other words, they're hard at work coming up with a deal. Like a Delta/Northwest deal, a United/Continental deal would have to target capacity and service, but in different ways than a Delta/Northwest deal.

For instance, looking at capacity, Continental has very been successful in filling planes to Newark and Houston, its two largest hubs. Flights to these cities from many large US markets could be increased in order to increase the number of passengers transferring onto profitable international flights. One beneficial attribute of this merger would be that Continental, which has struggled at times to get the right aircraft for its service requirements, would have access to additional larger, more cost-effective planes to use on services from hubs. For Continental, regional capacity isn't as much of a problem as it has been for other carriers, in that Continental has been able to divest itself of some capacity over the past few years. Continental has had leverage over ExpressJet, its main regional jet provider, to help that company reduce its costs and its capacity. Continental has already trimmed a number of ExpressJet routes and if fuel prices increase further, additional routes could be cut.

But the problem for Continental is that almost all of its regional capacity is on 50-seat or fewer regional jets, which are very expensive to operate in a high-fuel cost environment. While Continental is starting to integrate more fuel efficient turboprops into its regional network, they will make up a very small component of the company's regional services at a time when Continental really needs more cost effective planes. Contrast this to United, which granted, contracts for a lot of 50-seat regional jets. But in addition to this, United has a rapidly-growing fleet of 76-seat regional jets, which United has decided to configure in a 66-seat configuration, allowing United to increase yields on these flights by offering First Class and Economy Plus seating. This has given United a marketing advantage with high-yield travelers on key regional routes, as well as a degree of pricing power. If a merger goes through, expect to see a reshuffling of some regional routes, with a greater emphasis on turboprops, especially in California and Denver. United operates a wealth of short-haul routes from its California and Denver hubs, and many of these could be operated with newer, more fuel efficient turboprops.

Moreover, while domestic flights may not see dramatic additions or reductions, Continental's ability to access United planes may allow the combined carrier to launch key routes from its Newark hub, a long-term strategic asset for the company. Additional routes from Newark to Asia and Africa could be launched with the procurement of additional planes. Continental has struggled to get enough long-haul aircraft, especially 777s for very long routes. However, United has several dozen 777s that will permit the combined carrier to assert itself in the Asia-Pacific, as well as in Europe and the Middle East. If Delta and Northwest get the go-ahead to merge, United and Continental's combined presence will keep pressure on prices on key routes to Japan, China, and other Asian destinations where United and Northwest currently have the only presence by US carriers.

If there's a market in this deal that will be the loser, it's going to be Cleveland. Continental may say, just like Delta did in its press release yesterday, that all hubs will be saved. This is a fallacy that's being perpetuated in order to keep Senators and Congressmen happy until the merger is approved. These secondary hubs are filled with high-cost regional jets, and don't have the origin and destination traffic to keep operating at current flight levels. The economics of these secondary hubs don't work in this market, and Continental will be forced to make tough choices. Regional services will be the first to go, though some regional service is likely to remain for the foreseeable future. Some cities will eventually be axed altogether, and for others, service could just shift to Houston or Newark. Any international service Continental has from Cleveland will also likely be cut. Some domestic routes may be kept, a focus city arrangement that allows Continental to continue serving key business markets from Cleveland. But the bottom line is that Cleveland is going to see fewer destinations. Though the upside of this is that while more passengers may have to make connections, a downsizing by Continental could allow Southwest or other low-cost carriers to start additional flights, lowering fares for area consumers.

Servicewise, this merger is going to be tricky. Both United and Continental have good customer service, though both carriers have been faltering of late to deliver the same quality of service that many customers have come to expect, due in part to increasing pressures on overworked and undercompensated employees. Both United and Continental will have to recommit themselves to delivering high-quality service from all employees if they are to retain the large share of the business travel market that they currently possess.

But, other issues relating to service will have to be resolved. First, United has an Economy Plus section on all of its mainline planes and many of its regional aircraft. Continental does not have such a section, and depending on the structure of a combination, Continental may need to reconfigure much of its fleet. The Economy Plus section has helped United retain higher-yielding customers who often expect a higher level of comfort with a higher ticket price, and it is a concept that should be adopted throughout the combined company's fleet as a way to resurrect the service culture that airlines should be delivering and to retain key customer groups.

The second major service-related issue that the combined carrier will have to deal with concerns onboard food and beverages. On many longer domestic flights, Continental offers complementary meals to customers, something not matched by any legacy carrier. This is something that the combined carrier will need to think carefully about. Providing meals is a good selling point, but it's also expensive. If the company is focused on cutting costs, then for consistency of operations, meals should be cut on domestic flights. But, if the company is serious about attracting business travelers, then it will offer improved food service on additional flights, offering all travelers food service at a standard similar to what most airlines offer for buy-on-board meals. This won't be inexpensive, but it's a cost worth having if customers value the meals. Airlines can serve decent onboard food (many of the buy-on-board selections carriers offer are of a much higher quality than the "free" meals they gave out several years ago), and while it's a cost, with the hassles travelers are facing at the airport, having food available onboard the aircraft may be a selling point to a lot of travelers.

If this merger is completed, the combined carrier will have a larger base of business customers than Delta/Northwest, and a critical advantage over that carrier in key business markets including Washington DC, Chicago, Houston, Denver, San Francisco, Seattle, Los Angeles, and others. It won't be a perfect match, no combination between two legacy carriers will be, but they do have compatibility, more so than Delta and Northwest, and while it will take time, I have more hope for this deal being a long-term success than the Delta/Northwest agreement.

For more details about the United/Continental deal, check out this earlier (speculative) post, or this post for information about the Delta/Northwest deal. If you haven't subscribed to our free feed, please do so by going to the Airline Bulletin home page and entering your email on the right side of the page, under Get Posts By Email. And if you haven't had a chance to support the sponsors on the site, please do so next time you book a trip. By doing so, you're helping to ensure that Airline Bulletin can keep operating.

Potential 2008 Merger: American and Continental

This is a merger deal that has been mentioned less often than a potential United/Continental deal, and it's in part because quite frankly, the match between them wouldn't contain as many synergies as the latter deal, due primarily to too much overlap in terms of both carriers' route networks, though there would be important fleet synergies that could offer cost savings. Of any two legacy carriers, American and Continental are most similar in terms of route structure. Both have very large hubs in Texas, as well as sizable operations in the Midwest (American having hubs at St. Louis and Chicago O'Hare and Continental having one in nearby Cleveland). Furthermore, both carriers have strong operations in the NYC metropolitan area, with a wide array of international flights, and neither carrier has a very diverse set of operations in the US west of Texas.

Moreover, while Continental has used its Newark hub to expand to destinations in Europe and Africa, a very large proportion of both carriers' international capacity is concentrated in Latin America, especially between hubs in the Southern US and Latin America. For many smaller destinations in Mexico and Central America, many of which are served by regional jets, a merger by American and Continental would leave very little additional service from US carriers, potentially raising prices for consumers. That would be beneficial from a competitive standpoint, but it could threaten the viability of the merger.

In an American/Continental merger, Cleveland has a very high probability of being sacked as a hub. The same is true in a United/Continental scenario. Cleveland simply doesn't have the yields and the origin and destination traffic levels to sustain the levels of service Continental has there right now. Continental's operation there could be downgraded to a focus city, with regional service being trimmed or eliminated altogether, and service maintained mainly to hubs and large business centers. This could open up the opportunity for Southwest to gain market share in Cleveland, where it already has a presence, by offering competing nonstop service to woo business travelers. Southwest could help lower fares for area travelers, but a reduction in Continental service will almost certainly mean a loss in the number of destinations served from the airport, forcing many travelers to make connections to reach many smaller markets. Moreover, any international flights Continental flies from Cleveland would very likely be eliminated in a merger. As a result of consolidation in Cleveland, most of that hub's traffic would get diverted to American's O'Hare hub. It's unclear how this deal might affect American's operations in St. Louis. Because Continental has no hub within several hundred miles of St. Louis, my guess is that it's operations will likely remain relatively intact, though St. Louis could feel the effects of a further reduction in regional jet usage if fuel prices continue to remain at such high levels, since regional jet flights are increasingly unprofitable due to high fuel costs. Many of American's flights at St. Louis are operated by regional jet contractors.

Of course the real wild card in any American/Continental consolidation is what would happen to the two carriers' Texas hubs, which are very close. It's likely that both hubs will probably remain intact in a form similar to the present, because American and Continental simply have too much to lose by giving up their position in either market, the yields are too good, and the market share is too significant. However, what could get shifted around are the routings of some international flights. Depending on which city has less competition, or has better yields for a given international route, certain international flights could get shuffled between Dallas and Houston. Moreover, flights between Dallas and Houston could be consolidated with larger aircraft and more frequent service, giving a combined American/Continental leverage against Southwest by lowering ASM costs and potentially boosting market share.

American Airlines has a very simplified fleet structure for an airline of its size. After 9/11, the company reduced the number of aircraft types in its fleet from 14 to 6, and this has produced tremendous operational efficiencies for the carrier. Continental, which has a range of 737, 757, and 767 variants, will complicate American's fleet. However, these aircraft, even those variants which would be new to American's fleet, would bring efficiencies in maintenance and training. But what's even more important, is that increasingly, US carriers have resorted to regional jets and smaller aircraft to fill the roles larger aircraft used to play, in order to increase load factors and revenues per available seat mile. Because of its relatively uniform domestic fleet, American cannot easily tailor capacity to certain markets at certain times. The company has a large capacity gap between its MD-80s, which seat over 140 passengers, and some of the 70-seat regional jets its American Eagle subsidiary operates. Continental, while not an ideal carrier to help fill this capacity gap, helps give American some flexibility. Continental operates a large amount of smaller 737s, including some that seat around 120 passengers, and Continental recently started contracting to use 78-seat turboprops on certain routes out of its Newark hub, that have allowed the carrier to better time capacity to meet the needs of business travelers, as well as reduce unit costs. With a more diverse fleet of 737s, the combined carrier will be better able to time capacity to certain times of the day in certain markets, giving it leverage over Southwest which only operates 122- or 137-seat planes.

Like a potential merger with United, a merger with American would help Continental realize its international potential. Continental is constrained due to its lack of 777 planes, but American has 47 which will help the combined carrier add new lucrative long-haul international routes in the coming years. With the exception of American's A300s, which are very useful aircraft for carrying large amounts of cargo on Caribbean routes, both carriers' long haul fleets are Boeing 767s and 777s, allowing the combined carrier to reap additional cost savings.

Strategically, the argument can be made either for or against a merger. On the one hand, because American and Continental are such similar carriers, with similar fleets and route networks, relative to other legacy carriers, then a merged carrier would not be a diversified one, but instead one with many more eggs in fewer baskets, than a Delta/United merger. Strategically, this could work out, but it will focus the carrier on hub-and-spoke domestic routes, international travel in certain regions, and certain products and service standards, all of these being much less varied than those of other carriers. If the carrier is focused on the right markets with the right levels of capacity and the right product, then it will have a tremendous advantage over the competition. It's a gamble, and one that I think will not pay off well for the combined carrier in the long-term because the market is changing too quickly to have a narrower strategy. A diversified carrier, like a combined Delta/United, has strength in virtually every location US carriers serve, as well as the ability to attract key groups of corporate flyers and leisure travelers. A combined American/Continental might be very, very strong in Texas and elsewhere, but its service frequencies to key business markets such as San Francisco, Los Angeles, Boston, and Washington DC might pale in comparison to a Delta/United combo, making the carrier less attractive for high-yield business flyers.

This merger is less likely to be approved by lawyers at the Department of Justice than a United/Continental deal. American and Continental would simply have too much market power in Texas, especially between Dallas and Houston which is one of the busiest air travel routes in the country. Moreover, American and Continental are the only two carriers for many smaller communities in Texas, Oklahoma, and the surrounding states. If these two carriers merged, higher fares and less frequent service would likely result for communities that have struggled to maintain precious flights. The last major regulatory conflict concerns whether the DOJ would examine how American/Continental consolidation would affect fares to certain international destinations, that the two carriers dominate from the US, particularly in Latin America. These are all hurdles that can be overcome, but they may be tougher ones to climb than what a combined United/Continental would have to face.

While some of the recent difficulties in securing the Delta/Northwest merger have made an American/Continental deal even less likely, it's still a scenario that should be considered. Even if legacies aren't able to spark consolidation this year, this deal may be one to watch for in future years.

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Potential 2008 Merger: United and Continental

If a Delta/Northwest deal goes through, which is looking increasingly likely, then United and Continental may be poised to join forces to create a formidable competitor. The combined carrier would be the combination of two carriers that have been very successful at maintaining relatively high service standards (for US carriers), even during the service downturn that customers have seen in the past several years, and as a result, each has maintained a solid base of business travelers.

What a combination would do is give this carrier dominance in certain international regions particularly in the Pacific Rim and the Middle East. As an increasing amount of business traffic is being directed to these two regions, the combined carrier would have a distinct competitive advantage over even a combined Delta/Northwest in providing high-quality, frequent service to these, and other, parts of the world.

A merger would likely do little to greatly realign the route networks of either Continental or United, with one notable exception. United has five very large hubs, all generating a significant amount of a high-yield origin and destination traffic and all a sufficient distance away from any of Continental's, that none of them are likely to see any major service reductions. But, Continental's Cleveland hub could see a gradual draw down in service, with the elimination of much of its regional service (or a reshuffling of that regional service to Chicago or Washington). Cleveland for Continental is similar to Cincinnati for Delta. Both are hubs that generate a fair amount of origin and destination traffic, and this traffic generates solid yields. But, the sizes of the hubs are dwarfed by others in the respective carrier's route network, and it's simply inefficient to maintain them should Continental and/or Delta merge.

In addition to some flight reductions at Cleveland, some eventual realignments and shifts in international service could occur. For instance, some international flights could get moved from Washington Dulles to Continental's Newark hub or vice versa depending on traffic patterns to facilitate easier connections from West Coast flights to lucrative international flights. It's also possible that some services to the Pacific could be realigned. For instance, Continental has a small hub in Guam, allowing the carrier to serve Micronesia. But, that hub can only be accessed from Honolulu in the US, whereas a much more convenient connection location for customers might be San Francisco or Los Angeles, because there are much more frequent and convenient connection opportunities for customers.   

Moreover, the merger would offer significant benefits in terms of fleet simplification. United has one of the most diverse fleets of any major US carrier, but since its mainline fleet is mostly Boeing planes, while Continental's mainline fleet is all-Boeing, then the combined carrier will yield some significant synergies with maintenance and training costs due to fleet combination.

If the fleets were combined, United may try to reduce the number of older 737 variants in its fleet, but because Continental also has many of these types, they may have to be kept for longer than either airline would like since it would be difficult to eliminate them outright. One of Continental's largest problems in recent years concerning its fleet has been its lack of 777 aircraft to service very long international flights. As a result, Continental has had to delegate its 777s to just a few select routes. United has dozens of 777 long-haul planes, and these could be added to some long-haul routes currently operated on Continental 767s (typically older, smaller planes) to add capacity and lower ASM costs.

Concerning alliances, the biggest thing that could stop this merger is the "golden share" which Northwest holds over Continental that essentially gives Northwest the right to veto any mergers Continental might conduct. But, if Delta and Northwest merge, Continental could purchase its golden share back from Northwest for $100, enabling the carrier to merge as it wishes. However, it's very likely that Continental will have to drop its codesharing agreement with Delta and Northwest if it merges with United, and assuming that United makes the acquisition, Continental will likely become a member of Star Alliance, leaving Delta and Northwest as the remaining two US carriers that are a part of SkyTeam.

Since it appears United will make the acquisition, I suspect the Continental brand could eventually be dropped, and all operations integrated into United. But like with the US Airways/America West merger, the transition period will take awhile, and so customers and employees need to be prepared. United has a team of experienced managers who aren't as ruthless as those who ran US Airways through its transition period, and the cultures at United and Continental are much more similar than at the old US Airways and America West, so there will probably be less resistance from employees to such a deal, provided management treats them fairly. As a result, even though a United/Continental merger is much larger than the US Airways/America West deal, it should be smoother.

This merger could mean good or bad things for business travelers. Both United and Continental have considerable bases of loyal business travelers who will likely continue to fly with the combined carrier. But, as shown a week ago, when United announced a new $25 baggage fee to its non-elite restricted coach flyers (many business travelers, especially those who fly for smaller businesses will travel on restricted coach tickets), one airline is focused on nickel-and-diming passengers while the other is focused on offering inclusive amenities and providing services to its customers. Continental continues to be the only major US carrier to offer free meals, even in coach, on medium-to-long domestic flights, and the company recently announced a new onboard entertainment system to be installed in many of its domestic mainline aircraft. If the two carriers merge, they will need to determine whether to continue down the path many other US carriers are taking, charging customers extra for services that were formerly free, or offering all-inclusive rates. I would argue that the latter option better meets the needs of business travelers, many of whom already pay exorbitant amounts for their tickets, and who make decisions about which carrier to fly based on amenities and service.

Like all legacy carriers, United and Continental are both moving forward with international expansion planes, while curtailing domestic flying. That's a fine, smart thing to do right now at this time when the economy is stuttering. But, if United and Continental become more international carriers and less domestic carriers, then to win over business travelers, they can't simply outdo other US legacy carriers with lousy service standards. They have to compete against foreign carriers, which on the whole, offer superior service and amenities to business travelers than US carriers. As more and more foreign carriers expand in the US, legacies like United and Continental will have a tougher time winning the patronage of business travelers, which is why a renewed emphasis on amenities, loyalty benefits for high-yield travelers, and most of all, customer service, will keep business travelers loyal. Many foreign carriers don't win over customers based on price, they win them over based on the experience, and since US carriers have less low-cost competition in foreign markets, they don't need to worry so much about winning on price but instead on delivering an excellent experience to customers. If a combined United and Continental can do this, then they will become the leading US carrier, and have a significant competitive advantage over American as well as combined Delta/Northwest.

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Potential 2008 Merger: United and JetBlue

First of all, let's start out with a reality check. This merger is not very likely. It's possible, but less likely than other merger scenarios, such as a potential United/Continental merger. However, this may be the most likely merger scenario involving a legacy carrier and a low-cost carrier. A United/JetBlue merger would deliver high levels of service to business and leisure travelers across the country, and create a company focused on higher-yield passengers.

The combined company would have tremendous synergies at several key airports. United has a substantial operation at JFK, and a combined JetBlue/United could use its synergies to create a more efficient and more comprehensive operation at the airport. A combined United/JetBlue could offer a third clear alternative in the New York market to Delta and Continental, by allowing customers to connect from JetBlue domestic flights to United international flights. Currently, both Delta and Continental have sizable hub operations, that connect traffic flows from routes all across the US to European flights, and United and JetBlue, both of which have very high customer service standards and huge legions of loyal passengers, could sift business away from Delta and Continental. Moreover, JetBlue has operations at four of United's five hubs (San Francisco, Denver, Chicago O'Hare, and Washington Dulles), albeit much smaller ones than at JFK. These could be easily absorbed into United's operations, reducing cost and increasing synergies by allowing customers to more easily connect flights and allowing JetBlue to trim its airport staff at these airports. The biggest loser in this case could be Frontier, because JetBlue, which offers a superior product to Frontier's, could add additional flights in Denver post-merger, squeezing Frontier even more as it tries to stay afloat in an increasingly saturated market.

The merger would offer tremendous benefits to JetBlue passengers, who love the carrier for domestic flights, but are unable to use it to easily connect to international flights. By teaming with United, passengers from upstate New York and elsewhere could easily fly JetBlue to New York city, and then connect to a United flight to take them to Europe and elsewhere. Moreover, now that Lufthansa, one of United's close Star Alliance partners, owns 19% of JetBlue, this could facilitate additional alliance-building on routes to Europe, and also make the potential merger easier to execute, if it ever were to occur.

Fleetwise, JetBlue only operates two aircraft types, the A320 and the Embraer E-190. United already has a large fleet of A320s, and the combined carrier could see reduced training and maintenance costs from having a larger fleet. The E-190 would be a new aircraft type to United, but one that would likely be well-received, as United needs an aircraft that is able to serve smaller and medium-size cities once or twice a day. JetBlue plans on receiving dozens more E-190s, and many of these could be put to work supplementing United's regional service in Chicago and Denver. However, with an increasing fleet of narrowbody aircraft, United may try to reduce some of its older 737 variants, though it may be challenging for the carrier to eliminate these entirely for several years.

A big question would be the issue of branding and this may be resolved in part by how the two carriers are structured post-merger. If JetBlue essentially remains a separate entity, but under the United umbrella, then United will feel less pressure to integrate JetBlue's amenities onto their mainline aircraft. But if the carriers completely interchange aircraft between the two fleets, then business customers may be put off by the differential in service standards between JetBlue and United planes. United's aircraft lack many of JetBlue's amenities (such as leather seats, televisions at every seat, hip snacks) but offers some amenities that JetBlue lacks (such as three-class seating on many domestic flights, with first, Economy Plus, and economy seats). One idea is to keep JetBlue as essentially a separate entity under the United umbrella, with a merger allowing the merged company to combine maintenance, training, and management activities. They would be two separate brands under one roof. There would be some problems with this, as it would make it more difficult for the combined company to interchange aircraft between the two fleets, and it would run the risk of alienating some premium travelers, who, for instance, may book on first class on a United aircraft, but then could be forced into coach on a JetBlue plane if a United plane is unavailable due to scheduling constraints.

Therefore, the best solution seems to be to already use the separate "airline-within-an-airline" that United already operates, Ted, and integrate that into JetBlue, by adopting the JetBlue brand and amenities. United's Ted, which is flies primarily leisure routes, and which operates A320 aircraft in a configuration very similar to JetBlue's, could be the best way to integrate JetBlue into United. JetBlue would adopt Ted's aircraft and operate the routes that Ted currently operates. When JetBlue received delivery of new planes, those planes would likely be used for shorter leisure routes and augment or even replace United mainline service. This would bring some sense of continuity to United's operations by maintaining a separate brand for leisure-oriented, lower-yield routes, one that would not offer premium class service, but one that would offer superior service to competitors.

However, while Ted would adopt JetBlue's product and amenities, JetBlue would likely adopt United's frequent flyer program, Mileage Plus. This program, which has many millions more members than JetBlue's TrueBlue, is also more consumer-friendly and better for business travelers, since it offers elite status and other incentives for very frequent flyers. In this sense, JetBlue would become part of the United family.

While employees at both companies could face staffing cuts, the effects of such a merger are likely less toxic than at other carriers. Because JetBlue is an expanding company, many redundancies (with some airport staffing and management exceptions) could be alleviated when JetBlue receives delivery of new planes. Flight crews, pilots, and maintenance staff will all be needed to operate these planes, and so their jobs are relatively safe, with some possible sporadic cuts depending on how capacity is realigned at the two carriers. Therefore, the layoffs from such a deal would likely be rather minimal, at least in comparison to most legacy carrier mergers. While a United/JetBlue is unlikely, it is possible, and would create long-term benefits for customers and shareholders.

Potential 2008 Merger: Delta and United

As the media has stated over and over in the past few weeks, Delta Air Lines is rumored to be a very important player in any eventual industry consolidation. And the two most mentioned partners for the carrier are United and Northwest (a scenario detailed in this earlier post). The Wall Street Journal has reported that Delta is seeking to enter formal merger talks soon with both United and Northwest, and the airline hopes to choose between the suitors in the near future. The United merger would create a very different carrier from the one it would create if Northwest were to merge with Delta, and I would argue that in fact, it would create a better company for investors, with a greater focus on business travelers and international expansion and fewer route and fleet synergies to resolve. For more information about the potential merger deals that could occur in the industry, see this post.

United has a lot to offer Delta, including an expanded international presence, especially in the Pacific Rim, as well as loyal legions of business travelers in key markets such as Washington DC, Chicago, and Los Angeles. United offers a very high standard of service (for a US carrier, that is) on international flights, and with international growth becoming increasingly important for carriers as a revenue generator, the competition on such routes will only increase. As a result, having top-notch service and great brand loyalty (which United probably has more than any other US carrier) will help ensure success.

Like with the Northwest merger, if Delta were to merge with United, it would force changes in the route networks of the combined carrier. All of United's hubs would probably be kept in one form or another. And that's a very bold statement, considering that United has five hubs scattered across the country. But all of these are simply too integral to the carrier, in markets that have a critical mass of business travelers, that they need to be kept, although some may be slightly downsized. United's San Francisco and Los Angeles hubs will likely be kept because of the amount of connecting traffic between the US and Asia as well as South America these generate. With large populations of travelers in both cities willing to pay a premium to fly to points in Asia nonstop, United has considerable pricing power. Some regional services from the two hubs, to various smaller markets in California and along the West Coast may be scrapped, but the vast majority of mainline United flights, especially international flights, will likely be kept. United's hubs in Chicago and Washington DC will also likely be kept, because in both those cities, United has great legions of business travelers, and in Washington, many government travelers who pay profitable prenegotiated fares.

Denver is a bit of a wild card because United has been hit really hart in the city with the pressures of Frontier's growth. Frontier offers very competitive fares, amenities, and a consumer-friendly frequent flyer program with low redemption requirements and has hurt United in the market, though to United's credit, industry-leading customer service and more flight options have enabled the carrier to hold its own more than other legacy carriers would have. But with the rapid expansion of Southwest in Denver, it's clear that the city is hungry for more low-cost flights, flights which United probably will not be offering. But Denver is a great hub location geographically, and it will probably be of some benefit to the combined carrier to maintain a hub there. This is especially true because Delta's Salt Lake City hub is smaller and the airline has invested less there, in terms of operations and infrastructure, than United has in Denver.

As a result, Delta may scale back its Salt Lake City operations into a focus city size, but much of their connecting traffic will get shifted to Denver, and Salt Lake City could see greatly reduced air service. This could open up the door for Frontier or Southwest to add additional flights from the city and plug holes that the downsizing of Delta will leave. But it's unlikely that if Delta reduces the size of its hub in SLC that it will maintain as many regional flights as it does now, and many smaller communities could lose some of their vital air service. While Delta probably would not keep its Cincinnati hub, it would keep a number of mainline flights in the city to serve high-yield business travelers, while shedding regional jet service from Comair to most markets. Also, Delta's massive Atlanta hub would likely be kept in its current form, again with the exception that some regional routes could be cut. Simply put, regional routes are important for legacy carriers, but with current yields, they're becoming more and more difficult to sustain and airlines have to be more discriminating with the short routes they serve.

Where the route maps of this merged pair would shift the most, I would guess, would be in focus city markets, cities where the carrier has a reasonable presence, with some point-to-point flights, but is not the dominant carrier. United's Seattle operations or Delta's Orlando operations are characteristic of this. Both companies have numerous point-to-point flights in addition to hub service (United, for instance, offers service to Hawaii and Tokyo, as well as regional feeder flights around the Northwest from Seattle and Delta offers nonstop service from Orlando to a number of East Coast destinations on both mainline and regional aircraft). I suspect that these point-to-point operations may be harder to sustain if the market is low-yield (such as Orlando), or if the carrier isn't dominant on the route. While some point-to-point service will be maintained (for instance, I suspect United will keep flying between Seattle and Tokyo because the flights are so popular with technology firms), many point-to-point routes, especially those operated on smaller aircraft, will need to be dropped if consolidation occurs. Moreover, many focus cities not only offer point-to-point routes, but also a lot of hub flights (perhaps in excess of what a market of that size deserves), and I suspect that some of those flights could be cut as well. At stake is a sizable reduction in United's operations in Seattle and Delta's operations in Boston, Orlando, and Columbus in order to realign their route structure to focus on hubs.

The other way the route systems of these two carriers will likely shift is in their use of regional jets, as alluded to before. Delta has huge regional jet operations in all three of its hubs, but 50-seater aircraft, of which Delta uses well over 100 in its operations, are simply inefficient with high fuel costs. 70- and 90-seat jets are more efficient, and their use will be expanded in the coming years, but many cities in and around Delta's Atlanta hub that currently receive one or two daily 50-seater flights could receive one 70-seat flight or none at all. A lot of smaller markets, in the Southeast and in the Midwest and California, where many of United's regional jet operations are, could lose much of their service, because with fuel prices so high, it simply doesn't make sense to serve them. However, there are certainly exceptions to the cutback mantra. For instance, many of United's regional operations in Denver could be preserved because they generate very high yields or have little competition, such as United's flights from Denver to Aspen. 50-seat regional jets will still make up a considerable portion of the fleets of Delta and United's regional jet contractors, but their use will need to be minimized in the future to save money.

Mainline fleet makeup will be a more challenging question. While the combined carrier would have compatibility with its longhaul fleet, given the prevalence of 777 and 767s in both United's and Delta's fleets, the short-haul fleet of the combined carrier would be a combination of Boeing, Airbus, and McDonald Douglas aircraft. Delta's MD-88s and MD-90s would likely get retired as quickly as the airline could manage, but that could take five years or more because there are so many aircraft (Delta has well over 100 MD-88s and MD-90s). It's hard to say what the merged carrier will do in the long-term to its short-haul fleet, but it may not order new shorthaul planes until Boeing or Airbus releases their next generation narrowbody in a few years or until domestic yields show signs of picking up.

One of the other difficult issues that the combined carrier will need to grapple with is how it chooses to brand itself. United has a very strong brand with business travelers, offering generous amenities, frequent flyer benefits, and seating arrangements (such as its Economy Plus seating, which offers additional legroom to premium travelers). Delta does not have the same loyalty from business travelers, but has instead targeted more leisure travelers, trying to outdo JetBlue and other carriers on amenities that attract families and other budget-conscious travelers, such as personal televisions at every seat on some planes. With increasing pressure on yields, it's likely that the combined carrier will standardize its fleet and do so in a way to minimize costs. I doubt that personal televisions will be put into seats all across the combined fleet. Moreover, I would not be surprised if much of the Economy Plus seating was removed from United's aircraft on domestic flights, so the airline could fit more seats into the cabin and increase revenues. The seats would only be left on international aircraft, where the airline could charge more for the additional legroom in addition to offering it to elite customers at no charge. As a result, to standardize operations, Delta may add premium economy seating on its international fleet. Similarly, United could upgrade some aircraft, likely 757s, with personal televisions at every seat in order to bring them up to Delta's standards.

If this merger goes through, it could create an airline with massive economies of scale in key business markets all across the country. The company will be able to leverage its ability in some markets to raise fares considerably. Look at New York City. Not only is Delta a very important player at LaGuardia, where the company operates its highly-profitable shuttle service, as well as numerous other high-yield flights, but it's one of the largest carriers at JFK, and combined with United's operations there, the airline would become the largest carrier in New York. With an array of destinations from both JFK and LaGuardia that could only be matched from Continental at Newark (and even Continental doesn't serve many of Delta's highly profitable international destinations), the new airline would have massive pricing power, manipulating fares lower on routes with low-cost competition from JetBlue, but likely keeping fares extraordinarily high if the only competition was Continental. New York could become an immensely profitable market for the combined carrier because there is very little connectivity out of LaGuardia (mostly high-yield flights to other cities) and most of the connectivity out of JFK is transferring domestic passengers to international flights, which is increasingly profitable for the carrier.

Similarly in Washington DC, strong market positions at both National and Dulles could create huge market power (and thus, pricing power) for the carrier. In fact, the Washington DC market is the one market where the combined carrier may have to shed some operations in order to appease regulators, because the only sizable competitor at either major DC airport to United and Delta is US Airways, which doesn't offer many point-to-point flights from the city.

Unlike a Delta/Northwest merger, this one would create a carrier with immense profit potential because of its dominance in so many of the nation's key business markets. There would not be as many labor and fleet issues to resolve (though there certainly are some) as with the Northwest deal, and the combined carrier would be able to structure a route system to cover the entire nation much better than a Delta/Northwest combination. But, a Delta/United merger may be harder to get by regulators because it would create a very, very large airline with considerable leverage at a lot of big airports. However, unlike a Delta/US Airways deal, which was proposed late in 2006, this one doesn't have any obvious road blocks with regulators (like the market positions of Delta and US Airways at key slot-controlled airports such as LaGuardia and Washington National in the proposed Delta/US Airways deal), though the Justice Department certainly has reasons for concern. While it's not a guarantee that a Delta/United deal would be approved, I would say the odds are probably greater than if US Airways were to make another bid for Delta.

As a result, a Delta/United merger deal would be an amazing deal for investors and the airlines involved. It's not perfect, but no combination of two legacy carriers, with all their idiosyncrasies, would be. Conversely, while airline consolidation will inevitably leave consumers with higher fares and fewer flight options, this merger could offer one of the worst deals for consumers imaginable. It will hang business travelers out to dry in many key markets, allowing the airline to essentially commit highway robbery against last-minute travelers. Travelers would have little recourse against these high last-minute fares because of the lack of competition. But, unfortunately for customers, this is an industry that desperately needs to cut costs and raise revenues, and even at the expense of consumers, consolidation will probably help salvage companies that otherwise might have to downsize even more, trimming air service in many areas as well as jobs for thousands of people.

The better deal for consumers would be a merger with Northwest. Not only would it minimize market power of the combined carrier in key business markets, but it would also likely improve the dismal customer service record of Northwest, since Delta's organization and employees seem to take customer service, baggage handling, and delay management more seriously. But the better deal for investors, one that would create enormous pricing power in San Francisco, Los Angeles, Denver, Chicago, Cincinnati, Atlanta, Washington DC, and New York, would be a Delta/United merger.

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Lufthansa Adds Seattle-Frankfurt Service

Lufthansa, the German Flag carrier, announced new nonstop service between Seattle/Tacoma and Frankfurt, starting spring 2008. The new service is just one of several new international flights to be added to Seattle, a city that has arguably experienced a shortage of nonstop, international flights. Air France launched service from Seattle this past summer, just in time for the peak summer travel season, and AeroMexico also recently launched service between Seattle and Mexico City. The Lufthansa service announcement also comes at a time when carriers are rapidly expanding their international flights, particularly to European destinations.

The possibility of Lufthansa coming to Seattle had previously been discounted by some, due to the fact that the airline currently operates successful flights from nearby Portland, with convenient connections to Seattle via shuttle flights. While Seattle will likely benefit from the move, it could start pressuring carriers, especially US carriers, to quickly add capacity in the market before the market saturates. While Seattle has experienced a shortage of European flights in the past, the recent additions in nonstop services, as well as an expanded array of connecting flights make it easier than ever for customers to travel to Europe.

With the US/EU Open Skies agreement coming into force next year, it's likely that additional point-to-point nonstop flights will be added between major US cities and points within the EU. That means markets which previously had no service or only one carrier could now find themselves with two or three competing carriers. This benefits cities in the West in particular, which have a harder time than many East Coast cities recruiting European service. Cities that could benefit from expanded European services include Portland (OR), San Jose, San Diego, Phoenix, and Denver, in addition to San Francisco, Los Angeles, both of which already have a considerable number of European flights.

With the US West Coast-EU market still lucrative, US carriers, most notably Northwest and United, may try to cash in before it's too late. London is a market of particular interest. United currently operates successful international service from Seattle (to Tokyo), making it more likely that the company will expand further from Seattle. United also recently announced service between London Heathrow and Denver, United's last remaining hub without nonstop service to London. With Seattle being one of United's largest non-hub markets, and United having operated the Seattle-London Heathrow route in a previous era, it's possible that the route may be reinstated.

Moreover, Northwest Airlines plans on expanding the number of cities with nonstop service to its Amsterdam hub. Northwest recently announced new service from Portland to Amsterdam, and the carrier may add Amsterdam service from other large Western markets. It's unlikely that Northwest will add point-to-point service from any European destinations other than Amsterdam. However, aside from United and Northwest, the US West Coast will see relatively few new European route announcements from other US carriers. American is focusing most of its international resources on expanding into Asia, Delta targeting international expansion from its hubs in Atlanta and New York, Continental is focusing most of its international expansion from Newark and Houston, and US Airways appears to be adding little new European service due in part to the unavailability of long-haul aircraft.

One point I'll respond to briefly is the notion of a new partnership structure between US and EU carriers, specifically the deal between Delta and Air France, which enables Delta to enter London Heathrow and gives customers of the two carriers more schedule options. This alliance will help both carriers maintain pricing power and attract business customers. Air France has been less aggressive in expanding into the United States than British Airways has, making Delta a good partner in enabling the company to generate more US traffic. Meanwhile, Delta desperately wants to enter London Heathrow and expand its European presence, which the deal allows for. Arrangements similar to this one can realistically be expected between American Airlines and British Airways, as well as United and Lufthansa, though it's difficult to place a time frame on when that could occur.

But the larger question, of whether a full-on merger between a US and EU carrier will occur is still up in the air. A well-thought merger would help both carriers tremendously, as it would give the new carrier unparalleled leverage with airports, aircraft manufacturers, and customers through pricing power. However, it's unlikely that a deal could be reached, especially with the thorny anti-trust issues raised as well as the unjust protectionist policies of the US to minimize foreign involvement in the airline industry. If the Open Skies deal succeeds, and passengers see more service and lower fares, then regulators will be more receptive to the notion of a merger, but if airlines are quick to consolidate their pricing power and drive out competition when the new deal is in place, then that behavior will only exacerbate under a merger scenario.

US Airlines Offer Bids in Fight for China Flights

Several major US Airlines offered bids a week or so ago for route authorities to China. The DOT will award up to six route authorities over the next two years, and the rules and process for which airlines can bid for which are obtuse to say the least. The most sought-after one enabes carriers to start service in 2009. American has applied for a route between Chicago O'Hare and Beijing. The airline already operates a route between Chicago and Shanghai which has been very successful for the airline. If successful, this route would be a major boon to the city of Chicago, which currently has no nonstop link with Beijing, and could use one as America's third-largest city. The route would likely be quite popular, given the amount of business traffic between the two cities, as well as the connecting traffic that American could generate from points in the Midwest and the Eastern US. Chicago is perhaps America's most important air traffic hub, and facilitates a great many connection opportunites. But while American's Chicago-Beijing route has a strong chance, I think Continental has an even better chance with its Newark-Shanghai application. The New York-Shanghai market is critical for business travelers, yet it has no nonstop service on a US Carrier. Continental applied for the route last year, but lost out to United's Washington DC-Beijing application. This time, I think Continental has a much better shot because the market is so underserved, yet so vital.

Another prominent route application has been filed by Delta. Delta wants to fly between Atlanta and both Beijing and Shanghai. Delta has previously applied for rights to fly between Atlanta and Shanghai, but the airline's application has been rejected. This time around, the airline has a much better shot on the Shanghai route, since it will be bidding for a route authority that's designated for carriers that don't yet serve China. However, the Beijing route will face much tougher competition in 2009. The economy has been booming in the South, with a great deal of new foreign (and especially Asian) investment, most recently with the announcement of a new manufacturing plant by Honda in North Carolina for its HondaJet aircraft. The DOT is very interested in adding new flights to regions which lack China service, and the South is a major underserved area. While Delta will have a tough fight to convince the DOT that it should be given route authority for China, it has a good shot at winning the Beijing rights. I think that Delta's odds are about on par with Continental's, and better than those of any other carrier for the 2009 slot. There's also a good article about Delta's bid in the Atlanta Journal-Constitution. 

Other airlines applying for the route authority include US Airways, which has applied for a Philadelphia-Beijing flight. While the DOT looks favorably on carriers which currently don't operate flights to China, US Airways has some very tough competition. Philadelphia is a very important business center, and certainly needs a nonstop China flight, as the city lacks nonstop service to China on any airline, but I don't think the route authority now up for grabs in 2009 will belong to US Airways. Philadelphia needs to develop its Asian market before it gets China service (the city currently has no nonstop service to Asia). Also, Philadelphia offers limited connection opportunities to points east (primarily for geographic reasons) and connections to the Northeast might be better faciliated by a flight from New York or Boston. Philadelphia has a shot, but the city may have to wait a few years.

United wants to add new service between Los Angeles and Shanghai starting in 2009, the first on a US carrier. While this service will eventually get added, given that this market is already served by a foreign carrier, and that United recently won a route authority, I don't think this bid is as likely as most others. However, United is also bidding for an authority to start service between San Francisco and Guangzhou starting in 2008. I think this one is much more likely, since United claims that San Francisco is the metro area with the most traffic to Guangzhou that lacks nonstop service to the city. Moreover, few other carriers are seriously looking at serving markets outside of Beijing and Shanghai, and adding nonstop links to additional points in China might be very beneficial to increasing US-China ties.

Northwest is also looking for rights to serve Beijing and Shanghai nonstop from Detroit. Northwest already has considerable service to China (for a US carrier) through its Tokyo hub, and service through Detroit would greatly expand the number of single-connection markets from which Northwest could offer China service. I think these bids are less likely, because although Northwest has experience flying to China, these routes simply aren't what's needed right now. The Midwest is receiving some new foreign investment and could use the flights, but Chicago has already positioned itself as the Midwest's Asian gateway, and since the city offers more connections to more places, it would make more sense for Chicago to get the route. However, it's very unclear what will happen as the DOT starts to make its China decisions. The DOT could be strongly influenced by politicians backing the China campaigns of various airlines, and political influence and hand-wringing may have more to do with an airline's success than the route's merit. However, in the past, the DOT has done a satisfactory job of keeping politics out of the decision-making process, and I suspect that the routes with the most potential for success will be the ones awarded.

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