Southwest Announces a Merger With AirTran

Southwest Airlines announced earlier this week that it would acquire AirTran, America's third-largest discount carrier. The deal surprises many industry watchers, including yours truly, because it represents one of the most drastic changes from Southwest's tried-and-true business model which have worked so well for the company for nearly 40 years. Southwest will take on a new aircraft type with this acquisition--the Boeing 717, as well as enter new international routes in the Caribbean. It will add stations with low frequencies, and, it will finally gain access to Atlanta--a crucial hub and business travel market that Southwest has studiously avoided for years.

The deal is a big coup for Southwest, which has extended its dominance in the domestic industry and created a low-fare behemoth that will be hard for any other discounter (JetBlue, Republic, Spirit, or Virgin America) to match. It will also give the company increased pricing power in some markets which, due in part to ferocious low-fare competition between Southwest and AirTran, have very low yields, including Baltimore/Washington, Orlando, and Fort Lauderdale. While passengers are likely to see fare increases from any industry consolidation, these markets are most likely to see fare increases as the consolidated discounter cuts capacity in those oversaturated cities.

The conventional wisdom is that this deal will put enormous pressure on JetBlue, the last remaining sizable discounter, to find a merger partner quickly to achieve the cost synergies of its combined competitors. But as is often the case, I don't think this advice pans out. JetBlue has successfully leveraged its position as the largest carrier at New York's Kennedy Airport to forge codeshare relationships with a large number of international carriers, including Lufthansa, Aer Lingus, El Al, and South African Airways. JetBlue has also started a codeshare relationship with American Airlines, allowing JetBlue customers to access connecting destinations through Kennedy on American that JetBlue does not yet serve. These relationships do very little in terms of costs, in fact, they tend to increase the complexity of JetBlue's operations and likely raise costs. But the revenue benefits far outweigh any cost increases, and that will be the key going forward. JetBlue gains customers who would most likely otherwise fly on a different airline for their domestic segments, helping to fill aircraft in a very competitive market. As JetBlue's CEO has noted, JetBlue is most like Alaska Airlines, in that it has a very strong brand in its core markets (NYC, Boston, and Florida) with loyal customers who swear by the company. Similarly, Alaska has a plethora of codeshare agreements with other carriers which help feed traffic to the company's regional and Alaska routes while maintaining a loyal following in the Pacific Northwest. JetBlue does have relatively high costs, and while the company can make some adjustments to reduce these, it also operates in relatively expensive markets where it receives a price premium for its services, and the company has achieved a scale where further consolidation will have declining marginal returns to the bottom line.

This is not to suggest that JetBlue has no reason to worry. Southwest and AirTran will be an imposing force in the three big East Coast markets that JetBlue intends on growing in--Boston, NYC, and DC. These markets, popular with business travelers, demand high frequencies and service to a wide variety of destinations, which a bigger airline is more able to provide. The growth of Southwest in these markets will make it harder for JetBlue to carve out a niche with business travelers, and may subject the airline to continual price wars on key East Coast routes. But on the whole, JetBlue is an apt competitor and has built a strong following in its core markets. While the merger is not necessarily good for JetBlue, there should be no cause for alarm at JetBlue headquarters.

There are losers in this deal, and the biggest is likely Republic, the owner of the former Frontier and Midwest Airlines. The expanded Southwest will be a very imposing presence in this carrier's two biggest markets, Denver and Milwaukee. Southwest has publicly stated its intention to expand its operations in both markets, and the company has had enormous success in Denver, though mostly at the expense of United and not Frontier. I imagine, however, that as Southwest continues to grow in these markets that it will have a detrimental impact on the viability of Republic's mainline operations. The new Frontier lacks the same codeshare feed that JetBlue has, and although both Frontier and Midwest had a loyal customer base, it will be increasingly difficult to remain loyal to Frontier as it reduces the size of aircraft used on many routes (many of which lack the personal TVs and other amenities passengers are used to) while charging fees for many of the same services (such as checked luggage) that Southwest provides for free. Republic's smaller aircraft also have higher operating costs and are competing with larger, more fuel-efficient planes on many routes. And Frontier is not that well known outside of Denver (and now Milwaukee), and there may be relatively few opportunities for expansion, which would give the company further economies of scale that would enable it to more effectively compete with a combined Southwest/AirTran.

This is not to say that Frontier is doomed, but in that company's case, I think that further consolidation will be necessary to its survival. Possible candidates include JetBlue (which operates both A320 and E190 aircraft that Frontier does, and has LiveTV onboard), or Virgin America (which operates A319s and A320s like Frontier does). The third possibility, though unlikely, is US Airways, also an Airbus and Embraer narrowbody operator. While US Airways has had difficulty with mergers in the not-too-distant past, and is still sorting out some issues related to its deal with America West back in 2005, a merger with Frontier could be a very positive development for US Airways, if it could get the labor situation sorted out. The company would have a stronger presence in the Western U.S., and also potentially enhance its relationship with United, by providing feed to United's international flights from Denver. This is a longshot, admittedly, but it would make US Airways a larger domestic competitor and allow the company to diversify its route structure.

Obviously, the Southwest/AirTran merger is not a done deal yet, but if it goes through, it will clearly have considerable implications for the industry, and in particular the dwindling number of discounters left in the United States.

Trends & Predictions for 2010: Part II

As promised, here is the second part of Airline Bulletin's discussion of trends and predictions to examine in the coming year.

Prediction #1: Industry Consolidation, Especially Abroad
While U.S. carriers have made efforts to reduce their capacity and form strategic partnerships with other carriers, it does not appear likely that we will see a full-fledged merger or buyout in the U.S. in the coming year. This is not to say that such consolidation is impossible, rather that it's simply unlikely. There aren't a lot of perennially weak airlines left to consolidate. Frontier (which has recently showed signs of strength) and Midwest have been combined, Sun Country, to my amazement, seems to be hanging on, and small LCCs like Spirit and Allegiant that have defined business models and solid market niches don't appear to be losing buckets of money either. That being said, anyone is a possible takeover target or buyer. Even Southwest, which has historically avoided growth by acquisition (with a few exceptions), has signaled of late that it is open to potential mergers.

US Airways Deals?
One carrier that still mystifies me is US Airways. The airline has been very aggressive in implementing ancillary revenue-generating programs and cutting costs/capacity. CEO Doug Parker seems to know what he's doing in this regard. But, US Airways may not be very poised for future business travel growth. It operates by far the smallest international route network of any of the 5 legacy carriers in the States, and has actually cut some of its European routes recently due to poor loads. Growth in Asia has taken something of a hiatus, as US Airways let its Philadelphia-Beijing route authority expire after the airline wanted to avoid opening the route due to the recession. And the carrier's position in Star Alliance has been weakened due to Continental's recent entry, and due to the announcement of a strengthening of reciprocity between United and Continental frequent flyer programs. The conventional wisdom has been that American would make a bid for US Airways, since American has avoided much of the consolidation activity within the past 7-8 years, and as a result, has watched its market share decline, while US Airways needs an available suitor. But American and US Airways have almost no fleet compatibility--American is mostly Boeing, US Airways is mostly Airbus. And another merger would only further complicate the labor troubles that have hampered US Airways recently, particularly with its pilots union having trouble integrating seniority between old US Airways pilots and former America West pilots. On the plus side, the route networks of American and US Airways would align somewhat, with US Airways having hubs in the Southwest, Southeast, and Northeast, all regions where American lacks hubs (American's Miami hub, mostly geared towards traffic to/from Florida or Latin America notwithstanding). However, both carriers are relatively weak in Asia and the Middle East, areas where they will need to ramp up capacity if they hope to compete in these increasingly important business markets.

What seems to be a more plausible idea, actually, is a buyout of Spirit by US Airways. US Airways as noted above has been very aggressive, perhaps the most aggressive of any legacy carrier in seeking out new ancillary revenue opportunities, and transforming itself into an LCC which can effectively compete against the likes of Southwest, JetBlue, and AirTran on the ultra-competitive routes along the eastern seaboard. A buyout of Spirit would have very strong fleet complementarities--both carriers fly A319 and A321 aircraft, as well as strong route network complementarities. US Airways tried a few years ago to open a mini-hub in Fort Lauderdale--Spirit's biggest base, with routes to Caribbean destinations, but was fended off in part due to Spirit's competition. There is clearly money to be made on these routes, but US Airways lacked the cost structure several years back to adequately compete. Now the carrier has realigned its costs, and a buyout of Spirit would make accessing such routes much easier.

It would also do something else which is pretty important. The two slot swap deals announced earlier this year, which (if approved) will strengthen legacy carriers at slot congested airports while helping to keep out low-cost competitors. US Airways, even though they are starting to act like a low-cost carrier, is not a low-fare carrier, unless it is forced to be through competition. US Airways would rather stifle demand with higher fares (and higher profits) than lower fares which stimulates demand but reduces yields, which is what Southwest tends to do. Keeping slots in the legacy carrier "family" prevents potential low-cost competition at slot-congested airports (see also Prediction #2). Spirit is one of the few LCCs to have slots at both LaGuardia and Washington National (even though it has relatively few slots in both). A buyout of Spirit would help diminish low-fare competition at these airports, and allow legacies to charge higher fares to business customers. However, I still think that this deal is somewhat improbable, only because Spirit is presumably a money-making carrier with a good market niche, while US Airways is a money-losing carrier with lots of problems that could make a merger tricky. It could be an easy buyout, or it could just be an obstacle to US Airways doing what it needs to do to revamp itself to compete against LCCs while expanding its international network.

European Consolidation
In Europe, the picture is much simpler. I don't anticipate many state carriers to go out of business, however I do imagine that governments will work even harder in the next year to privatize or revamp the following state carriers, named yesterday in Part I:
CSA Czech Airlines
Croatia Airlines
LOT Polish Airways
MALEV Hungarian Airlines
TAROM Romanian Airlines

After additional research, I also want to add the following carriers' names to this watch list:
Aer Lingus¹
Air Malta²
Bulgaria Air

Given the obligation of these governments to maintain positive images, it appears extremely unlikely that they will suddenly pull the plug on these carriers' operations, stranding passengers (voters) and angering the public, a la the recent FlyGlobespan fiasco. However, such airlines are definitely at risk of being purchased by larger airline conglomerates or of being privatized. 

Notes:
1. Aer Lingus may be at risk for another Ryanair takeover attempt in the new year. The carrier has struggled to compete against Ryanair, and has gotten push-back from its unions as management tries to contain costs. Efforts have been made to diversify the carrier away from Ireland, opening new routes from London Gatwick. While the carrier may avoid a Ryanair takeover, serious reforms are needed to make the company profitable once again, and these do not appear forthcoming.
2. Air Malta may also be in need of further reform due to the recent arrival of LCCs in Malta after the airport lowered passenger charges. Air Malta had effectively been protected from LCC competition due to these high charges, but this is no longer the case. As a result, the carrier must find ways to diversify and compete. But since the vast majority of Malta traffic is holiday-oriented, and thus, price-sensitive, it appears unlikely that unless Air Malta can turn itself into a bare-bones LCC, the carrier could face extinction. Another possibility would be a buyout, perhaps by another LCC like easyJet, which would reform the carrier, much as it did with GB Airways, while maintaining most of the its routes.

In terms of LCCs, there are simply too many out there, and too few of them have such well-defended market niches that they can't be attacked by market leaders easyJet, Ryanair, Wizz Air, and Norwegian. I believe that the following carriers are in trouble, and are at risk of potential sudden shutdown. As a traveler, I would do some research before booking with them, and then only with a credit card:
bmiBaby_³
Cimber Sterling⁴
Niki
SmartWings
Vueling⁵
Windjet⁶

3. bmiBaby is unlikely to engage in a sudden shutdown, now that the carrier is owned by Lufthansa. If bmiBaby is closed, it will likely be in a controlled fashion, or if it is sudden, passengers should anticipate far fewer inconveniences than when FlyGlobespan shut down (ie. Lufthansa will likely offer alternate flights, etc.). However, bmiBaby is under heavy competition from easyJet and Ryanair. And while the carrier is growing--it recently expanded at East Midlands which easyJet vacated due to poor yields--it is unclear whether the airline, with relatively old, inefficient planes and infrequent service on many of its international routes, will thrive in the coming years. Lufthansa may use its recent acquisition of British Midland mostly for its aircraft and slots at Heathrow, taking the airline's good routes and using British Midland to help feed into Lufthansa's long-haul routes, while scrapping much of the rest of the company. As British Midland's low-cost subsidiary, bmiBaby doesn't have very much to offer Lufthansa, and a sale or suspension of services appears likely.
4. Who knows what's going on with Cimber Sterling? The carrier seems bereft of a coherent strategy, flying both business and leisure routes with a bizarre mixture of aircraft. Most of Sterling's core routes were taken over by Norwegian and Transavia immediately after that carrier's demise, and Sterling's new namesake has been left with relatively thin routes and little room to grow. I see Cimber as extremely vulnerable to shutdown.
5. Vueling is probably not going to shut down immediately, but will be increasingly vulnerable to competition from easyJet and Ryanair in Barcelona and Madrid. It is unclear whether the combination of Vueling and Clickair has really made the company more financially stable, and due to this lack of information, I am concerned about the carrier's future. However, Vueling has potential to thrive and grow within the coming years. It has a large fleet, a relatively low cost structure, and by operating from primary airports, including Heathrow, can attract higher-yielding business travelers. Thus, it is less vulnerable than most of the other carriers named on this list, but is vulnerable nevertheless.
6. Same issue as with Cimber. It's hard to know what's going on with this carrier. It's privately owned, not discussed much in the press, and it seems hard to believe that they have a real competitive advantage in the marketplace. Now maybe they're like Spirit Air in the U.S., and have a relatively undisturbed market niche on thin routes to/from Sicily. And given Ryanair's recent announcement that it may close domestic routes within Italy, WindJet may benefit through expansion of services. But without clear evidence that WindJet is a profitable LCC with competent management, I have to place them in the same category as Cimber--extremely vulnerable to shutdown.

Prediction #2: Continued LCC Growth
As the economy continues to suffer, expect more businesses to shop around for travel, and send employees on LCCs when necessary. LCCs will try to respond to this growing demand. In the U.S. in particular, LCCs will likely make more efforts to enter or expand services at airports that are dominated by legacy carriers and which are the few remaining bastions of high fares in the U.S. While virtually every large metro area in the U.S. has low-fare airline service, many large, primary airports in these metro areas lack much low-fare service. Examples include Dallas Fort-Worth, Miami, Chicago O'Hare, Newark, Washington National, Cincinnati, Charlotte, Houston Intercontinental, and Atlanta (obviously, AirTran has a large hub here, which keeps fares lower than they otherwise would be, nevertheless, the lack of Southwest, JetBlue, or other LCCs in the Atlanta area at all is problematic and allows a Delta/AirTran duopoly to set prices). Although some of these airports are more congested and delay-prone, they are often preferable for business travelers, as they are easier to access, are located closer to where companies are situated, have better facilities and connections to other airlines, etc. In the coming year, expect expanded service from AirTran, Southwest, and JetBlue to the airports above. While new leisure-focused service will be added, particularly to/from the Caribbean, don't count out future expansions at these key airports for business travelers. Leisure demand has actually held up better than business demand, and so while LCCs will do well in leisure markets, because they are already strong in California, Florida, and the Caribbean, less of the growth in their operations is likely to be concentrated in those regions, since little added LCC capacity is needed to handle this traffic.

In Europe, while it may seem like business routes would also see expansions in service, this does not seem to be the case. Ryanair has announced minimal service of late that will be attractive to business travelers, mostly because it is concentrated in very distant and inconvenient airports. EasyJet, which has aimed to take business customers away from BA and other full-service carriers, has instead recently announced that it will add new service to a host of leisure destinations next summer, mostly in Turkey. Such moves seem to place easyJet and Ryanair in closer competition with European charter carriers such as Monarch than legacy carriers like BA. It will be interesting to see whether carriers like Wizz Air, Norwegian, and Air Berlin follow suit and concentrate growth mostly on leisure routes, but that would be somewhat counterintuitive, given the growing demand of businesses to trim travel costs.

Prediction #3: Increasing Focus on the Environment
While there are other interesting predictions to be discussed, it's getting a bit late and I need to get this out. So I'll conclude with my third prediction, which is something that will be of increasing importance not just in 2010 but in the coming decade. Expect more airlines to highlight their "green" credentials whenever possible, through marketing campaigns, press releases highlighting environmental initiatives (such as this recent announcement highlighting airline participation in a jet biofuel scheme), and programs to offset emissions. Such efforts will be reinforced as Boeing delivers the fuel-efficient 787 Dreamliner to its first customers next year, and as the U.S. Senate debates a cap-and-trade bill to combat climate change. Although we're in a recession and customers are price-sensitive, more and more consumers are going to make what they perceive to be environmentally-friendly choices, given growing awareness of environmental concerns. While airline efforts to address the issue are mostly greenwashing, since the benefits of getting customers to recycle soda cans on the plane or powering one engine with 50% biofuels aren't diddly squat compared to the effects of contrails fully-loaded commercial jets spew out at high altitudes, such efforts will likely succeed at winning customers over since most people don't know any better. What we won't see, however, are serious efforts to make the industry more environmentally-friendly through new technologies. V-shaped aircraft ("flying wings") or better yet, high-altitude airships would radically alter the airline industry as we know it, but they would also make a substantial dent in the industry's pollution levels. But because such technologies aren't compatible with current air transport infrastructure, are not seen by consumers or regulators as safe, and in some cases are slower than conventional aircraft, don't expect Boeing to announce production of such aircraft anytime in the near future. This is not to say that such technology won't be commercialized, but significant steps aren't likely to be taken within the next year due to the recent air travel slowdown and manufacturers' focus on the latest generation of fuel-efficient planes.

In 2010, as the airline industry globally continues to struggle, it will likely once again continue to make headlines as it tends to do, and Airline Bulletin will be here, whenever possible, to offer commentary on these events. Until then, have a wonderful new year!

Sun Country Parent Files for Chapter 11

Sun Country Airlines parent company Petters Group filed for Chapter 11 bankruptcy protection amidst an ongoing investigation of fraud by former group chairman Tom Petters. While the airline expects to continue normal operations, at least for now, I have serious concerns about the health of the carrier. Recently, the company (complying with the federal WARN act) announced that it may lay off all of its employees if it is unable to improve its cash flow, and to do this, it may have to trim employee salaries by as much as 50%. These drastic measures signal a carrier in serious trouble.

While Sun Country is a pretty small potato in most of the country, it's an important carrier in Minneapolis, its base of operations, where the carrier not only operates a variety of services to leisure destinations, but also important business destinations such as Seattle, New York, and Los Angeles. There is no reason to believe that Sun Country will manage to survive the next six months. The airline simply has too many things going against it, and unfortunately, Sun Country is unable to command a price premium in most of the markets it serves, as it targets leisure travelers, making profitability ever more allusive. If Sun Country folds, expect Northwest to move quickly to shore up its position as the top dog at MSP, perhaps adding flights to some of the destinations Sun Country currently serves. But more importantly, Sun Country's departure would create an LCC vacuum at the airport, since it would only have minimal coverage by LCCs (mostly on Frontier and AirTran which don't offer many point-to-point flights). Perhaps Southwest will use its impending arrival at MSP in March to offer service on some of the routes Sun Country is abandoning, particularly to Los Angeles, Phoenix, Las Vegas, and Orlando. That would give Southwest a stronger competitive position at the airport, make the carrier attractive to business travelers, and provide Minneapolis flyers a more stable LCC that is unlikely to go bankrupt anytime soon.

ATA Files For Bankruptcy, Shuts Down

ATA, which has in recent years downsized its scheduled service operations to focus more on its charter business, filed for bankruptcy and ended scheduled service flights today. ATA had in recent weeks announced the closing of its Chicago-based scheduled flights, mainly because high fuel prices were making them unprofitable. However, what did ATA in was the loss of a very significant military charter contract, without which, the company was unable to survive. ATA, once the 10th largest airline in the US, was a much smaller player immediately before its demise, and so its loss isn't tremendously significant to the overall market. However, given that the carrier served a number of routes to/from Hawaii, it will deliver another blow to that state, which has been reeling from the loss of Aloha. Fortunately, other carriers will likely fill in the gaps left by ATA, though passengers from Oakland may be forced to trek across the bridge and fly from SFO in order to get to Hawaii. Passengers on Hawaii routes could also wind up paying higher fares, though competition is still plentiful on these routes, and fares won't increase dramatically.

Perhaps the biggest victim of this collapse is Southwest Airlines. Southwest, which had a codeshare agreement with ATA, will be unable to immediately fill many of the gaps that the agreement brought. Southwest funneled passengers from its flights onto ATA flights to Hawaii or Mexico. Since Southwest averages lower load factors than most other US carriers, the codeshare agreement helped the company fill seats on flights that otherwise would not be full, generating critical revenue at a time when the airline was facing higher costs. Southwest is looking to start flights to Mexico with its own aircraft and ATA could have provided additional capacity and travel options for Southwest customers traveling from Mexico or other international destinations. Moreover, at these international destinations, ATA and Southwest could have shared ground crews and gates, reducing costs and making their service more competitive.

With two small LCCs collapsing in the past week, will we see more? Probably not, at least not in the near-term. That being said, there are a couple smaller carriers that are vulnerable. USA3000 may be in trouble, as that carrier is in a similar position as Aloha, facing heavy competition on its routes with low yields. While it still operates a strong charter and vacation package business, that could be threatened due to a potential decrease in consumer spending on air travel, especially leisure travel, as a result of the impending economic slowdown. Sun Country is also trying to figure out a solid business model in this climate, and that carrier may reduce some of its scheduled service operations and focus more on its charter business. However, larger LCCs are unlikely to fail anytime soon, because they have much more substantial cash positions. That being said, in this environment, successful airlines will need to be able to have more control over their capacity, and legacy carriers, with larger fleets and a higher percentage of owned versus leased aircraft than some LCCs, will be better able to make adjustments. The carriers who could be vulnerable are those that don't have many aircraft that can easily be parked (due to high lease costs), and which are facing heavy competition and low yields. Frontier is in this category, and it has the added disadvantage of having a weaker cash position than many of its larger rivals, making it more vulnerable in a time of uncertainty. While the airline is making the smart decision to diversify its operations through regional service, it may not be enough to offset increasing competition on its mainline Denver routes. Unless Frontier finds some way of redeploying its capacity, that company could face trouble, as neither Southwest nor United are going away anytime soon in Denver.

If fuel costs continue to rise, there could be other carrier fatalities, as well as increased capacity reduction in some markets. Airlines will have to pass higher fuel costs on to customers, and not everyone can pay them. Therefore, demand on many routes, especially leisure-oriented routes, could decrease, potentially delivering another blow to LCCs, which tend to have more leisure-centered networks. In the immediate future, the little cuts that most airlines will need to make will add up, though they may not attract the media attention that ATA's collapse did, and customers will begin to notice just how problematic high fuel costs are to our air transportation system.

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How Low-Cost Carriers Should Approach the Impending Consolidation

While much of the attention surrounding the merger frenzy in the industry right now has centered on legacy carriers and their many possible combinations, low-cost carriers are also very much in the fray, and could be important instigators of consolidation. There are several reasons for this. The first is that many LCCs are seeing their costs rise after years of solid cost containment. Older aircraft, more senior employees, as well as rapidly rising fuel costs are challenging LCCs. At the same time, many of these carriers recognize that there is relatively little "fat" to trim. These carriers have minimized staffing, fuel, airport, and other costs, and unfortunately, unless they were to convert to a Skybus-style business model (which, even then, doesn't yield tremendous cost savings), can't pare their costs much more.

Second, many of these carriers are smaller than the legacy carriers they compete with (with the notable exception of Southwest). Smaller carriers often lack the economies of scale that larger carriers have, and the even larger legacy carriers that could be created after a merger frenzy will have economies of scale that LCCs will simply be unable to match.

Third, many of these LCCs recognize that their business model has limited growth opportunities. Point-to-point domestic routes simply don't cut it anymore. To attract travelers and keep expanding, airlines need to offer connectivity with smaller aircraft (such as with Frontier's Lynx operation, or Alaska's longstanding partner Horizon Air), or they need to offer additional international service (as JetBlue and Spirit are doing in the Caribbean). Legacy carriers will continue to expand the diversity of their networks, and low-cost carriers, with their obvious fleet and cost constraints, will struggle to match them.

At a time when international growth, not domestic growth, will lead to higher profits, many low-cost carriers need to seriously think about how to offer more service options to customers. Spirit and JetBlue are looking towards Central and South America, Frontier towards Canada and Mexico, and Southwest towards unnamed international destinations. But even with this expansion, it misses the big prizes of Europe and Asia, which LCCs, in their current form, will be unable to serve.

The question is, though, whether a low-cost carrier would merely get bought out by a legacy carrier, as is quite possible, given that certain legacy carriers could otherwise get left out of the consolidation frenzy (like American and US Airways), or whether two low-cost carriers would merge together. I would suggest that the latter option is less likely, but possible. Since many LCCs have distinctive cultures and brands that they want to maintain, as well as a low cost base, it would be challenging to find a pairing of low-cost carriers that fit together very nicely. While there are certain scenarios that would be possible in this regard, they are limited in scope.

One brief example: I think Aloha Airlines is good takeover bait for Southwest or even Alaska, since both Southwest and Alaska are interested in Hawaii expansion, all three carriers operate 737-700s, and both Southwest and Alaska offer considerable service to the continental US from the smaller West Coast airports that Aloha serves, such as Sacramento, Oakland, and Orange County. However, Aloha is a relatively small carrier, and the acquisition of it by Southwest or Alaska would do very little to reduce either company's costs and instead be more centered about expansion.

A buyout of a low-cost carrier by a legacy carrier, would, however, be a way to add capacity to the network of a legacy carrier, even though it could destroy the brand of the bought carrier. This scenario is imperfect as well, since legacy carriers are focused mainly on improving efficiencies and yields on international routes, not the domestic ones where LCCs chiefly fly. The acquisition of a low-cost carrier would be to a legacy carriers' minimal advantage, unless that low-cost carrier had a certain degree of market share or pricing power in a key market.

For instance, while neither of these scenarios are in any way likely, a buyout of Frontier by United would give United an even greater degree of pricing power in Denver. The same would be true with a Delta buyout of AirTran, again, an unlikely possibility. Moreover, both these scenarios raise certain regulatory issues, since the Department of Justice is active in trying to prevent significant market power by one airline in any given market. However, I would argue that certain markets are large enough such that this wouldn't be a significant issue. Moreover, the unification of both carriers could create benefits for the customers of both companies by expanding route networks and flight schedules.

But if legacy carriers are focused on international growth, why would they want to expand their domestic networks, which would be inevitable with the takeover of an LCC? The main reason is to increase market share, particularly in critical markets of strategic importance to the company, where there are large concentrations of higher-yield travelers. Is there a merger that would do these things? I know of at least one, between United and JetBlue, which is detailed in this post. This is not to suggest that other merger scenarios are unthinkable, for all low-cost carriers are quietly discussing various merger scenarios and how they want to play a role in the upcoming consolidation, but I would suggest that the most attractive merger scenario involving a low-cost carrier is between United and JetBlue.

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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.

Possible 2008 Merger: Northwest and US Airways

From a fleet and route perspective, a merger between Northwest and US Airways could be a big winner. But from other perspectives, and more specifically, a labor perspective, it could be a major problem. However, if the merger were successful, it would create a company that would offer forceful competition in key domestic and international markets to a potentially merged Delta/United. For more information on the current merger frenzy that's sweeping the industry, see this post.

One of the largest potential problems that analysts foresaw in the US Airways/America West merger that occurred a couple years ago was that it was the unification of two carriers which had very strong route networks on opposite ends of the country, but there would be no central hub to join the two ends of the barbell, so to speak. Given the fact that the new carrier would not have many larger, more cost-effective aircraft for transporting flyers long distances, it raised the possibility of two-connection travel for many flyers, which, given all the potential problems of delays as well as the extra time it requires, could dissuade many travelers. While this hasn't proved to be as big a problem as I or other industry-watchers suspected, with rising fuel prices, operating transcontinental flights has become rather expensive, especially with A320-size aircraft which have higher available seat mile costs than 757s or 767s. Having a central hub, particularly one that can draw from traffic bases both East and West for international service, will be critical to the success of a national carrier, and that's what Northwest brings to US Airways in a potential merger.

And while the combined carrier would retain probably two central US hubs, if a merger were to occur, Memphis as a hub for Northwest would almost certainly be dumped, though the combined carrier might retain a focus city operation in the city to capitalize on business traffic. However, Northwest's exit from many markets from Memphis could open the door for a low-cost carrier, such as Southwest to enter the market. Or perhaps, if Northwest makes a major withdrawal, Frontier will make another attempt to set up a focus city in Memphis, though the company denies that it is planning any expansions of point-to-point services outside of Denver.

The combined carrier, with six remaining hubs in Philadelphia, Charlotte, Detroit, Minneapolis, Las Vegas, and Phoenix, will likely keep all those cities as hubs. However, to simplify operations, some hubs could focus more on mainline traffic to destinations that can support narrowbody mainline aircraft, while other hubs may focus more on bringing in a variety of connecting traffic, including regional jets and mainline planes (both narrowbody and widebody). By doing this, the airline is still able to maintain strong market positions in all six cities, but it makes the company's operations more efficient by simplifying where regional jets and international aircraft are needed (and thus the related crew scheduling and maintenance functions associated with the different aircraft types).

Phoenix, Detroit, and Charlotte will all likely remain hubs where regional jets, narrowbody aircraft, and widebody aircraft have a large presence. Phoenix is a fast-growing business center, and offering regional jet service from the city helps US Airways draw traffic to its expanding array of international flights from the city. As Phoenix grows, the combined carrier will want to offer increased international service, and so it will need a large supporting base of regional and mainline services to support that service. Given Northwest's massive infrastructure investments in Detroit, with its practically new terminal and assorted facilities, that city will need to remain an all-aircraft hub. Moreover, since Detroit is very close to the Northeast, where US Airways currently has a strong presence with regional aircraft, it can take over some of the regional jet flights that currently make their way into Philly. Charlotte will also need to remain an all-aircraft hub for the combined carrier because of its proximity to the South (no other hub in the network, save for Northwest's Memphis, which will likely get eliminated in a merger, can serve many small Southern cities, and only one other hub operated by any carrier in the South (Delta in Atlanta) has the range of regional jet flights that US Airways at Charlotte offers.

While Las Vegas, Minneapolis, and Philadelphia could lose some of their regional jet flights, and a select few mainline flights, the core of these operations will not be affected. None of these cities will lose all their regional jet service, and I doubt any will receive even a sizable cut in mainline service. Minneapolis and Philadelphia generate high yields for their respective hub operators, and airlines focused on increasing revenue will want to keep these with a considerable amount of service. Las Vegas is an important market for volume and market share reasons. Even though yields are lower to and from Vegas, it can absorb a lot of excess capacity in these carriers' fleets, and even though it's not the most profitable way to use that capacity, it does get utilized and make some money.

The carrier, like all of the consolidated legacy carriers, will need to have a large emphasis on international routes. And it's likely that Northwest gateway cities along the West Coast will maintain their service to Tokyo. Moreover, many large markets also have nonstop Northwest service to Amsterdam, which will also likely be maintained. US Airways, meanwhile, will likely continue with expansion plans from its Phoenix hub, even if it merges with Northwest, and will add additional flights to Latin America and Asia. Even though some hub flights could get realigned, most international flights in the two carriers' networks will not get shifted. There will be some small adjustments, but most of the hubs, even if they lose some of their regional service, will likely maintain many of their international flights because they offer convenience to business travelers.

This also speaks to the question of alliances. Northwest is part of the SkyTeam alliance, while US Airways is part of Star Alliance. It appears that if the two carriers merged, they would probably join SkyTeam. The main reason for this is the very close marketing and codeshare alliance between Northwest and KLM, two large SkyTeam members. Through this partnership, Northwest passengers gain terrific connectivity to destinations across Europe through KLM's Amsterdam hub, allowing customers to reach destinations they couldn't easily reach with other carriers. Northwest and KLM have received antitrust exemptions on certain transatlantic routes through their partnership, and both seem eager to continue the deal, which has resulted in higher yields due to less competition. If Northwest were to discontinue its SkyTeam membership, it could be very difficult for Northwest to continue its KLM alliance, and instead KLM could choose to partner with one of Northwest's competitors, such as Delta or Continental, both of which are also part of SkyTeam. Since Air France, which is under the same corporate umbrella as KLM, is a major Delta partner, a Northwest/US Airways deal could threaten these precious alliances, and force Air France/KLM to choose whether to maintain close relationships with either Delta or Northwest. Even if the combined Northwest/US Airways were to remain a member of SkyTeam, it could lose the close affiliation it has with KLM and only have the looser frequent flyer affiliations that SkyTeam affords. But, those affiliations are still important, and probably better than those offered by Star Alliance.

Another advantageous asset for the combined company are US Airways' slots at LaGuardia and Washington National. Having slots at these airports will allow the combined carrier to offer a greater frequency of flights than other carriers to critical business destinations, and better serve high-yield travelers. With higher fares imminent, especially for business travelers, this will bode very well for the carrier.

Fleetwise, the big focus with all mergers, and this one is no exception, is about removing regional jets (particularly 50-seaters and below) from aircraft fleets, as well as older, less fuel-efficient mainline aircraft. Like I've mentioned before, Northwest's DC-9s will probably see some sort of accelerated retirement in a cost-cutting deal, but given the size of Northwest's DC-9 fleet, that clearly won't happen for at least several years. Regional jet flying, from Mesaba, Mesa, and other contractors could be reduced. On the chopping block are some of Northwest's CRJ-200s, as well as some of the contracted flying done for US Airways. Turboprops will probably be kept in most cases, since they're more fuel efficient, though turboprop (and especially 19-seater flying) could be reduced by some regional partners, who often operate these flights at a higher risk than their regional jet contracted flying. The reductions in this kind of service will likely depend on what sorts of hub route realignments take place.

Northwest may continue to take delivery of its 787 planes, even though it means the combined carrier could have unnecessary redundancies. In the depth's of US Airways' financial hell several years ago, the carrier received a $250 million loan from Airbus, in exchange for the company agreeing to purchase new A330 and A350 (the competitor to Boeing's 787) aircraft. When the combined carrier receives delivery of these planes, they could become a burden because the two fleets overlap and will generate extra costs. However, depending on Airbus's delivery timetable for the A350, this could be seen as an advantage. While many US carriers wait several years to receive their 787s from Boeing (even more so given the recent production delay announced by Boeing yesterday), which has tightened its production capacity to minimize cost, a Northwest/US Airways combined company could be receiving aircraft from two streams, increasing its ability to provide international service quickly at a lower cost and get a jump on the competition. While this advantage may be short-lived, it could be significant, depending on when the company receives these aircraft, when its competitors receive their planes, and what happens to oil prices in the coming years.

The one major area of difficulty that this merger has is what will be done about the labor situations at both carriers. Employees at both Northwest and US Airways have just cause to be angry at their management due to past failings, and unfortunately, a merger will lead to additional job cuts. What cannot be done, however, is treat employees in such a manner that hurts them more than what is inevitable. For instance, after the US Airways/America West merger, many US Air pilots were very upset by the way the two seniority systems at the companies were integrated, partly due to the questionable decision of an arbitrator. It left the pilots angry, and a similar incident cannot happen again if this merger occurs. Management at both companies need to ensure that the two sets of employees reach amicable conclusions.

But more importantly, they need to do a better job of showing that job cuts are necessary and will not be for temporary financial gain. Job cuts need to be justified, and management needs to make sure that they recognize the importance of providing solid customer service as well as supporting the bottom line. When US Airways had a major fiasco a couple years ago with an inability to process bags at Philadelphia due to a staff shortage, the airline quickly added several hundred additional staff. Those kinds of things can't happen, especially when customers are so irate at the service they're receiving and employees are worried about job security. Quick spurts of hiring and firing need to be smoothed out to give greater consistency and predictability to customers and employees.

Fortunately, if this merger is proposed, it will likely encounter far fewer regulatory hurdles than other potential deals. US Airways and Northwest are both smaller carriers than Delta, making the merger more palatable to regulators. A merger would give the combined carrier a market share not much larger than the current largest carrier, American, instead of a potential Delta/Northwest deal which could make the combined carrier substantially larger than any unmerged competitor. If Congress plans to put up hurdles to merger deals, then a Northwest/US Airways deal may be one of the few deals that can be approved. The merger would offer tremendous benefits particularly for US Airways, which is at risk of losing out in the current merger frenzy, since it's the smallest of the legacy carriers, by linking it to a carrier which can cover the service gaps it has in the Midwest, as well as internationally. Meanwhile, Northwest would get a carrier with a lot of capacity in attractive markets, particularly on the East Coast, as well as additional aircraft to help the company grow. While this deal is less talked-about than a potential Delta/Northwest deal, it would probably be a better matchup for both Northwest and US Airways than a Delta/Northwest deal, but whether it will ever get proposed, given the increasingly advanced state of Delta/Northwest merger talks, is up in the air.

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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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On Potential Merger Deals in 2008

The big issue that the airline industry will have to tackle in 2008 is to what degree consolidation will play in reducing costs for the industry given soaring fuel prices. A great deal of merger scenarios have been proposed, and many industry observers believe that early in 2008 will be the time when many of these deals are announced. Many executives believe that if consolidation occurs, Delta will be the catalyst that will make it happen. This was shown when in late 2006, US Airways made a surprise bid to merge with Delta, a bid that ultimately failed. However, with Delta being a very attractive merger partner, given its diverse operations and recent cost-cuts, it's likely that the carrier will be involved on an upcoming merger.
Moreover, other carriers, including low-cost carriers such as Southwest and Frontier, have been rumored as merger partners with each other or with legacy carriers. So-called low-cost carriers are also trying to cut costs and diversify their operations, and a merger may be the way for these carriers to do that, even though they will likely lose their ability to simplify some aspects of their operations, such as having one family of aircraft or having the luxury of flying relatively short routes. It will be interesting to see how the merger scenarios play out in the coming weeks and months, and stick with Airline Bulletin as we bring you additional information about the merger situation.

Will Skybus's Launch Provoke Other Airlines to Add Fees?

Skybus's launch has been getting a lot of attention in the past few days by a range of national media (such as this column in USA Today). But much of the coverage has not centered on Skybus's new routes or the opportunities it presents for smaller, underutilized airports. Rather, many news outlets have focused on what Skybus is not providing, at least, not for free. Skybus plans to charge for virtually any extra passengers need, short of using the restroom. And since this is a revolutionary idea in the States, it is picking up a lot of media coverage. But it begs the question: Will other carriers consider adding more a la carte amenities in a bid to raise revenues? If fares continue to remain relatively low, LCCs will need to find more ways to make money, and ancillary revenue streams are the easiest, cheapest, least risky way to accomplish that goal. Low-cost carriers have seen their costs rise in recent years. Many of them have new fleets which are now getting older and which require more costly maintenance. Also, many LCCs have labor agreements that are becoming more expensive to maintain, since many employee groups are looking for higher wages and more profit-sharing. When airlines first start out, employees typically get paid quite little relative to their counterparts at other airlines. But as they gain experience and seniority in the company, many employees receive pay increases, and that costs LCCs more and more money each year.

And with fares increasing very little, airlines are trying to figure out how to raise more revenues. Food and beverage sales is one idea that hasn't been fully exploited by LCCs, something Skybus will try. It's probable that other LCCs will start cracking down on some of the free snacks they are handing to customers, and may charge customers for the treats. Also, some LCCs may start charging customers for beverages, a move that could be very profitable, since beverages typically can be sold at high profit margins and many passengers find themselves dehydrated inflight. Moreover, most US LCCs have excess baggage fees that are similar to legacy carriers. Only Spirit has taken steps to remedy that, but even that carrier still allows customers to check one bag for free (although this will soon change, and customers will need to pay for all checked bags for reservations made after June 19). LCCs, especially those aiming to have a tighter grip on their costs, including Southwest and AirTran, may crack down on their checked baggage policies. While most US LCCs offer hotel and car rental reservations on their Web sites, and collect commissions from sales, they don't advertise these outlets very well on their sites and airlines don't appear to be focused on offering customers a good value for all their travel needs. Airlines typically make it difficult to purchase a flight, hotel, and car rental in one search, since hotel and car rental reservations are often kept on separate pages on US LCC sites. And many of the hotel and car rental partners airlines contract with offer lower rates at their respective Web sites, and if airlines want customers to book hotels and car rentals through them, they need to ensure that customers are receiving the best deal. Also, Allegiant and Skybus are the only two LCCs to charge for the privilege of boarding early. Allegiant offers advance seat assignments for an additional fee, and Skybus offers early boarding with no seat assignments. The revenue from these services costs very little to obtain, and if it improves a customer's comfort level on a given flight, people will pay it. Other LCCs, including Southwest and AirTran may charge for early boarding in the future. It's an extremely profitable and easy-to-implement revenue stream, more so than any other ancillary revenue stream, and LCCs would be foolish not to utilize it with LCCs so desperate to raise revenues. LCCs may also add fees for the use of their in-flight entertainment systems. AirTran, for example, offers customers satellite radio at every seat, and customers can hook up to it for free (assuming they have their own headset). However, AirTran would be an ideal airline to charge customers for the use of that entertainment because it doesn't market itself primarily based on entertainment like JetBlue and Frontier do. Even if customers were only charged $2 or $3 on a flight, that could still raise hundreds in revenue that AirTran otherwise wouldn't receive.

Even though customers prefer airlines that provide free amenities, it simply doesn't make sense for LCCs to do that in a stagnant revenue environment where legacy carriers are much more cost-competitive than they were several years ago. LCCs need to find ways to raise additional revenue, and in the wake of Skybus charging for many of these previously free services, the airline has paved the way for many other LCCs to start doing the same. As customers get used to paying for checked luggage, seat assignments, or in-flight sodas on Skybus, then other airlines will have fewer difficulties getting customers to accept these new fees. LCCs that market themselves primarily on the basis of low fares, such as Southwest, AirTran, Spirit, and Alaska (which, to be quite honest, is hard to classify as either an LCC or a legacy carrier), are the most likely candidates to implement these new fees. LCCs that attract customers less on the basis of fares, and more on the basis of their amenities, including JetBlue and Frontier, will be less likely to adopt some of these ancillary revenue streams because they could hurt their brand and discourage airline loyalty. While more fees may be one more hassle customers will need to deal with when flying, greater adoption of more ancillary revenue streams, including fees as well as commissions, may enable many LCCs to continue making money in the face of higher costs and marginally increasing fares.