United and Continental's Mega-Merger

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

What is likely to happen:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

May 17, 2010 in Continental Airlines, Delta Air Lines, JetBlue Airways, Low Cost Carriers, Southwest Airlines, United Airlines , US Airways | Permalink | Comments (12)

December 29, 2009

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!

December 29, 2009 in AirTran Airways, Allegiant Air, American Airlines, EasyJet, Environmental Issues, European Carriers, Frontier Airlines, JetBlue Airways, Low Cost Carriers, Midwest Airlines, Ryanair, Southwest Airlines, Spirit Airlines, United Airlines , US Airways | Permalink | Comments (24)

October 01, 2008

Southwest to Serve Minneapolis-St. Paul from March 2009

Southwest Airlines announced its first new destination in more than a year, Minneapolis, from which the airline will begin service to Chicago Midway starting in March 2009. The airline is keeping expectations low, saying that the carrier will begin a "modest" operation at MSP with service only to Midway. This is not in keeping with previous Southwest destination openings, which typically see routes to several cities and at least 10 daily flights. Even a smaller market like Fort Myers, FL received 9-10 daily flights when Southwest first began service to the city. But how the times have changed. Southwest is likely making this a more conservative opening because of the uncertainty over flight demand. Even though Southwest is adopting a bold strategy to attract business customers, who are looking for nonstop flights to a variety of cities, Southwest simply cannot risk too much of Northwest's wrath in this tight market by making a stronger move. Eventually, Southwest will likely add service from MSP to some or all of the following markets, depending on the Chicago route's performance, Detroit, Cleveland, Baltimore, Los Angeles, Phoenix, and Las Vegas, but for now, the company needs to test the waters.

The route to Chicago is a very good test of Southwest's efficacy to attract business travelers with relatively little risk. Northwest, American, and United all operate in the market, and all charge exorbitant fares. AirTran tried to take on these carriers a year or two ago with discount fares, but was forced to withdraw due to lack of demand. Southwest, because of its brand loyalty and reputation in the Chicago market, will likely be more successful than AirTran. Moreover, the carrier is taking a limited risk by flying to a market where the carrier has a strong base of operations, and one which is only a short distance from MSP, allowing Southwest to generate higher yields using less fuel. While Southwest's Minneapolis operations may not become the size of Chicago's (with over 200 daily flights), this is an important announcement in Southwest's push to make itself a more viable option for business travelers by filling in the holes in its network. This could be a signal that Southwest may be getting ready to serve other major markets it does not yet have a presence in, including Atlanta, Cincinnati, Memphis, and most importantly, New York (Regardless of the claims to the contrary, Southwest's Islip operations are not very effective at serving business travelers headed to NYC). Hopefully Southwest will add these destinations in the future in keeping with a more conservative outlook. With $100+ barrel oil, airlines simply cannot add routes willy-nilly, and with today's limited announcement, Southwest's management seems to recognize the necessity to tread carefully.

October 1, 2008 in American Airlines, Low Cost Carriers, Northwest Airlines, Southwest Airlines, United Airlines | Permalink | Comments (0)

August 05, 2008

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.

August 5, 2008 in Continental Airlines, JetBlue Airways, Low Cost Carriers, Southwest Airlines, United Airlines , Virgin America | Permalink | Comments (0)

May 04, 2008

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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May 4, 2008 in Continental Airlines, Low Cost Carriers, Southwest Airlines, United Airlines , US Airways | Permalink | Comments (0)

April 15, 2008

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.

April 15, 2008 in Continental Airlines, Delta Air Lines, Midwest Airlines, Southwest Airlines, United Airlines | Permalink | Comments (0)

April 03, 2008

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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April 3, 2008 in Aloha Airlines , ATA, Frontier Airlines, Low Cost Carriers, Southwest Airlines, United Airlines | Permalink | Comments (1)

March 19, 2008

Legacy Airlines Making Cuts To Deal With Record Fuel Prices

As evidenced by yesterday's Delta announcement that the carrier will trim 2,000 jobs and reduce its domestic flying, many airlines are feeling pressure to shrink in the face of high fuel prices. Moreover United and Northwest have issued warnings that legacy carriers may need to shrink in order to survive by trimming routes that simply aren't profitable with such high fuel prices, especially those on higher-cost regional jet aircraft. Carriers are starting to feel the pinch. The question is, will these cuts be enough?

Perhaps the greater uncertainty that carriers face is not what the price of crude oil will be tomorrow, but rather what demand will be for air travel, particularly from business travelers, in the coming months and years, given a slowing economy. While the rise in oil prices hasn't helped the economy, most of the reasons for the recent economic slowdown are independent of oil prices, and so airlines are feeling a double-whammy from the economic slowdown and the recent rise in oil prices. What airlines have been able to count on in recent years is that demand is still strong, both from business and leisure travelers. But with a slowing economy, many businesses may try to reduce travel expenditures. Many travelers who work for small businesses or others who have unmanaged travel accounts provide lucrative yields to carriers. But their employers could be hit hardest by an economic downturn, and may have less of an ability to keep funding pricey travel. This would challenge airlines, especially because business travelers have a greater ability than leisure travelers to deal with the fare increases that airlines have had to impose due to rising fuel prices. As a result, many legacy carriers, are looking to expand abroad, where they feel demand will pick up more in the near future. Whether this is true or not is unclear, but there are two key drawbacks that carriers need to be aware of with regard to this expansion.

The first is that many of these long-haul flights, while offering higher yields, also have higher fuel bills to go along with them. Many of the new destinations that carriers are adding, in East Asia for instance, have 12+ hour flight times, which burn a tremendous amount of fuel. Moreover, many legacy carriers are operating these routes with older 767-variant aircraft, which are less fuel-efficient than the newer 777s. And with only 2 US carriers placing orders thus far for the fuel-efficient 787 aircraft, it may be awhile before US carriers can significantly reduce their international fuel needs. While legacy carriers can afford these fuel bills for the time being, because the yields are higher, many of these routes could be cut too. Many legacy carriers are expanding to new markets, markets that have little nonstop service to the US. Adding service to a market that has little nonstop service to the US offers greater risks and rewards than would a flight on an already-established route. With the heavy demand on fuel resources that international flights require, many carriers may not allocate a sufficient amount of time to let their new flights gain enough demand to a point where they can be profitable, because the initial losses will simply too severe due to high fuel costs. Any route takes time to gain demand and become profitable, but in this environment, airlines may be more risk-adverse. This may have good short-term implications for airline balance sheets, but if the new international markets airlines tout really do warrant service to the US, then other carriers, foreign carriers, may make the leap to start service and get a valuable head start on US carriers in terms of gaining market share.

The second drawback is this expansion of service by foreign carriers in US markets. In many cases, these foreign carriers have higher product and service standards than their US counterparts, especially in first and business class, allowing them to gain additional high-yield passengers, even if they start service on a route after a US carrier starts service. Moreover, foreign carriers often offer nonstop service where US carriers offer hub-and-spoke connections (though this works both ways, depending on the routes, since passengers can connect in the US on American carriers or abroad if flying on foreign carriers). Many passengers would prefer to spend five hours in Frankfurt than five hours in Chicago. US carriers have tried in recent years to upgrade their cabins to compete with foreign carriers, but sadly, they have fallen behind in many areas, and this could impact their ability to make international routes as profitable as they desire.

Legacy carriers have done nearly all they can to reduce costs. There are no major cost cuts they can make, and any further cost cuts will either shrink the size of the carriers, or trim operations that shouldn't be trimmed for the long-term benefit of the company. What will need to happen now is that these carriers will need to look into the future and see how they can best position themselves towards these new realities. As much as legacies would like to believe that fuel prices will dramatically decrease, oil over $80 is a new reality that carriers need to adapt to. This means that carriers need to rethink their expansion as well as their new aircraft purchases and timing. Expect increased pressure from airlines around the world on aircraft manufacturers to create an aircraft that can deliver dramatic fuel efficiency gains. Moreover, airlines may exert continuing pressure on government to offer better solutions to energy policy. This isn't a problem we can drill our way out of, but rather one where established alternative energy solutions need to be implemented (such as electric vehicles) so oil can be used for industries where serious alternatives do not yet exist (such as aviation). By reducing the pressure on oil prices from automobile drivers and other oil users, airlines will see lower crude prices. But that will only come when airlines and other large companies lobby for a comprehensive national energy policy that takes renewables seriously. If the airline industry is to thrive, oil prices will have to come down, and the only way to do this is to reduce demand. Ultimately, this is where the solution lies.

March 19, 2008 in Delta Air Lines, European Carriers, International Carriers, Northwest Airlines, United Airlines | Permalink | Comments (0)

March 02, 2008

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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March 2, 2008 in American Airlines, Continental Airlines, Delta Air Lines, Low Cost Carriers, Northwest Airlines, Southwest Airlines, United Airlines | Permalink | Comments (0)

February 10, 2008

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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February 10, 2008 in America West, American Airlines, Continental Airlines, Delta Air Lines, Low Cost Carriers, Northwest Airlines, United Airlines , US Airways | Permalink | Comments (0)