On August 8, 2012, I appeared on CNBC to discuss a possible merger between American Airlines (AA) and US Airways (US). Afterwards, I received several calls and emails requesting I elaborate on my perspective, since the on-air time was limited. Your wish is my command…
Let me start by saying I’ve advocated that AA doesn’t necessarily need a merger partner. The airline’s route network gives it a good domestic footprint, though it’s far from perfect — for example, AA doesn’t offer the same north-south utility along the east coast compared to United (UA) and Delta (DL). AA is finally beginning to benefit from its various joint business agreements with some of its oneworld alliance partners such as British Airways, Iberia, and Japan Air Lines, and its partnerships with unaffiliated airlines such as Alaska (AS) and JetBlue (B6). AA’s recent business performance has been strong, with impressive revenue improvements in April, May, June, and July 2012 as measured by the airline’s load factors and PRASM. AA has been clear in its belief that its future will be best served by remaining independent — but, if a merger is to occur, AA has stated it wants to be the one who does the choosing.
For several years, US Airways has been impressively honest about its need to grow, and how it sees a merger or acquisition as the most efficient way to accomplish this objective. US Airways sees AA as its best partner. That interest is understandable. To start, an acquisition by US of AA will likely be less expensive while AA is in bankruptcy (provided that US is able to obtain the various approvals necessary to acquire AA). US’s two east coast hub cities, Philadelphia (PHL) and Charlotte (CLT), are tangibly smaller than other markets such as New York and Atlanta, which increases the airline’s need to compete for connecting passengers. For all its challenges, AA remains a strong franchise, with hubs in top-tier markets, a large base of corporate clients, more than 60 million members in its AAdvantage® loyalty program, and an “anchor” position in the oneworld alliance. A key benefit of an AA-US merger would be the airline’s strength along the east coast — the combined airline would have hubs in New York, PHL, CLT, and MIA. US can and would benefit — greatly — if its bid for AA is successful.
So, if AA and US were to combine, would air travelers face doom and gloom, as some have suggested?
No. Far from it.
Consider these points.
1. A combined AA-US would lead, but not, dominate the US airline market. Based on US Department of Transportation (DOT) data for calendar year 2011, looking at both domestic and international available seat miles (ASMs), AA-US would have about 24% of the market. The next largest airline, UA, would have approximately 22%. DL, with 20%, occupies third place. If we look exclusively at 2011 domestic capacity, AA-US would have 22% of the ASMs — ahead of other airlines like UA and DL (about 16% each) and Southwest (WN) (15%), but a lead that nonetheless can and will be challenged as these and other airlines explore expansion. And while many network airlines, including AA, have new aircraft on order, much of that capacity is intended to replace existing aircraft — meaning their capacity will remain essentially flat. In contrast, “low cost carriers” such as B6, WN, and Virgin America (VX) have new aircraft on order to add more flights between existing cities, add more destinations, or both.
2. US and AA have minimal overlap. AA and US have complimentary route networks. The two share no common hubs. At AA’s key hub airports — DFW, JFK, LAX, ORD, and MIA — US’s seat share is in the 1%-2% range. Similarly, in US’s three hub cities — CLT, PHL, and PHX — AA has just 2%-3% of the seat share.
A report states that AA and US will overlap on 22 routes, but that is not quite correct: Based on the schedules filed by the two airlines for July 2012 (peak days), AA and US have just 12 nonstop routes in common. It appears that the report may have counted each direction in a city pair as a single route (e.g., the Phoenix (PHX)-Los Angeles (LAX) route was counted as both PHX-LAX and LAX-PHX). It’s important to put those 12 shared nonstop routes in context: AA operated 508 nonstop city pairs in July on a peak day, and US operated 384. The small number of overlapping nonstop routes accounts for 2%-3% of each airline’s operation.
3. The industry will remain vigorously competitive. In discussions with reporters and other parties, many have asked whether a merger would reduce competition.
Of the 12 nonstop city pairs that AA and US share, 10 either have or will have competition. Some, like PHX-LAX, are served by multiple airlines. Other have competition among the different airports that serve a city (for example, US flies DCA-RDU, while UA flies IAD-RDU).
You know that expression “nature abhors a vacuum”? Airline planning executives abhor vacuums even more. In spite of the various mergers that have occurred, we’ve seen airlines add new domestic flights. VX, for example, has added nonstops from LAX and SFO to ORD, DFW, and PHL. Spirit (NK) has added flights at both ORD and DFW. B6 has added flights from its JFK and BOS hubs, including BOS-DFW. Following its slot swap with US at LGA, DL added nonstops from LGA to numerous cities, including CLT, DFW, and many small/mid-sized cities up and down the east coast as well. Let’s not forget that in 2014, the Wright Amendment restrictions on Dallas Love Field (DAL) end, which will enable AA’s cross-town rival WN to expand its service from DAL to almost any city the airline will be serving. And let’s not forget the entrepreneurs who continue to see business opportunities in the airline industry. Efforts are underway to relaunch PeoplExpress. California Pacific Airlines is working to launch service out of Carlsbad, CA. A few years ago there was discussion of an attempt to relaunch Eastern Airlines.
If the AA-US merger occurs, US has publicly stated it would continue to serve nine airports that AA dropped in the last year. According to US, there are 31 US cities that can served from AA hubs, and 56 AA cities that can be served from various US hubs. An expanded AA-US would be able to add more connections between cities, thus increasing its utility and appeal to travelers — and increasing competition and consumer choice. What about marginally profitable routes or cities? There’s no guarantee they would remain independent of a merger (it’s that “marginally profitable” thing).
US has stated that, if it merges with AA, it would move from the Star Alliance to oneworld, the alliance in which AA is a founding member. Though this would reduce Star’s flight options, it would strengthen oneworld, allowing oneworld to better compete for corporate accounts and business travelers — the alliances’ primary target audiences — against both Star and SkyTeam.
That’s not to say everything will be hunky-dory. Let’s start with the fact that a merger will obviously take two independent competitors and combine them. Key airports like LGA, JFK, and DCA are slot controlled, limiting the ability for new airlines to start service, and inhibiting incumbent airlines from adding flights to existing or new destinations. At some airports, including some “fortress hubs,” AA or US may control terminal ticket counter and gate facilities to a point that could limit other airlines’ ability to expand.
4. Neither AA nor US control air fare pricing. FareCompare.com states that thus far in 2012, there have been eight attempts to raise airfares, with two led by WN. Only four of the eight attempts — including the two WN-initiated efforts — have succeeded. Air fares tend to be set by the LCCs — a group that in addition to WN, B6, and VX now includes three airlines in the new “ULCC,” or “ultra low cost carrier,” category: NK, Allegiant (G4), and Frontier (F9).
DOT data shows that, adjusted for inflation, 1Q 2012 US domestic air fares actually cost 19.2% less than what they would have cost in 1999, illustrating the great financial value air travel offers consumers. Mind you, this bargain exists in spite of the higher cost of fuel. For the first six months of 2012, AA spent nearly $4.4 billion on fuel — 35% of its operating expenses, and 8.2% more than the first six months of 2011. US, in turn, spent nearly $1.8 billion on fuel in the first half of 2012, nearly 5% more than it spent in the same timeframe in 2011. Fuel represented nearly 27% of US’s operating expenses for the first six months of 2012. No reasonable businessperson would expect an airline to absorb higher fuel costs like these.
Let’s not forget that airlines are businesses. They exist to both serve their customers and provide an acceptable return to their stakeholders (they’re better at the former than the latter). The airline business is brutally competitive — trust me, I’ve been there. Airlines routinely match fares to maintain market share. Admittedly, the potential for higher airfares in “fortress hubs” is a legitimate concern in any airline merger. However, we’ve seen enterprising airlines (especially LCCs and ULCCs) enter markets they perceive to either be underserved or overpriced. I live in San Francisco, where VX just celebrated its fifth anniversary, WN operates from all three Bay Area airports, and G4 has launched service at Oakland. Though an AA-US merger may lead to the right-sizing of its hubs, this isn’t a new practice and isn’t limited to mergers. CO closed its DEN hub in 1994, when no merger was in sight, because the DEN hub wasn’t profitable. Unable to generate an acceptable financial return, DL closed its DFW hub in January 2005, long before it merged with NW.
Should an AA-US merger receive appropriate government scrutiny — if it ever happens? Of course. But will an AA-US merger be a flat-out bad thing for consumers or communities? No. Should it occur, an AA-US merger will in all likelihood produce an airline that is more financially stable and better able to compete due to a more comprehensive route network and a fleet of aircraft that can be more easily tailored to match the right size aircraft to market demand.