The world is waiting for that shoe to drop, and it may be a big one. The biggest network carriers are pretty widely expected to be ready to start some cutbacks and possible fleet groundings as oil keeps rising faster than cost cutting or even than fare increases. This latest crisis, or stage of the long-running crisis, is forcing the carriers to look at revising their business plans. And they’ll have to do it on a faster timetable than the long day’s journey into night that a merger runs on. On Monday, oil was over $111 per 42-gallon barrel before dipping as bad economic news from around the world led traders to bid it down, on the belief that OPEC may pump more in a move to bring down prices and so keep its customers from dipping into recession. Mergers present a lot of problems other than taking time, and a good and smart friend of ours, George Hamlin, has some thoughts. George knows whereof he speaks: he worked for TWA in its glory days, has worked for Airbus and consulted for many majors. He's now with Airline Capital Associates or ACA as it's known.
Here's his piece (and Here's George, below):
While mergers seem to be on hold, the concept is an old idea that is likely to return. The present airline structure reflects past combinations, in the U.S. and elsewhere. United reached the pinnacle of airline size when it acquired Capital. Both British Airways and Air France are the products of mergers and acquisitions, as is Japan Airlines.
Management at several carriers, both in the US and elsewhere has been quite vocal about the need for mergers as a means of ‘rationalizing’ industry capacity (in addition to producing transaction fees, of course). Other carriers, however, are quiet on the subject, or have adopted a defensive posture (“we’ll consider M&A if appropriate, or if we find the whole industry coalescing around us”), suggesting that not all carriers believe that this is a requirement now.
Merging carriers like Delta and Northwest, or Continental and United, needs to be examined critically, particularly from a policy standpoint. At the forefront is the contention that mergers can be used to prune capacity in a reasonable manner, and thus, enhance profitability of the company in question while theoretically benefiting the industry overall.
If there is excess/uneconomic capacity extant, why are carriers seemingly unable to perform this function unilaterally? A significant part of the answer is that airlines historically have been fixated on market share, and thus, have been extremely reluctant to reduce their scope of service lest a competitor gain the traffic, leaving the departing carrier a smaller, weaker entity. There have been exceptions, particularly in terms of abandoning hubs that were no longer viable (Continental at Denver; Delta at DFW, American at several locations), but the list of these is not extensive.
Furthermore, in the short run, mergers tend to produce, not reduce, costs. There are multiple examples of employees at the partner which previously had a cost advantage being raised to the higher levels of the surviving carrier, in order to achieve labor “peace”. And while overhead costs may be reduced over time (only one headquarters should be required), these savings are not likely to be immediate. Merging operating and IT systems is fraught with peril on both cost and reliability criteria. And ‘culture’ differences can impact product quality and costs during the transition to a single unified entity.
The biggest problem, however, is that mergers are not an effective way to remove the deadwood from the forest. In a manner reminiscent of Newtonian physics, airline capacity, once in place, tends to stay that way, largely in the hopes that when another competitor leaves the field that it will become profitable. How can this be overcome?
Part of the problem is the seeming adherence to the ‘failing business’ doctrine. In the regulated world, airlines weren’t permitted to fail, which is how United got Capital. Post-deregulation, this concept faded, as virtually all new-entrants in the U.S. during the 1980s, as well as long-time carriers such as Braniff, Eastern and Pan Am, actually disappeared via the bankruptcy process.
No one clamored to acquire the domestic route systems of either Eastern or Pan Am (with the exception of certain niches such as the Shuttles). Did this benefit anyone else? Arguably, Delta survived its 1990s near-meltdown at least in part due to the fact that its Atlanta hub had no direct full-scale competitor after Eastern’s exit. Other carriers also benefited via the acquisition of specific assets of the failed carriers, in particular slots at airports in the US northeast.
Why didn’t this occur in the last spate of bankruptcies? A possible answer is that there was so much money looking for something to do that finding funding for emerging from Chapter 11 was relatively easy to do, even in the presence of fungible, transportable assets such as aircraft.
This represents an opportunity missed, and suggests that the process will likely have to be repeated before the industry achieves long-term financial stability in its more mature portions, such as the U.S. and Europe. Part of this is understandable: from a human nature standpoint, who wants to surrender or put longstanding workforces on the street?
At some point the financial community will have to come to grips with optimizing the size of the airline industry from an investment standpoint, however. Until then, it’s worth studying and understanding the history, benefits and costs of airline mergers, because, as stated by multiple pundits, those who do not understand history are doomed to repeat it.