Karen Walker

Driven as they are by the shareholder, the major US carriers will no doubt sit up and take notice of a new report from a Wall Street analyst that assesses their growth potential, and therefore investment worth, based on the relative strengths and weaknesses of their hubs.

Passengers might also want to take notice: the report's key recommendation that fewer and larger hubs be created by consolidation is potentially bad news for the customer.

New York analysts Lehman Brothers have published the 1998 hub factbook, which takes the view that, in a mature airline industry such as in the US, hubs are the key investment determinant. Brian Harris, vice president at Lehman, has led the study, which analyses six aspects of 29 hub operations at nine major hub-and-spoke airlines. These are local market growth potential, connection potential, growth constraints, market share, the number of gates controlled by the airline, and gate utilisation.

Harris also takes a look at Southwest Airlines, which is almost alone in having done spectacularly well operating a point-to-point system.

Harris concludes that the industry remains overhubbed and would be more efficient if there were fewer, larger-sized hubs, especially in the mid-west where he identifies the presence of nine hubs, including two in Chicago and three in Ohio. 'They are basically all slugging it out,' says Harris. 'My view is that too many hubs are doing the same thing. Hub economics work better where there are larger, fewer hubs in big cities. We see an opportunity here from an economic efficiency standpoint for industry consolidation.'

Harris gives the example of two medium-sized hubs in Ohio, in Cincinnati and Cleveland, that would no longer have to compete if their respective incumbents, Delta Air Lines and Continental Airlines, consolidated. One hub could then be upsized and the other downsized, says Harris. Whichever way round that hypothetical transaction worked, air fares from either destination would presumably be upsized.

Harris says he is not aware of anyone tearing down a hub, pointing out that in today's buoyant economic environment, even suboptimal hubs are making money. But he guesses that informal discussions are going on and that even a modest marketing arrangement forged between two of the majors would be sufficient to spark a wave of similar agreements. Such a spark might not be long in coming. Continental and Northwest Airlines are believed to be talking about a codeshare alliance - an idea that is being warmly received by analysts and carefully scrutinised by the pilot unions.

Studying hubs to assess the strengths and weaknesses of the individual airlines is not new. Lehman has done similar reports before, and the US General Accounting Office has periodically examined hubs from the consumer's point of view and found a strong correlation between high fares and those hubs where a single carrier is dominant. But other observations made by Harris might be a source of discomfort for some chief executive officers.

According to the Lehman analysis, the three airlines with the most growth potential are Continental, US Airways and United Airlines. 'I think the most interesting insight of all this analysis is that United, the world's largest airline, is still showing significantly above average growth potential,' comments Harris. Especially in United's favour is its Los Angeles hub, where the airline now holds a 25 per cent market share - up 0.9 percentage points from 1996 - and has been gaining since 1992, replacing Delta as the most dominant airline. US Airways, meanwhile, has increased its dominance at Philadelphia by 3.4 points to 64.5 per cent, while Continental has rosy growth potential its two main hubs, Houston and New York/Newark. Newark, in particular, has 'excellent' growth potential, says Harris, and Continental has been able to take advantage of that despite some runway constraints. At Houston, Harris predicts, Continental can grow in an even more unfettered way.

There is a warning note for Delta, even though Harris picks out Atlanta as '. . . probably the most profitable hub' because of its strong, largely unchallenged, catchment area in the southeast. However, a relatively low portion - 49 per cent - of its traffic is local. 'That works fine now but [they] could be exposed in the next downturn, particularly if they don't improve product quality,' says Harris. Local revenue is important, says Harris, because it tends to be more stable and higher yielding than connecting traffic, which is more competitive.

The report also highlights the fact that, as well as losing market share to United at Los Angeles, Delta has steadily lost to American at Dallas-Fort Worth. Describing this as the 'second fiddle' phenomenon, Harris says: 'Over time, the number two carrier's market share slips behind slowly. The study shows that the economics are far in favour of the larger hub at dual hub airports.' Many start-up carriers have already learned this lesson, of course.

Lehman decided to include Southwest in the study, even though Southwest avoids hub-and-spoke operations, because it wanted to see whether the airline was showing hub-like tendencies at any of its top five airports - Dallas, Houston, Las Vegas, Los Angeles or Phoenix. The short answer is 'not yet'. Southwest averages 6.2 million passengers a year out of each of its top five airports, which is considerably less than the 9.4 million average for hubs. Southwest also handles relatively little connecting traffic - 8.9 per cent compared with 35.9 per cent at hubs. Even in Phoenix, Harris' bet for the most likely hub, only 13.1 per cent of Southwest's passengers make connections. 'They have no intention to be a hub carrier as far as I know,' concludes Harris. Which will probably have Southwest customers crying 'Vive la difference!'

Source: Airline Business