The proposed United and Continental airlines merger announced May 3 would create the world's largest carrier, help shrink industry capacity and perhaps push airfares higher. Long viewed by many airline executives and Wall Street analysts as a way to solve the industry's persistent financial woes, a large-scale merger could trigger more consolidation resulting in just three remaining U.S. hub-and-spoke network carriers.
Airline mergers are neither easy nor quick. They often create an abundance of employee and customer-service issues. But so far the integration by Delta Air Lines of Northwest Airlines largely completed this year has demonstrated that a big merger in the U.S. market can be lucrative and need not be ruinous from a customer-service perspective.
If the all-stock United-Continental deal is completed in the fourth quarter as the carriers expect, the effects for corporate buyers and travelers--as with any merger or tight-knit alliance--would depend on their organizations' travel patterns. Some could see their negotiated deals grow in scope, with associated discounts on more routes providing additional savings. They also might see the biggest airlines and most closely aligned partners bid aggressively for their business to keep fewer but stronger rivals at bay. In other cases, the loss of a competitor in certain markets could cause complications to the detriment of preferred carrier programs.
Consolidation 'Logical' Solution To Industry Challenges
In terms of domestic traffic in the U.S. market, United ranks fourth behind Delta, American and Southwest airlines; US Airways places fifth and Continental sixth. A United-Continental combination would vault ahead of Delta, at least on paper, until the new entity started cutting capacity.
[PULL_1]J.P. Morgan analysts wrote that they assume the combined airline would make an 8 percent capacity reduction (and an "incremental $600 million of operating profit in 2011"). UBS analysts said they'd "be surprised‚" if cuts "weren't approaching 10 percent of combined domestic capacity," which would represent 2 percent of industry capacity and be "good news for all of the major airlines."
"The airline industry remains a financial mess with no major U.S. airline earning its cost of capital," according to an April report from UBS. "Consolidation, though not easy, riskless or free, is a logical way to attempt to rectify this long-standing problem. Consolidation reduces capacity, the number of competitors and the capital employed in the sector. With less seats and competition, pricing should improve."
Looking at specific markets, Travel Leaders Corporate CEO David Holyoke speculated that Continental's hub in Cleveland would "eventually be downsized in favor of Chicago," United's base.
According to an April report by Fitch Ratings analysts, renewed speculation on airline mergers "reflects the notable improvements in the industry operating outlook and the long-term logic of increased concentration in a largely commoditized industry that remains vulnerable to external demand and fuel price shocks."
Executives at American Airlines (which hasn't attempted a major acquisition since buying assets from bankrupt TWA in 2001) and US Airways (which withdrew from merger talks with United shortly before United inked a deal with Continental) also sounded bullish on U.S. consolidation. Presuming completion of the United-Continental deal, AA and US Airways would be the smallest of the four hub-and-spoke network carriers, leaving some to conclude they'd merge.
[PULL_2]"The issue in this industry is too many hubs and too many airplanes and what that does to pricing, particularly one-stop pricing," said AA CEO Gerard Arpey. "Whatever vehicle would lead to a more rational balance between supply and demand would be effective in getting prices to the point where you are covering your costs. That can take many forms."
"We have long held the view that the right number of hub-and-spoke airlines for this industry is three," said US Airways CEO Doug Parker. "At some time in the future--it could be two years, it could be five years--the next transaction that happens could be with [Delta, United or American] and US Airways."
Mergers Are No 'Silver Bullet'
Despite his apparent advocacy for "inevitable" consolidation, Arpey said mergers are "not a silver bullet" and cannot cure the industry's "long history of financial challenges. Generally, fewer carriers would probably be better for the industry, but it's not a panacea."
Brookings Institute senior fellow Cliff Winston doesn't understand the excitement over airline mergers and said there is "no evidence" airfares would move much. "I can appreciate that they want to lose a competitor," he said during the Phoenix Aviation Symposium in April, "but airlines are running 80 percent load factors so I am not sure how much more capacity they could take out."
A merger also presents a tall task operationally. Airline management teams, employees and seasoned travelers know the inherent complications. Given labor-union integration challenges and the work required to combine operations, fleets, customer-service programs and countless other systems and services, disruptive mergers in the industry's history far outnumber smooth ones. To ease the process, Continental and United said they will create a transition team to "develop a specific integration plan." They may take some cues from the Delta-Northwest merger in an attempt to replicate some of the successes.
[PULL_3]"For a larger deal that you are not really going to use, you are not getting the return on investment," said Carlson Wagonlit Travel U.K. director of industry affairs Nigel Turner. "You want to be able to pick and choose."
"It can become problematic because you may have had a great relationship with carrier A and B, but an awful one with C," according to HRG's Gleason, "and now you are being asked to have a relationship with A, B and C."
BCD noted that some clients have insisted on single-carrier contracts, but settled for "far lower discounts." Brindley, of BCD's consulting arm Advito, added, "If a carrier's joint-venture partner is not selected for a client program, the airline won't cut off its nose to spite its face by walking away from a deal that suits it individually."
Delta-Northwest Neutral To Positive For Most Corporate Programs
By most accounts, Delta's integration of Northwest has been among the smoother U.S. airline mergers in recent memory. From a customer-service perspective, the airline reported no major snags as it retired the Northwest brand, switched reservations systems and pushed ahead on combining all aspects of the operations. "It's a blueprint on how mergers ought to be done," said Prashanth Kuchibhotla, director of American Express Business Travel Advisory Services in EMEA.
[PULL_4]From a corporate-contracting perspective, competitive detriments were fairly isolated when combining the complementary route systems. According to sources, many accounts maintained or even increased discount levels, and secured discounts on more routes, as more of their volume fell under the purview of a single provider. "Yes we lost Northwest competition to United, American or Delta on the Atlantic routes, but there is so much competition on the Atlantic that it didn't really matter," said Kuchibhotla.
"There was a little bit of hub competition for some flow traffic, but overall that was a relatively minor negative impact for corporate clients," said Advito vice president of business solutions Bob Brindley. "In some cases, [the merger] may have had a positive impact." U.S. companies with modest transpacific travel, for example, may not have had enough business to Asia to warrant discounts from Northwest or United, but now realize some incremental benefit when that traffic is packaged under the umbrella of a larger Delta contract.
With a network that blankets the U.S. market and competes on many transatlantic, transpacific and Latin routes--represented in Europe by SkyTeam partners Air France-KLM--Delta "picked up a little over $100 million in new corporate revenue just in the negotiations we have held in the past 12 months," said Delta president Ed Bastian in April. That "should be indicative" of the revenue "we will be realizing over the course of the next year."
The Delta/Northwest integration during the March quarter generated $200 million in "incremental synergies‚" and "$1 billion in annual run-rate synergies from the transaction," according to Delta CEO Richard Anderson.
He acknowledged that some work remained, especially in terms of information technology, saying that "we have some investments to make because the last 18 to 24 months have been focused on integration and not continued improvement in our systems." Bastian added that Delta this year hopes to resolve "employee representation issues with our flight attendants and airport employees."
Europe Down To Three: BA/Iberia Deal Would Create Mega Airline
In Europe, a third mega commercial aviation group is emerging now that British Airways and Iberia signed an agreement on a merger deal they expect to close by year-end. In the works since last year, the deal combining the U.K. and Spanish carriers would create a multinational entity with the network breadth needed to keep pace with Air France KLM and the Lufthansa Group.
The proposed BA-Iberia deal would create an airline group that accommodates 58 million annual passengers with 408 aircraft operating to 200 cities, the companies said. It would encompass BA's strong North Atlantic position and Iberia's operations to Latin America, and "have greater potential for further growth by optimizing the dual hubs of London and Madrid and providing continued investment in new products and services," according to a statement by British Airways CEO Willie Walsh, who would lead the new group.
BA and Iberia already operate a joint venture on U.K.-Spain routes (notably London-Barcelona and London-Madrid), participate in the oneworld alliance, cross-market various flights and cross-sharehold with each other. As such, a full-blown merger is not expected to change corporate contracting by any large degree.
"The great advantage of a merged organization and not an alliance is you can talk to them with one point of contact," said Carlson Wagonlit Travel U.K. director of industry affairs Nigel Turner. "In an alliance, you still have individual operating airlines and sales forces, so you are talking to a roomful of people instead of one person. That is somewhat diminished with antitrust immunity, but still not the ideal solution." Turner expects BA-Iberia will construct a corporate sales team and process similar to that of Air France-KLM, in which both operating companies are represented but negotiations and contract management are handled across a single, combined network.
Other sources pointed to potential benefits for corporate buyers, including more vigorous competition in certain markets. For example, "BA may want a piece of those U.S.-Spain routes that Delta may be getting today," said Advito's Brindley.
Meanwhile, when combining Iberia's transatlantic operations between Latin America and Europe with oneworld alliance partner American Airlines' U.S.-Latin operations, "then you have some more interesting synergies," according to HRG's Gleason, especially if AA, BA and Iberia secure final approval for an immunized joint venture.
"Iberia has an extensive connecting network through Madrid beautifully located on the southwest corner of Europe so it can funnel anything from Europe to anywhere in Latin America," said Amex's Kuchibhotla. He also suggested that the combined entity would better withstand economic cycles, as British Airways' exposure to North Atlantic business conditions and Iberia's to South Atlantic conditions are mitigated when combined.
When asked generally about consolidation in the European market, Turner pointed to the consumer benefits of combined networks and said, "Overall, there still is enough competition out there."