Airline Mergers: No Big Deal?

Conventional wisdom has it that the union between American Airlines and US Airways – the fourth domestic airline mega-merger in as many years – is no big deal.

Listen as analyst Rick Seaney butts heads with conventional wisdom:

American Merger: What Travelers Need to Know

The storyline plays out something like this: healthier airlines foster a more pleasing passenger experience and that coupled with flat prices will have Wall Street and travelers alike singing Kumbaya.

Let me poke a bit at the talking-points driving this supposed utopian air travel ecosystem.

  • American Airlines and US Airways have minimal route overlap

The key word in this statement is “route.” If you take that to mean a non-stop flight, then the statement is true because both US Airways and American employ a hub-and-spoke model and their hub cities don’t overlap. By the way, there are typically three to five hub cities in this model.

However, the only folks who will be flying non-stop are those heading to a hub city, or those who live in a hub and are traveling to a spoke-city.

Taking a slightly deeper dive now, if we assume there are no service cuts, a newly combined mega-airline would serve about 215 different domestic cities (and just for the record, US Airways currently flies to about 146 cities while American claims about 167).

This leaves nearly 100 cities – about half of the newly minted mega-airline’s – where both airlines currently compete, albeit through different connection cities. Another way to look at it is there are about 4,900 routes where American and US Airways will no longer contend which is a far cry from “they have minimal overlap.”  Yes, fewer people travel those routes, but that is little solace if you happen to reside in one of these cities.

Timeline: American Airlines in Transition

The reason this is so important is that on any given day, a particular airline could launch a sale on a given route and its rivals would be forced to match prices (or end up out of the running with their fares not showing up until page 40 of a shopping site’s results).  With this latest merger, of course, there is one less carrier to initiate a sale.

This lack of competition affects airfare hike attempts, too. For example, when an airline attempts to raise fares – which occurs on average more than once a month – there will be one less airline that might refuse to match the increase, and such refusals are what almost always forces a rollback.

  • Low-cost airline competition will keep the remaining legacy airlines prices in check

Have you seen the prices on low-cost airlines lately?

Historically, low-cost airlines like Southwest and JetBlue had a 25+% cost advantage over legacy airlines. In other words, for every mile flown, the expenses for these low-cost carriers such as fuel, labor and the like were significantly less than the expenses for legacy carriers. So naturally, true to their advertising, some of that savings was passed on to consumers in the form of lower fares.

But as legacy airlines have gone through bankruptcies, they have reduced their cost structure – while at the same time, the expenses of low-cost airlines have been rising. The combination has effectively reduced the gap between the two types of airlines, as well as reduced the amount of wiggle room that allowed savings to be passed on to consumers – the same wiggle room that allows the low-cost carriers to stay profitable.

One last note on this: The remaining four legacy airlines serve over 300 domestic cities, while the low-cost airlines (Southwest, AirTran, JetBlue) serve just under 100.

  • Financially stronger mega-airlines can manage fuel costs more efficiently (and pass the savings on)

Airline management would dearly love to lock in fuel costs at a known price since it is almost impossible to plan ahead without some knowledge of one of your biggest expenses.

Some airlines “managed” fuel expenses in the past by buying fuel hedging contracts – and Delta went so far as to buy a refinery. But let’s be clear about this business of “managing”: it’s a synonym for “bet.” Are these educated bets? Yes, but they are bets nonetheless and presuming the winners of these bets will pass on savings to consumers is being charitable at best.

  • The last line of defense: our wallets

For consumers the last line of defense on higher airline prices is our ability or lack thereof to pay for airline tickets.

Airline business models now require every middle seat to be filled, but if they overcook airfare prices, we stop buying and discounting soon follows, or worse – capacity cuts.

As competition is minimized, supply-and-demand and the wildcard of fuel become the future’s main driver of airline ticket pricing.

The bottom line is, this latest likely merger-to-be – along with the other three recent airline mega-unions – has tipped the airline pricing scales in favor of the carriers. Over the long haul we are going to see higher ticket prices, but here’s the real question: will we be able to afford them – and more importantly does Wall Street know the lyrics to Kumbaya?


Published: February 13, 2013