Airlines try to get merger off the ground
By Jeremy Lemer
Published: May 28 2010 20:46
Financial Times London
When Jeff Smisek and Glenn Tilton, the chief executives of Continental Airlines and United Airlines, testified before the Senate antitrust subcommittee this week on the proposed merger of their two companies they painted a compelling vision.
Their merger would create a global airline combining complementary networks, better able to protect jobs and important local routes.
Sitting beside them, however, two consumer advocates took a dimmer view.
The tie-up, they said, would lead to reduced service, higher prices on important routes and make the industry more, not less, vulnerable to strikes and shocks.
The gap between the two viewpoints highlights the surprising fact that even after decades of consolidation there is little consensus about its benefits or even clarity about how it is supposed to work.
Since 2000 alone, there have been three big mergers in the US, most recently between Delta Air Lines and Northwest, but the US carriers have managed to make more than $15bn of operating losses.
In making their case, Continental and United argued that this time would be different. The pair expect the greater “scope and scale of their network” to win $900m of extra business a year.
Put in plain English, they are gambling that expanded schedules at key airports and enhanced package deals will make their offering more appealing to high spending, globe-trotting corporate clients.
The trouble is that “revenue is a zero sum game”, according to Don Carty, who ran American Airlines when it bought the bankrupt Trans World Airlines in 2001. “You can’t count on revenue synergies because implicitly you are taking revenues from someone and they will have a strategy to take them back.”
With additional revenues looking challenging, the analyst community is banking on domestic capacity cuts to make the sums work. Kevin Crissey, with UBS, is typical when he writes that: “We’d be surprised if they weren’t approaching 10 per cent.”
The companies’ reluctance to talk about capacity reductions is understandable, Mr Carty says. “It is really all about politics ... If [they] start talking about capacity drawdowns, somebody is going to get upset.”
Reduced flying, Mr Carty says, means fewer jobs for workers, disgruntled unions and pressure on state politicians to ask awkward questions at congressional hearings and pester the Department of Justice, which is reviewing the merger.
For the regulators, it would raise concerns about higher prices. But recent academic research suggests that competition from low-cost rivals and the transparency of online booking sites keep prices in check even when airlines merge.
Instead, trimming capacity relies on the unspoken idea that big-spending business customers are travellers of necessity. When seats are cut, the number of corporate passengers tends to stay the same, meaning that low-fare leisure travellers are displaced. Costs go down and average fares go up.
But even a reduction in domestic capacity may not help as much as hoped.
While traditional airlines such as Continental and United cut flights in the recession and have pledged to remain disciplined, low-cost carriers have maintained their positions and have every reason to add more capacity when demand returns.
If they do, they will be able to undercut rivals and take market share at the expense of legacy airlines, says Michael E. Levine, a former senior airline executive who teaches at New York University School of Law.
“At best, United and Continental are talking about $1.2bn from synergies, or 5 per cent of total revenues ... not much of a margin for error.”
Copyright The Financial Times Limited 2010.