Why US Airways Needs a Merger

ByTed Reed, TheStreet.com Staff Reporter , On Friday July 23, 2010, 12:01 pm EDT
CHARLOTTE, N.C. (TheStreet) -- Want more evidence that US Airways needs a merger? Throughout the world -- and the nation, -- major airlines are defined by their hubs. That's a problem for US Airways, because its hubs are not the best.
"US Airway's largest hub, with 612 daily departures to 120 destinations, is Charlotte Douglas International (downtown Charlotte is pictured above). The only southeast hub besides Atlanta (the world's busiest airport), Charlotte is a well-managed airport with the lowest per-passenger cost of any major hub and a recently-opened third parallel runway. In fact, US Airways has built Charlotte into the 11th busiest U.S. airport, in terms of passengers.

"Charlotte is a great hub, but it's a smaller city than Atlanta," said US Airways President Scott Kirby, speaking recently at the Bank of America Merrill Lynch investor conference. Philadelphia, US Airways' other eastern hub, "is a great hub and a great international launching point, but it's a smaller city than New York," said Kirby.

Phoenix, US Airways' third hub, ranks ninth in total passengers and ninth in origin and destination passengers, but lacks business passengers, who often pay higher fares.
Charlotte lacks just one thing: origin and destination (O&D) passengers, folks who begin or end their travel there.

The best hubs tend to be those with the largest numbers of O&D passengers; airlines can charge more for non-stop flights, their premier product. When they offer one-stop flights through their hubs, they must compete with other airlines offering exactly the same product: one-stop flights through their hubs.

In 2009, Atlanta had 26.2 million O&D passengers, according to the Transportation Department's Bureau of Transportation Statistics. Atlanta ranked fifth in the U.S. Charlotte had 9.4 million, and ranked 31, the lowest for any major hub.

US Airways has said this dynamic puts it at a 10% disadvantage in revenue per available seat mile, relative to its peers. (A revenue passenger mile, a key industry metric, is one passenger carried one mile.)

To produce the same profitability as its peers, US Airways requires a cost advantage, which it achieves with 10% lower costs. "The way for our employees to ultimately get to industry standard wages is to combine with one of those networks that has even better profitability and even better hubs," Kirby said.

"From a global perspective, a strong local traffic composition is the key ingredient" in the capability of a hub, said OAG consultant Stan Hula. "Once you get into details the equation becomes more complex. The issues are the population of the hub city, the wealth of that population, the nature of the traffic and how much competition there is for it. Then you similarly look at the flow components. But without strong local traffic, you have a weak hub no matter what else you have."

In fact, the three largest O&D markets are not key hubs. Los Angeles International the number one O&D market, is a strong international hub but not so good domestically because it lacks destinations to the west and no airline has been able to accumulate a dominant share of its passengers. The other top two O&D markets are Las Vegas and Orlando, but the large number of leisure passengers that pass through them balk at paying high fares.

It's fair to say that it did not take any particular genius for the Big Three airlines to establish their hubs in big cities that became great hubs.

Delta started as a passenger airline in Monroe, La., and moved its headquarters to Atlanta in 1941. Dallas was a key city for American by 1930. In 1978, around the time that airlines began to create hubs, American moved its headquarters to Fort Worth. United, meanwhile, was formed in 1930 after a predecessor bought a large, Chicago-based carrier.

By contrast, one principal US Airways predecessor was formed to carry mail to the Allegheny Mountain region centered near Pittsburgh, while the other was formed in Winston-Salem, N.C., about 75 miles from Charlotte, in 1947. Before its 2005 merger with America West, US Airways had hubs in Pittsburgh, Charlotte and Philadelphia, three cities within a day's drive of one another.

US Airways executives have long recognized the airline's plight and have sought to overcome it through mergers. Onetime CEO Stephen Wolf said repeatedly that the carrier was the last of its kind, neither a low-cost carrier nor an international carrier with a global route system. Wolf and longtime associate Larry Nagin pursued a 2000 merger with United, where they had worked together to build a global carrier.

After arriving at US Airways in 2005, CEO Doug Parker tried a hostile takeover of Delta, but the carrier fought him off. Parker has twice entered negotiations with United; both times, United preferred to merge with Continental.

Now speculation about a US Airways/American merger abounds. The concept seems to have the support of everybody -- except American itself .

But US Airways knows what it needs. As Kirby has said: "Further down the road, there's a high probability that US Airways will wind up merging with either United, Delta or American."
-- Written by Ted Reed in Charlotte, N.C.