Ask the pilot

Who benefits when airlines merge? Who gets hit the hardest?

By Patrick Smith

Read more: Technology & Business, Airlines, Merger, Business, P. Smith, Ask the Pilot

Feb. 15, 2008 | Fulfilling many months of rumor and speculation, the long-predicted consolidation of the U.S. airline industry is finally upon us. As of this writing nothing is official, but reports are that Delta Air Lines and Northwest Airlines, the nation's (indeed the world's) third- and fifth-largest carriers, respectively, are close to agreeing to terms, and will announce their intentions to merge. It may already have happened by the time you are reading this.

With the first merger on the table, expect at least two, and probably three, additional ones in short order. Don't be surprised if a United-Continental deal is struck in the coming weeks -- or even days. There is talk of a Southwest-AirTran union as well.

Whether this is good news or bad, and to what degree, remains to be seen and depends where you stand. Stockholders, employees and the traveling public each have their own perspectives and self-interests at stake. Airline mergers are notoriously knotty, and things could grow contentious as the paperwork wends its way through the approval process. Nothing will be official until the Department of Justice, the Department of Transportation and the unions all sign off. How long that might take is anybody's guess, but I imagine there will be a push to have everything signed and sealed before next fall's election. A change of presidents -- or, more important, a potential change of parties -- could hamper things substantially. The existing Republican administration would presumably be more merger-friendly than an incoming Democratic regime, especially if large-scale layoffs are part of the plan.

Why is this happening? Well, although the legacy carriers have mostly recovered from the calamitous stretch that began just prior to Sept. 11, their long-term health is hardly ensured. Among other problems, the airline industry suffers chronically from oversupply -- that is, too many seats chasing too few passengers. Periodically it gets so bad that some airlines cannot remain economically viable. The weakest go out of business, either by ceasing to operate or, as happens more often, by being swallowed in a merger or acquisition. It's nature's way of thinning the herd. Meanwhile, for six years the majors have been selling tickets at unsustainable prices in order to remain competitive with the likes of JetBlue and Southwest. Call it collusion, monopolizing or whatever you want, but banding together provides them a competitive edge that will help stabilize a battered and teetering industry, dampening what has for decades been a wildly cyclical pattern of highs and lows.

It's also a hedge against future catastrophes such as a terrorist attack, a severe recession or continued spikes in petroleum prices. If, as many are predicting, the so-called peak oil crisis hits in the next five or 10 years, massive consolidation will be the only means of survival. Best to start now. The eagerness to merge is in many ways a survival tactic.

Mergers are nothing new; the main difference, this time, will be the scale of the combined companies. At a minimum, four of the industry's six biggest names will be pairing up. The resulting entities will be immense. To give you some idea, below are the world's top 10 carriers, measured in annual RPKs (revenue passenger kilometers, shown in millions), the standard gauge of airline size.

1. American (224)
2. Air France/KLM (197)
3. United (189)
4. Delta (159)
5. Continental (127)
6. Northwest (117)
7. British Airways (115)
8. Lufthansa (110)
9. Southwest (109)
10. Japan Airlines (96)

Granted a merger would bring about the trimming of redundant routes and the reshuffling of aircraft, but either way a Northwest-Delta and United-Continental axis would instantly cast American Airlines into third place. The absence of American from the ongoing merger talks leaves the airline at a bit of a disadvantage. The pairing off of its four chief competitors might send AA scurrying after a dance partner of its own, but options will be limited. Somehow an American-US Airways combo wouldn't be as mutually beneficial as those already in play.

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