US Air + American = Good Or Bad?

Well, that depends on who you ask, of course. For shareholders and employees, it is likely a good deal. For some flyers, probably a good deal. For many others, not really. 

But the whole thing is quite fascinating, especially to students of economics and business (not to mention government regulation – invisible hand, anyone?). For such readers, here are two such articles I recently read.

Exhibit A, from Steven Pearlstein on The Washington Post, was written in August, when the Justice Dept was suing to block the deal. Some of the reasons why it was doing it:

One pillar of the government’s case concerns US Airways’ current Advantage Fare program, in which it has defected from the industry practice and prices one-stop trips at a 40 percent discount from the non-stop flights offered by competitors. In a truly competitive market, of course, all carriers would do that, reflecting the significant value passengers assign to non-stop service.  But the other airlines have a tacit agreement not to “undercut” each other’s non-stop fares. US Airways has refused to play along.  The government cites e-mails and analyses from American and US Airways executives suggesting Advantage Fares will go the way of free baggage check once the merger is complete.

The government suit also shines a spotlight on another cute industry practice that goes by the name of “cross-market initiative.”  An example:  Back in 2009, US Airways lowered fares and relaxed restrictions on flights from Detroit, then a Delta/Northwest stronghold, to Philadelphia. Delta responded by lowering its fares on US Airways’ lucrative Boston-Washington route. US Airways’ pricing team got the message loud and clear and concluded it had far more to lose by going ahead with the Philly-Detroit move and walked it back.

Among the more embarrassing documents unearthed by the government was a string of e-mails among US Airways executives from 2010 complaining about a new “triple miles” promotion launched by Delta as it sought to move into new markets and bring some mothballed planes back into service. US Airways chief executive Douglas Parker complains that the aggressive move would hurt the profits not just at Delta but at all the other airlines that would be forced to match it. Then he suggests bringing pressure on Delta by contacting industry analysts to have them criticize the move.  To reinforce the point, Parker even sent the e-mail string to Delta’s chief executive, who quickly remonstrated Parker for his ham-handed attempt at price fixing and forwarded the whole thing to his general counsel.

Then, on November 12, in exchange for a few concessions, the government agreed to let the merger happen.

So what happens next?

Justin Bachman, in Businessweek, talks about 6 of the merger’s implications, the last of which I cite here for your amusement:

6. Is there a winner in this? Yes—the attorneys who will bill the new American Airlines for many, many hours of work.

Enjoy the rest of his article here

PS: I was wrong, a few weeks ago, when I said this deal wouldn’t go through. So much for predictive analysis…

Add-On Fees: Not The Only Route To Airline Profitability (?)

Spirit Airlines in the US, and Ryanair in Europe, continue to attract media scorn while churning out highly enviable profits.

As many have noted, the principal driver of those profits has been low fares, various types of add-on fees and a spirited(!) enforcement of various rules that trigger those add-on fees. Here’s Derek Thompson of The Atlantic, on Spirit, in a recent article:

The subtext of most Spirit hate is that the fees are unfair and we’re being fleeced. Indeed, Spirit earns “40% more per airplane than any other U.S. airline,” according to the Wall Street Journal. This is a direct result of the high-fee, no-mercy strategy employed with such ruthless efficiency in Chicago. Maxim Group airline analyst Ray Neidl concludes Spirit exists for one reason only: “To make money.” Spirit is a business, yes, but few businesses are so nakedly businessy than Spirit.

But unfortunately for other airlines, they can’t fully transform themselves into Spirit (though they haven’t exactly lagged behind in terms of converting various hitherto-free items into charged-for items with great success – 53 of the world’s airlines reported $27.1B in “ancillary revenue”, for 2012) because of the target market, consumer behavior, etc.

So what else can airlines instead do?

Kaizen – the Japanese “lean” system – said a couple of people from McKinsey, back in 2003. In a longish article, they argued that lean techniques, long applied to manufacturing across industries, including airline manufacturing, should be applied to airport and maintenance hangar operations – two areas that they posited have the highest amount of resource, time and money wastage – so that airlines can increase throughput and realize some pretty impressive cost savings. 

On airport ground operations, for example, they had this to say:

When operations leaders take their newfound lean vision beyond maintenance, they see additional opportunities. Consider ground operations. Aircraft worth $100 million or more routinely sit idle at gates. Turnaround times between flights typically vary by upward of 30 percent. Lean techniques cut hours to minutes with a changeover system that mimics the A-check. The process is disciplined to the standard: one person is responsible for the job; each function is in place and ready to go before the plane arrives; passengers are briefed prior to boarding; flight attendants help stow carry-on baggage to speed seating. We have seen turnaround times at two internationally based carriers reduced by 20 to 40 percent in this way (Exhibit 4).

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Baggage handling is another lean candidate. Most business travelers would now rather lug a 20-pound bag through a mile of airport walkways and security checks than put up with the current system. But just as in maintenance, lean techniques can reorganize work flows, standardize tasks, and improve visibility. At most airports, there is no physical reason airlines can’t deliver baggage with 100 percent accuracy in the time it takes a passenger to walk to the baggage claim—and would that systemically speed up boarding! 

Lean techniques can also help customer service. A lean check-in system would lift throughput by segmenting passengers: most would be handled routinely, the rest by special-service agents. It would also carefully match staffing to passenger-arrival rates, standardize best practices, and monitor processing times. (A casual review of an airport check-in counter reveals that process times vary among agents by more than 50 percent.) In addition, such a system would systematically eliminate the root causes of slowdowns and supply a well-rehearsed set of protocols to deal with uncontrollable events, such as weather-driven cancellations.

Interesting article…but that was 2003 and this is 2013. Surely at least a couple of airlines must have taken this advice to heart and tried to realize savings. Wonder how successful (or not) they were in real life.

Should be a good candidate for a future post. 

Competing on Price (Alone) – Lessons From Ryanair and Spirit

Treat customers right and you make money today and into tomorrow, right? Maybe.

That’s because this maxim ignores the fact that there’s a whole class of customers out there that doesn’t care about anything but cost. And Ryanair proves that serving those customers without focusing on customer service at all is not a bad way to make money at all…as long as you can continue to offer the lowest price, of course. (Presumably, and obviously, this is not a customer segment very big on loyalty.)

As a recent article on The Economist says,

FOR a business with a reputation for treating customers with an indifference bordering on hostility, Ryanair has done rather well. The Irish low-cost carrier is Europe’s biggest airline, transporting 80m passengers a year. It is still growing, and raking in pots of cash. Michael O’Leary, its abrasive boss, says the common perception is that Ryanair’s tickets are so cheap that travellers will “crawl over broken glass” for them.

In the US, the closest thing to Ryanair, at least in the airline business, is Spirit airlines (in fact, it is modeled on Ryanair). Mildly demonized in the media for various kinds of fees,

Need an agent to print out a boarding pass at the airport? That’s $10. Want some water? That’s $3. Rolling a bag on board? The tag costs $35 from home and $50 at the airport. In all, there are about 70 fees enumerated in dizzying detail on Spirit’s Web site for customers to navigate.

its low fares continue to attract millions of flyers and its financials are the envy of other airlines:

…the model has allowed Spirit to offer cheap tickets. Since 2008, Spirit’s airfare has dropped by 20 percent, averaging $75 in 2012 compared with $94 in 2008. The difference often jumps out at a customer searching for flights. On Friday, Spirit was offering a nonstop flight from Oakland, Calif., to Portland, Ore., in mid-July for $156; the same trip was $296 on Delta.

Because of its growing list of fees, however, nonticket revenues grew to $51.39 in 2012, from $18.61 in 2008. As a result, while fares fell, Spirit’s total revenue per passenger grew by 12 percent from 2008 to 2012, reaching $126.50. Fees now account for 41 percent of Spirit’s revenues, an industry record.

Not a bad way to build and run a profitable business. 

American and US Air – Not Destined To Be Together?

After United+Continental and Southwest+AirTran – not to mention Delta+Northwest – everyone thought American+US Air was a fait accompli (because mergers are a solution to the airline industry’s historic “wretchedness problem“). 

No, said the DOJ today and filed a lawsuit to block it. 

Interestingly, according to an NYT article, it cited those past mergers as the reason why it thought this one, which would have created the world’s largest airline, shouldn’t be allowed. Those transactions, it contends,  led to higher prices and fewer choices for air travelers – something it says it can’t allow yet again.

And according to a blog post on The WSJ’s CFO section, not only is the DOJ not bluffing, but its case might be built on some pretty damning evidence:

Experts in antitrust law tell Reuters that the Justice Department lawsuit signals a sincere intention to block the deal, not just a negotiating ploy to get concessions before possible approval. Jonathan Lewis, an antitrust lawyer in Washington, called the suit “very powerful” because it quotes company documents and executives anticipating higher prices through consolidation. “If there were going to be a settlement, it probably would have happened already.”

As the WSJ points out, the Justice Department built its lawsuit largely on company executives’ own past comments. The 56-page court submission is full of remarks company officials allegedly made in settings from industry conferences to internal publications, the Journal says. The lawsuit quotes US Airways President Scott Kirby as saying that industry consolidation has allowed airlines to increase fares and charge fees for services like checked baggage. And the department said a US Airways presentation last summer observed that fewer airline competitors had allowed the industry to “reap the benefits.”

But what about the financial health of these airlines should they stay separate?

American, for one, will take a hit – though not a fatal one, says this excerpt from another WSJ article

A scuttled merger would prolong AMR’s stay in Chapter 11, perhaps until late 2014, said another person close to the process. The company would have to fashion a new reorganization plan to emerge from court protection as an independent company, revise its financial projections and negotiate anew with bondholders, unions and other creditors—all of which would take considerable time.

As for US Air, it’s stock took a 13% hit following the news, as was to be expected.

But very interestingly, other airlines’ stocks suffered too because a resurgent US Air might actually do things that are detrimental to the industry:

Investors worried that if American were forced to remain independent, it might try to bulk up to the size of merged behemoths Delta Air Lines Inc. and United Continental Holdings Inc. That could cause industry capacity to grow and earnings prospects to diminish, according to J.P. Morgan Chase & Co.

For now, both airlines are putting up a brave face, vowing to fight the DOJ and promising to complete the merger before the year.

Who’s going to prevail? My money is on the DOJ.

Airbus To Fly Against The Law Of Large Numbers

Profit margins are tricky things.

When a company is small, it is (relatively) easy to increase margins (again, relatively speaking). But as companies grow big, moving the margin percentage needle by 1 or even 2 points is a pretty big deal. And in automotive, aerospace and other such industries (click that to see operating and net margins broken down by industry, based on a database of 6177 firms – as of Jan 2013), I have to imagine that it is nothing short of a herculean task. 

Consider then what Airbus wants to do:

Airbus is on track to more than double its profit margin by 2015 through greater efficiency and revamped management, Chief Executive Fabrice Brégier said.

Mr. Brégier, who took over as CEO last June after five years as chief operating officer, said in an interview that he has been working to shake up the way Airbus builds planes, by giving factory managers more autonomy and instilling “a more entrepreneurial spirit” throughout the company.

Pretty amazing and downright impressive, that goal.

The rest of the article I excerpted from (written by Daniel Michaels, on The WSJ) offers additional details.

Boeing and Airbus Turn To Model “Extensions” To Minimize Risk

Risk mitigation is in the air. 

The latest industry (after the movie industry) to think about ways to mitigate risk is the ever-wary-of-risk Airline industry (don’t blame the industry for that attitude, blame super high fixed and just high variable, costs).

Writes Christopher Drew on The New York Times, 

Boeing’s announcement last week that it had begun pitching airlines on an enhanced version of its 777 jet, rather than a whole new plane, underscores how the aerospace industry is pulling back from the risky bets that have led to costly, and humbling, delays on other planes, like Boeing’s 787 Dreamliner.

Instead of following the Dreamliner template, in which it sought to create a revolutionary plane brimming with new technology, Boeing is now seeking a safer, more incremental path. It plans to add the most crucial new technologies, like lightweight plastic composite wings and more fuel-efficient engines, to the 777, while avoiding the time and expense of designing a replacement from scratch.

To be clear, even extending existing models by upgrading various parts (the wings, the engines, other systems) iteratively is not without financial risk either. Unlike generic lego blocks that easily snap onto each other, fuselages for example are designed to support a certain set of systems and materials. So when new materials are used, some major new design work may be required – just not as much as is needed for a brand new plane though. 

PS: And these concerns are not limited to Boeing by any means. The article also includes this memorable quote:

“Risk, risk, risk,” Tom Enders, the chief of Airbus’s parent company, European Aeronautic Defense and Space, said of Boeing’s approach to the Dreamliner.

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