A US Airways Takeover of American Would Make No Sense

CrankyFlier reviews the American Airlines bankruptcy and says that the dream result would be US Airways taking over the airline. That makes no sense.

Now, the only argument in favor I can imagine is that it would mean a new management team, and the theory that they can’t make worse decisions than American has over the past decade — beginning with acquiring TWA out of a prepackaged bankruptcy. TWA failed because (1) they paid lower than average wages but still had higher than average labor costs due to crazy onerous work rules, like maintaining a 747 maintenance base when they no longer operated 747s, and (2) being hubbed in St. Louis they had virtually no high revenue origination/destination traffic.

American has had above average costs, in part because they didn’t go through bankruptcy while other major carriers have, but that was management’s decision believing that they could come to agreements with their labor unions without a strategic bankruptcy — something they utterly failed at. And the wasted years in the meantime have meant billions in losses. And poisoned labor relations, with American’s pilots now expecting to eat huge pension losses and flight attendants (who have gotten less media attention) likely to take a major hit to compensation.

But it isn’t just about the labor costs, as Scott McCartney pointed out yesterday, there’s a bigger revenue gap than there is cost gap between American and its rivals.

Delta Air Lines Inc. collected 12% more revenue than American for every seat flown a mile in the third quarter this year. And yet it cost Delta 6% less to fly each seat one mile. (A seat mile, one seat flown one mile, is the standard way to compare unit revenue and costs in the airline industry.)

It’s a similar story when you compare American to United, its other giant U.S. airline competitor. United’s unit costs were lower than American’s, and United’s unit revenue was higher per seat-mile flown. And so it’s little surprise that Delta earned $429 million in the last quarter and United earned $653 million, while American, in the period that includes much of the busy summer-travel season, suffered $162 million in net losses.

American is bleeding especially on its Chicago transatlantics, they’ve killed off the Brussels flight already but London is killing them. Yields have been so low that they wind up pulling connecting traffic out of Los Angeles instead of those passengers flying direct.

Now, what does all of this mean for US Airways?

One of the biggest operational challenges that US Airways has is poisonous labor relations. The America West / US Airways integration hasn’t gone forward yet, even though the pilots were ostensibly represented by the same union. The East Coast pilots lost under their union procedures and arbitration, so since they were the larger group went out and formed a new union whose primary purpose was sticking it to the West Coast pilots (rather than the company!). Meanwhile, there have been recent campaigns against the airline that has had the carrier seeking court injunctions and their own workers.

US Airways hardly has the formula for labor piece, it’s inconceivably that they could smoothly integrate their pilots in with American’s.

Meanwhile, the route networks are hardly complementary. One of the very first lessons I learned years ago is that you don’t make money overflying your own hubs. American is undercutting its Los Angeles – London flights with Los Angeles – Chicago – London, other carriers can pull it off but American doesn’t seem able to.

What US Airways and American would have is a route map that makes no sense. There’s little logic in maintaining East-West service out of both Los Angeles and Phoenix. Meanwhile, neither carrier has a strong presence in the Northwest. American has a huge operation at New York JFK, while US Airways hubs in Philadelphia. I don’t know American’s New York numbers, perhaps they concede to Delta and retrench to Philly?

An American/US Airways combination would wind up with hubs and focus cities all up and down the East Coast, New York-Philadelphia-Washington National-Charlotte-Miami.

About the only places where there’s not meaningful overlap are Chicago and Dallas — both American cities, where a US Airways combination adds nothing to the mix.

It’s not clear how this combination would solve the route and revenue issues, or the labor issues. About the only scenario I can see is on the cost side where American quickly downsizes its fleet and operates with US Airways’ newer planes and with future orders in order to gain fuel efficiency. The pilots still hate it (and relations get worse as a downsized carrier means fewer flying opportunities spread across a fixed number of pilots). And then they axe New York or Philly, axe Phoenix or Los Angeles, and figure out whether Charlotte continues to make sense sandwiched in between DCA and Miami.

US Airways gets mention because it’s about the only player left, and because its management seems to like mergers (they kept trying unsuccessfully with United, after having come over from America West).

Airline mergers rarely bear the sort of fruit that’s promised. And this one doesn’t even seem as promising as usual. There’s real work to be done at American, and they need to do that real work, not just look to make it someone else’s problem.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community InsideFlyer.com, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. Am I the only one who also thinks regulatory approval of any legacy merger will be difficult to obtain even if the airlines did try to go down this ridiculous path? Running out of major players to effectively merge, don’t ya think?

  2. Obviously I couldn’t disagree more, and I have a more detailed post on my thoughts on why a US/AA merger makes sense coming out tomorrow. But I should note that I have always rolled me eyes at people saying that AA should buy US. It made no sense.

    But US buying AA in bankruptcy makes perfect sense. You get a management team that knows how to run an airline and they will make major, drastic changes that need to be made at AA.

    On the route side, it can fit together quite nicely if dramatic changes are made (as they should be).

    And labor is not an issue. You have 9,500 active AA pilots and 5,000 active US pilots. All this ridiculous USAPA garbage goes away immediately and you have a unified union that management can finally bargain with.

  3. Nice analysis Gary and I agree with you. US/AA would be catastrophic without major changes to hubs, aircraft, routes, etc.

    Re: Cranky’s comment about US management “that knows how to run an airline.” Do they, though? While I don’t follow them closely nor fly with them, I question their strategy, particularly when they match Spirit fares. I think they’re stuck in still trying to figure out whether to be a LCC or national/global competitor.

  4. If I recall correctly, Cranky used to work at American Worst. I think that he should be disclosing this whenever he writes about US Airways since it allows the reader to know where he’s coming from.

    Cranky, is it based on your personal experience that you believe that US Airways management “knows how to run an airline?”

  5. @Cranky Flier – I don’t think the union issues go away, you have unhappy workers and more unhappy workers, exascerabted by a shrinking pie that stems from “dramatic changes” to routes (getting out of unprofitable markets and shedding expensive aircraft). You’ve got to break minimum flying clauses, integrate senior into a smaller route structure, and pay people less. That’s not a recipe for union problems ‘going away immediately’.

    And the need to make dramatic changes to route structure underscores how poorly the route networks fit together, since it isn’t just American routes that go away… US Airways would be far better off growing on its own, what does it really get in buying American?

  6. When it comes to FF programs and how to get value, I highly value the advise of Gary.

    When it comes to the nuts and bolts of the airline industry and the operations side, I listen to Cranky.

    The point being, Doug will make the tough decisions that Arpey was not willing to make.

    @Cranky Flier – I greatly anticipate your article tomorrow.

  7. @Derek I don’t claim to be an expert in all parts of the industry. But sometimes that’s a benefit. Experts in this iindustry have lost a LOT of money. 😉

  8. @Frequent Flyer – Yes, I worked with the current US Airways management team when I was at America West. I left 9 years ago. I was the manager of pricing when I left, so it’s not like I was working side by side with these guys on a daily basis. Do I know them? Absolutely. But I have no insider information at all, and haven’t had contact with anyone at that level since the bankruptcy filing. I’m convinced that posting my full airline background on the site is plenty of disclosure. (Though you’ll be happy to know that I reference having worked there in my post tomorrow.)

    @Gary – True, the issue never goes away in entirety because it’s the airline industry, but you eliminate the problem of the small group of East pilots holding the airline hostage. American pilots and flight attendants are about to get hammered in bankruptcy, so it doesn’t matter who is running the show. They’re not going to be happy. US pilots and flight attendants, however, would probably get raises. So why would labor relations be any worse with US Airways than with American’s current mgmt team?

    On route networks, I think they fit together well. It just forces them to make good decisions that they aren’t making today. I would bet that they’re not doing that well in NYC or LA, but there’s some proud reason behind being big in big cities. I remember when a lot of people freaked out when United walked away from Miami and also from most of NYC (before CO, of course). But that was the right thing to do. The US Airways management team would be able to make the right decisions.

    Also, US Airways won’t be growing much on its own. The airline is doing fine, but there just isn’t a ton of opportunity. They’re also fairly leveraged. So this merger would bring in a lot of outside cash and help feed a much stronger combined balance sheet.

  9. OK, I wear two hats here too because I’m both a frequent flyer and an investor, sometimes in airlines. Indeed, my name, “iahphx,” is based on the home cities of the two best airline management teams a decade or so ago (Bethune in Houston, Parker in Phoenix) when I picked it.

    I am 100% convinced that Parker and Kirby are the exact right people to turn AMR around and, if given the chance, they will successfully merge US Airways into American. They are probably the best bean counters in the industry, and they have the skill set and will to cut what needs to be cut, and keep what makes sense to keep. What they have achieved at AWA and US despite always having the “worst hand” in the industry is nothing short of extraordinary. Do you remember how many people mocked their chances when they acquired US (I think it was referred to as the “dumbbell” strategy)? Look who’s still standing now, and look who’s in bankruptcy, even though AA had every advantage (and AAdvantage, bada bing).

    Labor, to me, is a red herring. The East pilot group is not the problem “the herd” thinks it is. In a merger, they will be subsumed into a much larger group, and they will likely be happy enough — since they will get MORE out of this. Parker readily admits that he pays his pilots less because US’s route network produces less revenue. He will pay these US pilots more when they work within AA’s higher revenue-producing network. US pilots are smart enough to understand this, and you won’t hear too many complaints from them about any AMR deal (you will hear griping from AA pilots, who now face a new reality, whoever manages them).

    A combined AA-US route network won’t be as good as UAL’s, but won’t be materially weaker than DL’s. Sure, it will start off as weaker in Asia, but it will lead in Latin America and be extremely competitive in Europe. More importantly, it will have managers who know how to profitably run an airline.

    Where Parker and Kirby are a bit untested is in the stuff that matters to a lot of Gary’s readers: premium travel. We frankly don’t know how they’ll perform, because fancy industry-leading int’l service wasn’t a plausible business strategy for either AWA or US. My guess is they’ll manage this end of the business just fine, but this is perhaps the only experience weakness they bring to AMR. That said, I think they fully understand the importance and value of high paying business travellers, and do what it takes to successfully attract them.

    I’ll await Cranky’s column tomorrow, but in the meantime, you can get some color as to what this merger would be about from this wire service story tonight:

    http://finance.yahoo.com/news/American-bulk-US-Airways-apf-3248294088.html?x=0

    By the way, the article quotes Bethune (who has something of a rivalry with Parker over the years) saying Parker will be going after AMR. Indeed he will be.

  10. I am elite on both American and US Airways, so I am familiar with their route maps, programs etc. This merger makes no sense and I will tell you why.
    If US bought American it would effectively be American outsourcing(abdicating) their management responsibility. Lots of talk about that in the above comments.
    I used to do M&A integration. After a company was purchased it was my role to put them together and make them work. In general, all this does is potentially delay progress that each company could have individually made as the focus now becomes months/years worth of integration efforts. These same efforts could be placed into system enhancements etc. An integration effort typically delays progress by years. Now if a company isn’t making progress, its a different story. But people do not understand the amount of effort it takes in the background to integrate two companies. Many times the wrong decision is made around systems in the interest of expediency. American has an opportunity to improve their competitive position in Chapter 11. Many other companies have come out better for it. Mergers have a broad strategic appeal, but the results are not always what was envisioned going in. Just because everyone else is doing it, is no reason to be a follower. This particular merger appears to have less strategic benefit than most, especially around routes/hubs due to the extensive overlap. Hopefully runaway egos won’t get the better of this situation and cooler heads will prevail.

  11. @jimL “If US bought American it would effectively be American outsourcing(abdicating) their management responsibility” And THAT is the only real arguing for doing it, actually! It gets the folks who put AA in this mess out of the drivers seat and lets US management have a hand at it. Folks who think US maangement will do a better job of US/AA combined think it’s a good idea. Which isn’t necessarily good for US shareholders (as it doesn’t answer the question about the best way to improve US share price, it more answers the question of whether US folks can do better with AA than AA management can), and what’s best for US shareholders is *supposed* to drive this discussion rather than egos… 😛

  12. AWA shareholders benefited signficantly from the buyout of US Airways, and I would be shocked if buying AMR didn’t result in similar benefits. I don’t think you’ll find too many US Airways shareholders who don’t want to see the airline buy AMR. Everyone who owns LCC stock knows it’s basically an investment outfit looking to raise funds to buy airline assets and put them under Parker’s able management. The bankruptcy of AMR moved the timetable along considerably. That’s why Wall St. is suddenly “excited” about LCC stock again, now that merger stuff is eclipsing the dreary news about high priced financialized oil.

  13. Of the major airlines, US ranks worst in passenger complaints and satisfaction. They can transfer that mindset to AA.

  14. Everyone is an expert.
    Everyone is an idiot.
    The experts post what they THINK they know.
    The idiot reads it and believes it’s true.

    Oh Jerry Mandel: You feel really good when you complain.
    I can tell.

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