Introduction
Airlines have increasingly been consolidating in recent times, resulting in the mega airlines we see today and an oligopoly where the top 4 airlines in the United States have over 80% of the passenger market share in the country. Airline consolidation is driven by factors ranging from fuel costs to world events to regulations, and these mergers and acquisitions largely fall into specific periods of aviation history, which will be outlined in this article.
The Challenging Business of Running an Airline
Airlines, by nature, are an extremely challenging business. According to New York University’s Stern School of Business, the air transport industry operates at a 2.21% net profit margin, which marks it as one of the lowest profit margin industries in the world.
The core business of any passenger airline is to carry passengers, and the demand that those passengers produce is one of the most elastic of any industry. Travelers are incredibly price-sensitive and are always looking for the lowest airfare possible. This results in a constant race to the bottom when it comes to pricing flights.
Demand is also not just heavily based on price, but it is also highly unstable and seasonal. Summer is the peak season for airline demand, and most airlines produce a large portion of their profits during that time. However, the Fall and Winter seasons see significantly lower ticket sales for most airlines. This is a problem for airlines, which have to own and maintain aircraft, crew, support staff, and other elements of their business at a level that can handle the summer demand. They fail to see the same utilization during the lower demand seasons, which results in higher operating costs per passenger when demand is low. U.S. Airline profitability is also highly correlated with the U.S. Economy. The bulk of travelers for most airlines are leisure travelers, and when money gets tight, travel is the first thing to get cut out of people’s budgets.
Airlines also have incredibly high costs, whether they are fixed or variable. Airlines need aircraft, which are expensive to operate, maintain, and train crews for. Almost the entirety of the assets of an Airline’s balance sheet are made up of aircraft. Aircraft depreciate quickly and are extremely illiquid, meaning that should an airline run into financial trouble, these aircraft are a challenge to offload. Aircraft must comply with strict maintenance procedures and regulations, which means that each aircraft is losing money each minute it sits on the ground. In addition, aircraft have to be parked somewhere when they are not flying. This means paying expensive fees, especially when it comes to taking up gate space or operating out of overcrowded airports.
One of the largest expenses for an airline is labor. Airlines need pilots, flight attendants, ground operations personnel, gate staff, reservations agents, maintenance crews, aircraft fuelers, dispatch, ramp controllers, administrative staff, special service staff, management, and other roles that require an enormous number of staff. Airlines have worked to reduce this number as much as possible, as this is one of the ways that airlines can compete with each other.
The most ciritcal variable cost for an airline is fuel. Making up over 21% of operating expenses, airlines depended on cheap fuel prices to operate profitably. Even a slight increase in fuel prices can bankrupt an airline that was profitable the year before. Fuel prices are so important that airlines will choose to take on extra fuel for planes at airports where fuel is cheap and avoid fueling in airports with high costs of fuel. Airlines will also attempt to hedge fuel by negotiating with a fuel company for a contract at a fixed price for a certain period of time. This is ultimately a gamble, as if fuel prices drop, the airline no longer becomes competitive to other airlines.
First Wave of Mergers
The first big wave of airline mergers was back in the days of airmail in the 1920s and 1930s. At the time, airlines were popping up at a record pace to take on these airmail contracts. These contracts were issued by the government to develop the aviation industry and contained heavy subsidies based on the amount of mail carried. In order to be competitive and to offer routes from location to location, airlines often worked together to complete, such as American Airways, a collection of independent airlines operating under the same brand name to provide coast-to-coast mail service. As the industry continued to develop, airlines began to merge in order to pool their resources and reduce their operating costs.
However, in 1930, a new Air Mail Act was passed. The air mail system in the years prior was not very efficient, with airlines often stuffing their planes full of junk mail to ensure maximum subsidies. Airlines often ran similar routes, which reduced the value of subsidizing both operations. The goal of the new Air Mail Act was to reduce wasteful spending and increase efficiency through reassigning air mail routes to the most efficient airline. The act was also designed to replace the subsidy per pound of mail into a subsidy for the cargo capacity of each plane flying, whether the plane was full or not. Finally, the act limited the number of airlines that would be eligible for transcontinental subsidies to 3.
This instantly set off a chain of bankruptcies, acquisitions, and mergers. Larger airlines began hostile takeovers of smaller airlines, as well as being forced into mergers with other larger airlines in order to maintain their routes. The result was three major airlines: American Airlines, Trans World Airlines (TWA), and United Airlines. Airlines operating other routes also consolidated in order to be more competitive for regional bids. However, this new system came under scrutiny in what became known as the Air Mail Scandal, when it was discovered that airlines, who had submitted bids for subsidies significantly higher than other airlines, were getting routes when they shouldn’t have been.
The result was that all air mail contracts were revoked and were issued to the U.S. Army to operate instead. However, as the Army had not operated a contract in over 16 years, the end result was poor, and a new act was passed, reverting air mail contracts to private airlines with a return to competitive bidding. However, the act also came with a new set of strict requirements, including a requirement that airlines who previously held contracts could not bid for them under this new act. However, larger airlines chose to reorganize their businesses and changed their names, often switching their designator from “Airways” to “Airlines”.
This first era of mergers was critical, as it would establish a number of large airlines and would also put the industry under strict regulation. Additionally, airlines and aircraft manufacturers would be forced to separate, creating a separate airline industry.
The Era of Regulation
After the Air Mail Era, airlines came under the purview of the Civil Aeronautics Board. Designed to operate much like the government controls on railroads, the CAB controlled all aspects of the industry.
First, the CAB controlled the certification of all airlines. The CAB would have to approve a company that wanted to begin air service, with strict rules on the classification of the airline, which routes the airlines could fly, what the prices they could charge, and much of their operations. During this period, air travel was viewed as a public service and, therefore, something the government needed to guard closely, much like the railroads at the time.
The CAB would go on to strictly regulate airlines until the Airline Deregulation Act of 1978. This control extended to mergers and consolidations. In general, anyone who wanted to fly across state lines had to follow the requirements set by the CAB. This naturally resulted in strict restrictions on mergers.
During this period, few mergers occurred, with some examples including the acquisition of Capital Airlines by United Airlines, which was one of the largest mergers of the time and was approved by the CAB. However, airlines that held international routes required the route transfer approval from not just the CAB, but the approval of the president of the United States.
This period also began to see the advent of a new kind of airline, the intrastate airline. Airlines like Pacific Southwest Airlines, Southwest Airlines, and AirCal were formed to fly within the boundaries of a state, allowing them to bypass most of the rules for airlines set by the CAB. However, they were still regulated by the state, which often also had a strict set of rules. As an example, AirCal and Pacific Southwest Airlines were the main intrastate airlines of California. The state gave AirCal near exclusive use of Orange County Airport, which, despite poor management of the airline, allowed the airline to survive and compete with Pacific Southwest Airlines.
As a result of these factors, airline mergers remained scarce, as there wasn’t an incentive to merge, given that routes were assigned, airlines gained subsidies, and there was little to no competition on most routes. However, that would soon change in 1978.
The Airline Deregulation Act of 1978
In the 1970s, pressure was growing to deregulate the airlines. Regulation has proved to drive fares up, and economists had begun to pressure the government to deregulate the industry, allowing for competition in the market. In 1978, President Jimmy Carter signed the Airline Deregulation Act, which began letting airlines set their own prices, choose their own routes, and begin to shift their strategies. However, the CAB still had some power and was able to block a few mergers before it was dissolved in 1985.
With this change, the strategy of most airlines began to change. Under the grip of the CAB, routes were assigned, so most airlines operated a point-to-point network, which is where travelers fly from the origin to the destination directly. With deregulation, airlines began to route their networks through hubs, where most flights would either start or end at core airports, allowing for consolidation of the workforce, increased efficiency, and better leverage over markets.
For some airlines, though, deregulation spelled disaster. Many airlines were poorly managed, being propped up by exclusive routes that meant they didn’t have to be careful with their finances. Airlines were incentivised to compete on luxury and amenities, and so many airlines operated aircraft that were extremely fuel inefficient, ran with load factors of less than 40%, and were extremely space inefficient.
Weaknesses in the airlines of the past gave rise to new airlines that would be more streamlined and efficient in their operations. Airlines like Midway Airlines, America West Airlines, PeoplExpress, and Frontier Airlines were formed as a result of deregulation and began competing with the regulation-era giants of the time. Airlines like Southwest Airlines began to expand the low-cost model nationwide.
Merger Mania in the 1980s
With deregulation, airlines began directly competing. Lower prices and a focus on efficiency resulted in significant losses for weaker airlines. It also did not help that the oil crisis had just occurred, resulting in huge pressure on airlines. To consolidate market share and gain economies of scale, airlines began merging again at a rate not seen since before airline regulation. In addition, airlines were primarily concentrated within specific regions as a result of the CAB route structure, so post deregulation, airlines were incentivised to expand their networks to cover more of the country. Airlines like Pacific Southwest Airlines, Western Air, AirCal, and many more were merged into larger airlines.
At the same time, the 1980s proved disastrous for many prestigious airlines. Pan Am, the primary international airline of the United States, began its path of decline in the 1980s. Almost exclusively international due to regulation, the airline bought National Airlines, a large domestic airline, in order to try to cling to market share. However, the airline would still struggle and began shedding routes, selling them to other airlines, and vacating slots at major airlines for other airlines to gobble up. The airline operated a fleet of large, expensive aircraft, which no longer made sense to operate in the new market climate. Eastern Airlines was another core airline that struggled through the 1980s. Facing large debt and labor disputes, the airline also began to cut routes, selling off its prized shuttle service to Donald Trump. Both airlines would collapse in 1991, with Delta buying Pan Am and Eastern being fully liquidated.
Low-cost airlines also played a significant role in the decrease in interest in many legacy airlines, as passengers looked to cheaper fares, forgoing the luxury of the traditional airlines. While initially somewhat rocky in their growth, these airlines offered fierce competition to the traditional airlines.
1990s Further Consolidation
During the 1990s, further consolidation occurred in the industry as weaker airlines continued to fall. Low-cost airlines began to see huge gains, with customers moving to these new airlines with lower prices. This led to market share loss in many airlines, which failed to adapt to the operating structures of the new era. Airlines were no longer chosen based on reputation alone, but on cost, frequency, and route networks.
The 1990s saw the continued rapid shift to the hub-and-spoke model, where flights all originate or terminate at a hub airport for an airline. This model, which was rendered impractical during regulation, allowed airlines to reduce operating costs by operating fewer direct flights, and allowing the use of larger aircraft to serve many routes, thus reducing the cost per passenger for each aircraft. As a result of this new model, airlines were further incentivised to consolidate to gain marketshare and gates at certain airports to enable higher levels of control at these hub airports.
September 11th
After the events of September 11th, the airline industry was once again set in turmoil as the demand for travel dropped. In addition, the events of 9/11 also began a sharp increase in fuel prices for airlines. This event would trigger bankruptcies for almost all of the major airlines flying in the United States. However, for airlines with streamlined operations, a lower cost model, and more fuel-efficient planes, this was a good opportunity to expand once again.
Mergers Today
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Conclusion
Airlines are an incredibly unstable industry. The extremely elastic nature of passenger demand and fare prices often results in a race to the bottom that can financially ruin airlines. Therefore, the goal has always been to utilize economies of scale to put competition out of business and to be able to stay financially solvent.
Regulation, economic turmoil, and fuel prices have been the main factors for airline mergers. Deregulation has ultimately resulted in more competition for airlines, but this has also removed the stability that airlines had depended on under the control of the CAB.
In the future, airlines will continue to aim for mergers and growth, and it will be up to regulators to determine the extent to which they will accept industry consolidation.
Recent Mergers
Recent mergers and acquisitions in the United States have almost always involved a financially struggling airline, as generally, that is the only way to justify a merger. Some of the examples of recent mergers are as follows:
America West and US Airways:
US Airways was one of the largest domestic airlines in the United States. The airline had failed to merge with United Airlines a few years prior and had greatly suffered from the events of September 11th, as the airline had one of the largest presences in Washington D.C. The airline declared Chapter 11 bankruptcy in 2002, drastically reducing its headcount and operations. The airline had to take out government-backed loans to exit bankruptcy, but the company remained crippled, and once again entered Chapter 11 bankruptcy in 2004.
America West chose to bail the company out through a merger, having been interested in merging with the company for some time. The airlines had a similar operation at the time, both focusing on expanding their Airbus fleets. America West was a large player in the American Southwest, which complemented the primarily East Coast-focused operations of US Airways.
The merger was finalized in 2005, with the combined company choosing to keep the US Airways name, which had better brand recognition. However, America West stockholders were given a larger portion of the new company, and the America West leadership, including CEO Doug Parker, and backend systems, and operating principles.
One of the most noticeable aspects of the merger was that America West was a significantly newer airline than US Airways, with there being a nearly 50-year gap between the formation of the two airlines, and that this was one of the first instances of a post-deregulation acquiring an original legacy airline.
Northwest and Delta:
In the early 2000s, both Delta Airlines and Northwest Airlines were struggling. The events of September 11th had reduced travel demand for both airlines significantly, but more importantly, the rising price of fuel was crippling the airlines. Both Northwest and Delta operated older, more fuel-efficient jets, resulting in higher costs than other airlines. Both airlines filed for bankruptcy in 2005, minutes apart from each other.
Delta cut down its operation significantly and sold off a regional subsidiary in order to stay afloat. In 2006, Delta rejected a takeover bid by US Airways, which had just merged with America West. However, in 2008, Delta would begin to negotiate with Northwest for a merger bid. Both airlines were in a similar situation at the time and aligned better in their operating principles than with US Airways.
The stronger airline within the merger was Delta, and the merger could be considered an acquisition of Northwest. However, much of the management of Northwest stayed with the airline, including Northwest CEO Richard Anderson.
United and Continental
