This past week the US Bankruptcy judge overseeing American Airlines’ Chapter 11 process gave the green light to allow it to merge with US Airways. While the merger still requires US government approval, it is unlikely it will be blocked.
Mergers and Acquisitions in the sector are now commonplace and in the past 15 years, the industry has witnessed an important concentration in the sector. In Europe (excluding Russia and CIS), there are now three dominant airline groups: Lufthansa (LH) Group (Lufthansa Passenger Airlines, Swiss International Airlines, Austrian Airlines and Brussels Airlines); Air France-KLM and International Airlines (IAG) Group (American Airlines, British Airways and Iberia). Add EasyJet, RyanAir and Turkish Airlines and that’s about it aside from much smaller national flag carriers (e.g. Finnair, SAS, LOT Polish Airlines), some smaller LCCs and other regional airlines (e.g. Air Baltic).
In the US the case is even more stark: Delta-Northwest; United-Continental; American Airlines-US Airways; JetBlue, Southwest Airlines, Alaska Air and Hawaiian Airlines. In Africa, Asia and Latin America, the situation is still more regulated at the national level allowing for the survival of national carriers but in Asia for example, Air Asia’s emergence as the biggest LCC in Asia also demonstrates a slow shift towards greater concentration.
The obvious question is therefore – does a merger or acquisition improve the airline? By improvement, it is hard to argue that financial improvement is observable – in Europe and the US, only the LCCs are able to consistently generate profits so we need to go looking for improvement in two ways. First, does M&A activity reduce losses and second, does M&A activity enhance the customer experience? There could be a third criteria – does it improve the interests of employees in the sector but that is purely rhetorical – without exception, employees get laid off and those that survive the restructuring have lower salaries and benefits.
Before I move on, I want to emphasise that there are also exogenous factors that lead to changes in performance that are not directly related to M&A activity – ticket prices may rise for reasons other than increases in industry concentration for example. Nevertheless, if we can borrow that awful phrase from economics, ceteris paribus, we can try and isolate the M&A effect on performance.
Let’s consider the first part of the question. If we are looking to reduce losses, there are three obvious strategic ways to do so: synergy, cost-cutting and reducing competition. It’s obvious that when airlines merge or get acquired, the number of flights available to the travelling public are almost certainly going to be cut leading to less competition on routes and greater ability of airlines to tacitly or explicitly fix prices (fewer competitors make that easier to organise). We should therefore expect prices to rise after a merger. If the bigger airline can capture the higher revenues, that should stop (or at least slow down the bleeding).
Cost-cutting: after price rises, M&A should allow for the new entity to significantly eliminate overlapping costs and redundancies: for example – shared ground facilities; lower cost of capital to finance new aircraft; fewer employees due to lower number of flights and more efficient use of ground staff at the ramp and at check-in. The airline may be able to de-commission aircraft and simplify the fleet to reduce avionics costs. Last but not least the administrative arm of the new entity and other support services (procurement, catering, call centres) could also be streamlined.
If you combine higher prices and lower costs, we should expect smaller losses. Good news it would seem.
Third are the slippery and elusive synergistic benefits. Airline executives will often trumpet “synergies” when they are trying to sell the M&A to shareholders, regulators and other stakeholders. But it’s not clear what these synergies could be. My view of synergy has always been to focus on additional value creation that comes from shared experiences; knowledge; resources and market share. So if we are to consider the value of synergy we’d have to take a long and hard look at where two or more airlines coming together could produce such “added value”.
A potential source of synergy could be the development of new routes through enhanced (internal) code sharing. For example new intercontinental services from “hub” airports of the new airline. Another source could be related new products that enhance the customer experience – better online services or new ways of delivering premium customer value through enhanced ground services (better lounges, check-in facilities, better frequent flyer programs (FFPs)).
The synergy benefits are in my view over played and under delivered simply because of the difficulties of realising them.
This brings me to other major threat to enhanced performance – the time and effort it takes to integrate the airlines. Aside from the messy business of negotiating with employee representatives; airports and regulators on the integration of the two airlines there are two signfiicant additional costs that the airline needs to face. First, repainting aircraft and rebranding all visible, customer facing elements of operations if the M&A leads to a single brand. Few M&As in the industry lead to the maintenance of entirely separate brands – the IAG merger and LH Group perhaps being exceptions – so this is a substantial cost. Second building consensus on management processes and organisational culture – the most intangible cost and effort by far. Over years like any organisation, airlines develop specific cultures and norms that will be shaken up by M&A and unless the new organisation pays attention to this, it can lead to extended periods of integration difficulties.
Now, we have been putting the cart before the horse here somewhat because in principle, an M&A’s principle goal should be to enhance the customer experience since doing so should leads to improved performance (more customers, greater loyalty and so on).
First, merging FFPs at first can be ugly for some customers – they lose status or validity of mileage or find that the new program is less generous than their previous one – but in principle a bigger airline should offer more opportunities to gain status and bonus mileage for customers.
Second, improved ground services, better online services and premium product on board should also make customers happier and more willing to come back to the airline too.
Third, the new airline being able to finance new planes at lower cost may also lead to flying on newer, more comfortable aircraft too.
Dr. Brent Bowen of Purdue University and Dr. Dean Headley of Wichita State University – industry observers and researchers – have found that every M&A in the past two decades has resulted in lower performance as measured by key performance indicators such as flight punctuality, lost luggage, and overall customer satisfaction. Dr. Thomas Lawton of the Open University Business School in the UK has also expressed considerable skepticism of the current AA-USAir merger: “Despite the rhetoric, it is difficult to see how this agreement will benefit the average consumer […] Large-scale airline mergers both domestically (United-Continental) and internationally (British Airways-Iberia) have been fraught with operational and cultural integration challenges and there is scant evidence to suggest an enhanced customer experience on price, choice, or service.”