Street Journal. July 3, 2001. More Airlines Will Crash If Mergers Are
Jagdish N. Sheth and Rajendra S. Sisodia. (Dr. Sheth and Dr. Sisodia
are professional associates of Marconi Pacific)
The plan by
United Airlines to acquire US Airways is dead. American consumers are
left to contend with another weak and wounded carrier attempting to
stay airborne -- for how long, no one knows.
died because the Justice Department managed to stonewall it for 14
months, despite the blessing of the nation's largest airline passenger
consumer group. Members of Congress, moreover, become personally irate
when it comes to the airline industry; they depend on it so heavily to
manage their hectic schedules. Like all frequent travelers, they can
cite examples where they have felt personally let down, even betrayed,
by an airline. Many suggested that allowing these two airlines to merge
would have created unhealthy levels of concentration and further
exacerbated service problems.
But this is
a double standard. Most major industries have a far greater degree of
concentration than the airline industry. Worse, it's bad economics. If
Congress and the Justice Department are interested in promoting a
healthy and efficient airline industry that can satisfy customers,
shareholders and employees, they should approve this merger, and a few
more like it.
airline industry is divided into three groups of carriers:
big three. American, United and Delta own about 54% of the
market, each with approximately 18%. These carriers serve multiple
markets (though none can be said to be truly national in scope) with a
full range of services, including feeder, short-haul, long-haul,
international and freight.
specialists. Profitable niche players such as Southwest (a
"product specialist" focusing on short-haul flights), Jet Blue and
Midwest Express (both "market specialists" focusing on the New York
City and Milwaukee markets, respectively), and others.
- The ditch dwellers. These
are airlines that are stuck in a no-man's land between the big
generalists and the focused specialists. They are too large and
diversified in terms of markets and services to be viable as focused
specialists, but too small to compete across the board with the big
three. Those in the ditch (typically, companies with between 5% and 10%
market share) include US Airways, Northwest, Continental and, until its
recent purchase by American (justified, ironically, by United's
announced plans to acquire US Airways), TWA.
exhibiting this big-three structure, the airline industry represents
the rule rather than the exception, but with two critical differences:
The big three in the airline industry are not nearly as dominant as
they are in a typical industry, and the number of companies in the
ditch is far greater.
is that the ditch companies have no long-term future, and serve only to
drag down the industry's financial performance as well as its ability
to serve customers efficiently and with reasonable service standards.
Ditch companies incur costs that are comparable to those incurred by
the big three. In the airline industry, these costs include operating
multiple hubs with numerous gates, maintaining a fleet that includes
several different types of aircraft, offering three classes of service,
establishing expensive clubs at major airports, running national
marketing campaigns, and sustaining hybrid distribution systems that
include travel agents, corporate sales, Internet sales, and
consolidators. But ditch companies lack the market share over which to
spread those costs; US Airways's cost per passenger mile is 40% higher
than that of the big three.
companies thus operate with very low or negative margins. The first
strategy of desperate CEOs in these circumstances is to cut costs. The
brunt of this cost-cutting is felt by consumers, who soon respond by
deserting the airline, leading to further deterioration in financial
performance. This downward spiral leads inevitably to one destination
-- Chapter 11. Indeed, ditch companies in the airline industry have
sought bankruptcy protection numerous times over the past two decades.
industry needs to evolve from one that includes a number of
sub-monopolies -- markets (such as Denver) in which a single airline
(in Denver's case, United) controls the lion's share of traffic -- to
one that features true head-to-head competition between major carriers
in all major markets. In other words, the thrust of regulatory efforts
should be to promote vigorous market-by-market competition, rather than
set arbitrary limits on overall industry concentration. The best way to
accomplish this is to enable the emergence of three truly national
players, and ensure that they compete directly as often as possible.
studied hundreds of industries as part of the research for our
forthcoming book, "The Rule of Three." We found that in industries
allowed to evolve through competitive market forces, the three biggest
companies collectively control 70%-90% of the market, with the balance
comprised of product or market specialists. We further found that this
structure provides the highest level of operating efficiency along with
a reasonable amount of choice for customers.
industry needs to move as rapidly as possible toward this structure by
allowing the big three to merge with ditch players, as American has
done with TWA. This becomes especially imperative as the airline
industry globalizes over the next several years; carriers that have
consolidated their position in their domestic markets will be far
better positioned to emerge as leaders.
industries, ditch companies soon exit that uncomfortable domain,
usually by merging with one of the larger companies. In the airline
industry, unfortunately, this exit route has been effectively sealed
off. The only alternative for ditch airlines will be to shrink into
specialty markets. US Airways will likely be forced to retreat to its
roots as an "Eastern seaboard" specialist. This will keep the airline
industry in its present unsatisfactory state -- too many
sub-monopolies, not enough head-to-head competition.