Hot Flash - Monday, November 26, 2007
Sometimes, things get repeated so many times that their credibility becomes based on the simple fact that "everybody says so." That's the case with airline consolidation.
Today, hedge funds, investment houses, speculators, and a host of other financial entities are doing more drooling than a convention of English bulldogs over the prospects of airline industry consolidation. Some of them understand the airline business, but a lot of others don't know enough about the industry to fill a Post-It note. All they've heard is that it's one of those things that's just gonna happen. And if they hear any information to the contrary, it's hang up the phone time, because they conclude that anybody who disagrees with "everybody" must be nuts.
It's another reason that a Sealy Posturpedic might be a safer place to put your money than with some of these clowns. Some (but by no means all) operate on short-term emotion and the need to do a fast deal, caboosing on to somebody else's train, not really doing much research on where it's going.
Rule #1: Question What You Read. As one example of the intellectual level to which this consolidation issue has sunk (which is basically to the shallow end of the brain pool) there was an article in one on-line financial journal last week reporting that, shock!, Business Week had reported that United Airlines might be interested in a merger.
First, with all the noise United's made on the subject over the past two years, that's like revealing that the Denver Broncos are interested in the Super Bowl. But more importantly, note the source: another article, not hard research or reporting. Again, it's part of the "everybody knows" school of journalism. It goes round and round, in a hermetically-sealed information loop, feeding itself.
With all this frenzy, it might be a good idea to try to bring some calm review to the subject of airline consolidation.
Follow The Money. Because The Airline Industry Does. For guidance, we can refer to Hyman Roth, a sagely character in Godfather II. Referencing the fact that his best mob friend had gotten inexplicably whacked, he noted that "it had nothing to do with business" so, therefore, there was no value in getting mad or getting even. It was part of the nature of mob life. He counseled Michael Corleone that, "this is the business we've chosen" - and it had certain hard realities.
The airline business also has hard business realities, some of which are unpleasant. One is that an airline's future is predicated on share value, not necessarily just on traffic, airplanes, passengers, employees, or long-term strategies. Or even good business sense, maybe. It is the business we've chosen, as Mr. Roth pointed out.
That's not meant to be pejorative, per se, about hedge funds or stockholders looking to do airline merger deals. They are in fact pursuing an honorable goal - to make money. It's the nature of the beast.
That means the fallout and results of an airline merger deal are none of their concern. These have nothing to do with business. It means that there may be no primary focus on having the result be beneficial to consumers or employees - despite how it may be packaged to the public.
After the deal is signed, the financial types that put it together might not be past L.I. Expressway exit 35 on the way to celebrate in the Hamptons, before the merger layoffs begin and the service cutbacks start. But that is not their moral responsibility. It revolves around share value, even if it's short-term, and if air service levels, competition, and employees get whacked in the process, that's the nature of the business we've chosen, apparently.
Creating "Benefits" That Are Illusory. Nevertheless, a lot of the grand benefits and reasons for mergers being tossed around in the media are like klutzy cheerleader routines at a high school football game - they're mostly hyperbole and hype. Remember, the carrot on the merger stick is that a lot of people will make a lot of money. Therefore there's the dual propensity to create an image of "benefits" on one hand, and on the other try to ignore or smokescreen any factors that may represent downsides to those not in line for the deal dough. Like, for passengers and employees.
* Claim: Consolidation Will Cut Capacity. We'll start with this: look up the meaning of "consolidation". It means taking things, putting them together, and the result being less than the sum of the original parts. Less employees, less service, less flying. So the analysis goes like this: cut capacity, limit seats, and we can charge more for the seats that are left. It's basic classroom Econ 101.
But it's totally at odds with Airline Realities 101. What some hedge fund types keep repeating, is that consolidation will bring order to the Force by cutting competition. They assume that there is a finite number of airlines and airplanes, and consolidation will enforce a reduction in capacity. Unfortunately, there's no guarantee of that - particularly in high-density markets.
Let's also cut to the chase on the oft-repeated nonsense that consolidation will remove "excess capacity" from the marketplace. At 80% to 85% load factors, with increasing pricing traction, the implication that there's lots of empty or excess seats out there is not accurate. What this really means is that if, within these rosy circumstances, consolidation can reduce capacity in the face of strong demand, then higher fares can be squeezed out of the flying public. In short, restrict production to command higher prices.
The problem in this argument is that it assumes that all airlines will cooperate and not add any capacity in major markets when/if a merged airline cuts back. It's risky to rely on any strategy that depends on the actions of competitors to achieve one's goals.
But where capacity will come out as a result of airline consolidation is in small and mid-size communities. Bank on that one. Consolidation means fewer connecting hub operations, and that means less access for such airports. (Watch for the jive studies that some proponents may scrape up from under intellectual rocks to prove the opposite. Plan on the press releases: "New Study Shows Less Competition Will Bring Better Service To Rural America", issued by the usual suspects who either are paid to do them, or from dysfunctional college professors.)
Regardless of protestations to the contrary, in those small and mid-size communities - too small for LCC entry, and often too thin to be accessed by distant alternative hubsites, there'll be some increase in pricing power due to less current and potential competition. But in any big, high-density markets, think again.
* Claim: Consolidation Will Alleviate The Effects of High Fuel Prices. This, like the example above of a media article-repeating-another-article, is one of those non-factoids that is accepted and repeated simply because, well, it's being repeated a lot.
First, consolidation won't do anything to cut jet fuel prices. The Saudi Oil Minister, or that ding-dong running Venezuela are not going cut prices simply because they read that United is merging with East Cupcake Air.
Sure, if consolidation will result in restricted competition and capacity, and then if they can hike fares significantly based on offering less product, and if the competition agrees to go along, and if demand stays strong, the argument might hold that fares could go up faster than the price of jet-A.
But that's a lot of iffy planets that have to align. There's no guarantee that's in the cards. Bluntly, it's not. As a matter of fact, it's real unlikely that these financial institutions that are so rah-rah about consolidation would lay their own money long term on such a bet. But in an airline merger, you can bet that these folks will have ironclad codicils built in to assure they don't have that risk.
* Claim: Airlines Will Have To Merge When A Downturn Comes. The foundation of this argument is that airlines will need to reduce capacity when demand drops, and there's only one way to do that: consolidation. It's yet another bit of either wishful thinking from those in line to get a merger windfall, or from some of those hedgies who have no earthly idea of the structure of airline fleets, and just repeat what they've heard.
It would be remiss to believe that there won't be an economic downturn in the future. And it's a near-certainty that airlines will need to cut capacity in such an event. What this gotta-consolidate argument misses is the current fleet structure at US airline systems. United, American, Northwest, for starters, have significant parts of their fleets that have low or no ownership costs which they can park quickly and cheaply. They don't need to merge to valve-off excess capacity.
And consolidation would be a very time-consuming and expensive way to achieve capacity pull-downs. Remember, merging schedules, labor seniority, ops specs, and other processes take a lot of time. Parking DC-9s, MD-80s, and 737s can be done relatively quickly and without the brain damage of a merger.
* Claim: One Merger Will Necessitate Others. More from the "everybody knows" but nobody questions category. First, mergers are messy, time consuming and expensive. Second, the market synergies that the hedgies believe are there, aren't - at least for several years. Third, consolidation is about less, not more. A Delta-United marriage would result in one less competitor for American Airlines, not to mention (supposedly) less market capacity. That doesn't weaken or threaten AA. Quite the contrary.
Then there's the argument that the combined market synergies of one merger will force other mergers. What market synergies, especially when it will take years to get fleets, unions, IT systems, and ops specs under one roof? It assumes that other carriers would immediately find a perfect partner that would result in magic and immediate synergies to counter another combination of carriers. Not in the cards. But it's an almost unquestioned tenet repeated by the analysts in line to make the financial score and parrot-reporters who don't bother to do hard research before putting pen to newsprint.
But Deals Can Be Done. All that notwithstanding, airline boards of directors don't have a lot of leeway. If a deal is offered that lets the shareholders walk away with a pot load of money, they have no choice but to consider it. The shareholder mindset is not to preserve the carrier, but to preserve and increase the value of the paper they hold. That, too is part of the business we've chosen, and it certainly is not dishonorable in itself, issues of social outcomes notwithstanding.
Add to this that today United Airlines is "in play." Every CEO needs to be doing a lot of strategic research on what that could mean to his airline. That doesn't mean that consolidation is necessary nor inevitable. But it does mean that the nation's #2 airline is on the block, and it raises a lot of competitive options that need to be considered - including perhaps tacitly suckering a competitor to buy United and get mired in merger mud for a couple of years.
Bottom line: the supposed need for "airline consolidation" is based on the assumption that it will reduce competition, allow carriers to charge more for their product, and bring home more black ink to the P&L.
It's a dicey assumption based on intellectual quicksand. But with the millions that can be made, it makes no difference to the deal makers - they'll walk away with some serious gelt.
Unfortunately, employees, small communities and other "stakeholders" won't be as fortunate.
But this is the business we've chosen.
© 2007 The Boyd Group, Inc. All Rights Reserved
Sometimes, things get repeated so many times that their credibility becomes based on the simple fact that "everybody says so." That's the case with airline consolidation.
Today, hedge funds, investment houses, speculators, and a host of other financial entities are doing more drooling than a convention of English bulldogs over the prospects of airline industry consolidation. Some of them understand the airline business, but a lot of others don't know enough about the industry to fill a Post-It note. All they've heard is that it's one of those things that's just gonna happen. And if they hear any information to the contrary, it's hang up the phone time, because they conclude that anybody who disagrees with "everybody" must be nuts.
It's another reason that a Sealy Posturpedic might be a safer place to put your money than with some of these clowns. Some (but by no means all) operate on short-term emotion and the need to do a fast deal, caboosing on to somebody else's train, not really doing much research on where it's going.
Rule #1: Question What You Read. As one example of the intellectual level to which this consolidation issue has sunk (which is basically to the shallow end of the brain pool) there was an article in one on-line financial journal last week reporting that, shock!, Business Week had reported that United Airlines might be interested in a merger.
First, with all the noise United's made on the subject over the past two years, that's like revealing that the Denver Broncos are interested in the Super Bowl. But more importantly, note the source: another article, not hard research or reporting. Again, it's part of the "everybody knows" school of journalism. It goes round and round, in a hermetically-sealed information loop, feeding itself.
With all this frenzy, it might be a good idea to try to bring some calm review to the subject of airline consolidation.
Follow The Money. Because The Airline Industry Does. For guidance, we can refer to Hyman Roth, a sagely character in Godfather II. Referencing the fact that his best mob friend had gotten inexplicably whacked, he noted that "it had nothing to do with business" so, therefore, there was no value in getting mad or getting even. It was part of the nature of mob life. He counseled Michael Corleone that, "this is the business we've chosen" - and it had certain hard realities.
The airline business also has hard business realities, some of which are unpleasant. One is that an airline's future is predicated on share value, not necessarily just on traffic, airplanes, passengers, employees, or long-term strategies. Or even good business sense, maybe. It is the business we've chosen, as Mr. Roth pointed out.
That's not meant to be pejorative, per se, about hedge funds or stockholders looking to do airline merger deals. They are in fact pursuing an honorable goal - to make money. It's the nature of the beast.
That means the fallout and results of an airline merger deal are none of their concern. These have nothing to do with business. It means that there may be no primary focus on having the result be beneficial to consumers or employees - despite how it may be packaged to the public.
After the deal is signed, the financial types that put it together might not be past L.I. Expressway exit 35 on the way to celebrate in the Hamptons, before the merger layoffs begin and the service cutbacks start. But that is not their moral responsibility. It revolves around share value, even if it's short-term, and if air service levels, competition, and employees get whacked in the process, that's the nature of the business we've chosen, apparently.
Creating "Benefits" That Are Illusory. Nevertheless, a lot of the grand benefits and reasons for mergers being tossed around in the media are like klutzy cheerleader routines at a high school football game - they're mostly hyperbole and hype. Remember, the carrot on the merger stick is that a lot of people will make a lot of money. Therefore there's the dual propensity to create an image of "benefits" on one hand, and on the other try to ignore or smokescreen any factors that may represent downsides to those not in line for the deal dough. Like, for passengers and employees.
* Claim: Consolidation Will Cut Capacity. We'll start with this: look up the meaning of "consolidation". It means taking things, putting them together, and the result being less than the sum of the original parts. Less employees, less service, less flying. So the analysis goes like this: cut capacity, limit seats, and we can charge more for the seats that are left. It's basic classroom Econ 101.
But it's totally at odds with Airline Realities 101. What some hedge fund types keep repeating, is that consolidation will bring order to the Force by cutting competition. They assume that there is a finite number of airlines and airplanes, and consolidation will enforce a reduction in capacity. Unfortunately, there's no guarantee of that - particularly in high-density markets.
Let's also cut to the chase on the oft-repeated nonsense that consolidation will remove "excess capacity" from the marketplace. At 80% to 85% load factors, with increasing pricing traction, the implication that there's lots of empty or excess seats out there is not accurate. What this really means is that if, within these rosy circumstances, consolidation can reduce capacity in the face of strong demand, then higher fares can be squeezed out of the flying public. In short, restrict production to command higher prices.
The problem in this argument is that it assumes that all airlines will cooperate and not add any capacity in major markets when/if a merged airline cuts back. It's risky to rely on any strategy that depends on the actions of competitors to achieve one's goals.
But where capacity will come out as a result of airline consolidation is in small and mid-size communities. Bank on that one. Consolidation means fewer connecting hub operations, and that means less access for such airports. (Watch for the jive studies that some proponents may scrape up from under intellectual rocks to prove the opposite. Plan on the press releases: "New Study Shows Less Competition Will Bring Better Service To Rural America", issued by the usual suspects who either are paid to do them, or from dysfunctional college professors.)
Regardless of protestations to the contrary, in those small and mid-size communities - too small for LCC entry, and often too thin to be accessed by distant alternative hubsites, there'll be some increase in pricing power due to less current and potential competition. But in any big, high-density markets, think again.
* Claim: Consolidation Will Alleviate The Effects of High Fuel Prices. This, like the example above of a media article-repeating-another-article, is one of those non-factoids that is accepted and repeated simply because, well, it's being repeated a lot.
First, consolidation won't do anything to cut jet fuel prices. The Saudi Oil Minister, or that ding-dong running Venezuela are not going cut prices simply because they read that United is merging with East Cupcake Air.
Sure, if consolidation will result in restricted competition and capacity, and then if they can hike fares significantly based on offering less product, and if the competition agrees to go along, and if demand stays strong, the argument might hold that fares could go up faster than the price of jet-A.
But that's a lot of iffy planets that have to align. There's no guarantee that's in the cards. Bluntly, it's not. As a matter of fact, it's real unlikely that these financial institutions that are so rah-rah about consolidation would lay their own money long term on such a bet. But in an airline merger, you can bet that these folks will have ironclad codicils built in to assure they don't have that risk.
* Claim: Airlines Will Have To Merge When A Downturn Comes. The foundation of this argument is that airlines will need to reduce capacity when demand drops, and there's only one way to do that: consolidation. It's yet another bit of either wishful thinking from those in line to get a merger windfall, or from some of those hedgies who have no earthly idea of the structure of airline fleets, and just repeat what they've heard.
It would be remiss to believe that there won't be an economic downturn in the future. And it's a near-certainty that airlines will need to cut capacity in such an event. What this gotta-consolidate argument misses is the current fleet structure at US airline systems. United, American, Northwest, for starters, have significant parts of their fleets that have low or no ownership costs which they can park quickly and cheaply. They don't need to merge to valve-off excess capacity.
And consolidation would be a very time-consuming and expensive way to achieve capacity pull-downs. Remember, merging schedules, labor seniority, ops specs, and other processes take a lot of time. Parking DC-9s, MD-80s, and 737s can be done relatively quickly and without the brain damage of a merger.
* Claim: One Merger Will Necessitate Others. More from the "everybody knows" but nobody questions category. First, mergers are messy, time consuming and expensive. Second, the market synergies that the hedgies believe are there, aren't - at least for several years. Third, consolidation is about less, not more. A Delta-United marriage would result in one less competitor for American Airlines, not to mention (supposedly) less market capacity. That doesn't weaken or threaten AA. Quite the contrary.
Then there's the argument that the combined market synergies of one merger will force other mergers. What market synergies, especially when it will take years to get fleets, unions, IT systems, and ops specs under one roof? It assumes that other carriers would immediately find a perfect partner that would result in magic and immediate synergies to counter another combination of carriers. Not in the cards. But it's an almost unquestioned tenet repeated by the analysts in line to make the financial score and parrot-reporters who don't bother to do hard research before putting pen to newsprint.
But Deals Can Be Done. All that notwithstanding, airline boards of directors don't have a lot of leeway. If a deal is offered that lets the shareholders walk away with a pot load of money, they have no choice but to consider it. The shareholder mindset is not to preserve the carrier, but to preserve and increase the value of the paper they hold. That, too is part of the business we've chosen, and it certainly is not dishonorable in itself, issues of social outcomes notwithstanding.
Add to this that today United Airlines is "in play." Every CEO needs to be doing a lot of strategic research on what that could mean to his airline. That doesn't mean that consolidation is necessary nor inevitable. But it does mean that the nation's #2 airline is on the block, and it raises a lot of competitive options that need to be considered - including perhaps tacitly suckering a competitor to buy United and get mired in merger mud for a couple of years.
Bottom line: the supposed need for "airline consolidation" is based on the assumption that it will reduce competition, allow carriers to charge more for their product, and bring home more black ink to the P&L.
It's a dicey assumption based on intellectual quicksand. But with the millions that can be made, it makes no difference to the deal makers - they'll walk away with some serious gelt.
Unfortunately, employees, small communities and other "stakeholders" won't be as fortunate.
But this is the business we've chosen.
© 2007 The Boyd Group, Inc. All Rights Reserved
