ANALYSIS: With US Airways-American Merger, Airline Landscape Reshaped

(Chicago Tribune/MCT) -

When it comes to titles, Nov. 12 was a rough day for Chicago’s 233 S. Wacker Drive.

That’s the day the building, better known as Willis Tower and the former Sears Tower, officially lost its title as America’s tallest building – to be surpassed by 1 World Trade Center when it opens next year in New York.

On the same day, United Airlines, which makes its headquarters in Willis Tower and is the building’s largest tenant, learned it will lose its claim as the world’s biggest airline. That came when antitrust regulators dropped a lawsuit objecting to the merger of US Airways with American Airlines, which will end up bigger than United.

Indeed, even on its home turf of O’Hare International Airport, the new American could challenge to be a larger airline than United for domestic flights – and by some measures, it already is.

The effect on United in Chicago is just an example of the fallout from a dramatic reshaping of the airline landscape in recent years – in America and around the world. In the U.S., the metamorphosis has left just three major airlines – American, United and Delta Air Lines – along with one formidable low-cost carrier, Southwest Airlines.

It’s the fulfillment of a decades-old prophecy that the U.S. airline business could support only three major airlines. And it likely marks the end to a wave of major-carrier consolidation that has helped put U.S. airlines on more sound financial footing.

Could the U.S. airline industry finally have reached a healthy equilibrium that is better for the airlines and for its customers?

Some airline experts think so.

“If we can get to an industry that is financially stable, that is operating more of its flights on time, that treats its people better through greater job security, then ultimately, the passenger benefits,” said Henry Harteveldt, a travel-industry analyst at Hudson Crossing.

Now that the Department of Justice has exacted some concessions from the airlines and dropped its antitrust lawsuit, the $17 billion merger between AMR Corp., parent of American Airlines, and US Airways Group can go through, and it is expected to close Monday. American, which has been in bankruptcy for two years, cleared the final hurdle Nov. 27 by receiving the okay in bankruptcy court.

Passengers will begin to notice the merging of the carriers Jan. 7, when the airlines plan to begin acting like a single airline, offering reciprocal frequent-flier benefits, for example, executives have said.

The combination ends a spate of recent airline consolidation, spurred by a weak economy and billions in industry losses, starting with Delta and Northwest agreeing to combine in 2008. That was followed by United/Continental and Southwest/AirTran.

Now, the three majors and Southwest will control about 85 percent of the U.S. market.

It’s a result that was totally expected.

The “Rule of Three” management concept posits that three is the magic number for competitors in a mature market, according to a recent report, “Aviation Outlook,” by management consultant ICF International of Fairfax, Va.

” ‘Room for three only’ has been the universal prediction since the 1980s as flying became affordable and airplanes could take you nonstop almost anywhere. By 2014, in the United States at least, it will finally happen,” the report says.

The idea is that three is not too many competitors to perpetually fight and not too few to get greedy.

Europe also has three majors – Air France-KLM, British Airways and Lufthansa – as do Latin America, China and the South Pacific. There are three worldwide airline alliances, the report notes.

But the Rule of Three concept isn’t clean when applied to the U.S. airline market. That’s because of Southwest, which is the largest domestic airline in the U.S., as measured by number of passengers carried.

But Southwest is considered a low-cost carrier, not a direct apples-to-apples competitor with the three majors in terms of having an extensive route network, especially to international destinations. It doesn’t offer luxurious first-class amenities, and it doesn’t fly to quite as many smaller destinations as major network carriers do via their regional carrier partners.

“Three – or call it four – giant airlines are completely supportable and don’t sit on top of each other for every nonstop,” said Subodh Karnik, a vice president at ICF and former CEO of the now-defunct ATA Airlines, which once had a dominant base at Chicago’s Midway Airport.

The American-US Airways deal probably concludes the recent merger mania, he said.

“It would be hard to believe that further consolidation would be palatable to the government and to the traveling public,” Karnik said. “As time goes by and these major U.S. airlines perform well and become normal corporate citizens versus always being in bankruptcy, the idea of ‘let’s cut them some slack’ is also going to disappear.”

So fliers are likely to see the big three – or four – for some time to come. But that doesn’t mean competition is hurt and airfares will rise.

The soon-to-be-combined airline made a deal with the Justice Department and several state attorneys general to sell off some airport gates and landing slots, presumably allowing low-cost airlines to gain footholds or increase their presence in U.S. airports.

That’s likely to drive down airfares in some markets.

“It will disrupt today’s cozy relationships among the incumbent legacy carriers, and provide consumers with more choices and more competitive airfares,” Bill Baer, U.S. assistant attorney general, said in announcing the Justice Department settlement.

So far, the effect of five years of airline consolidation on airfares is difficult to discern amid a slow economic recovery from the recession.

In the second quarter this year, the most recent federal data available, average fares were lower than they were in the same quarters of 2012 and 2011, according to inflation-adjusted numbers from the Department of Transportation. For example, this year’s average fare at Chicago’s O’Hare in the second quarter was $389, compared with $399 last year and $395 in 2011.

And it has been argued that the most recent merger creates more competition by assembling another megacarrier with international capabilities to take on United and Delta. And many smaller airlines challenge network carriers on some routes.

“There’s still a lot of competition,” Harteveldt said. “Let’s not forget that airlines like Virgin America and Spirit continue to provide healthy price competition.”

The key to maintaining that competition is ensuring that smaller airlines have access to airports they want to operate in “without having to shell out a king’s ransom for gates or slots,” he said.

Even the Consumer Travel Alliance, which opposed the American Airlines merger, said the merger, modified by the settlement with the Justice Department, “may turn out to be a blessing for airline consumers and provide legacy carriers more competition than they bargained for.”

Just as important as competition and fares, major U.S. airlines, all of which have been in and out of bankruptcy in recent years, may finally be financially stable. That’s a good thing, allowing carriers to invest in the products and services travelers care about, Harteveldt said.

In Chicago, three of the big four airlines have significant presence, with Delta the only one with minimal market share.

As a combined entity, American and US Airways already fly more passengers on domestic routes out of O’Hare than United does, according to government figures.

Meanwhile, Southwest is larger than both on domestic routes out of Midway, in terms of passengers flown.

But accounting for flight distances and international flights – it is more the industry standard measurement, called available seat miles – United remains top dog in Chicago.

Whether that will continue is uncertain.

Harteveldt, for example, thinks United is vulnerable.

“American is in position to give United a whupping in Chicago,” he said.

Indeed, United has struggled with its 2010 integration of Continental Airlines, especially last year, when merged reservation systems led to widespread operational problems, such as flight cancellations and delays. Executives conceded that the airline lost customers as a result. United ranked last on several prominent consumer-satisfaction surveys, although its performance has improved markedly this year.

More recently, United missed third-quarter profit expectations. In response, it announced $2 billion worth of cost-saving initiatives.

The financial community took the cost-cutting as good news. Industry analyst Hunter Keay said in a note to clients that the announcement “contained encouraging signals about a clear turnaround that’s occurring here.”

Karnik agrees, saying United has moved past its darkest days.

“It’s kind of messy,” he said of mergers.

“It takes two or three years to sort that mess out and line up your ducks in a row. I think they finally reached the point where they have done that, and now it’s a matter of cranking it up,” he said.

As for United in Chicago? Karnik said the competitive dynamic between United and American ultimately might not change much after the merger. But for now, it’s an open question.

“We’ll have to see whether (United) will be able to defend their turf, or will customers shift?” he said.

The answer will not hinge on United losing its crown as world’s largest airline.

United CEO Jeff Smisek has said repeatedly he supported the merger of American and US Airways, even if it relegated United to No. 2, or perhaps No. 3 behind Delta. He has often said he has no particular interest in being the world’s largest airline, just being the world’s best.

Indeed, the importance of being the largest carrier is overblown and can amount to “silly bragging rights,” Karnik said.

It recalls the “mine is bigger than yours” mentality of former airline executives that were more concerned with market share than making money. “Today, the focus is on profits, not prestige,” Harteveldt said.

And global size matters less nowadays, because of airline alliances and growth of international airline partners that can take Americans to every corner of the world.

“The value of being the world’s largest airline is not what it once was,” Harteveldt said. “It doesn’t hurt, but it’s not a guarantee of success.”

And “world’s largest” is a title that doesn’t necessarily resonate with airline customers, Karnik said.

“To the customer, the metric always is, ‘Does this airline fly to every place I would conceivably want to fly?’ … From that perspective, United and American are basically comparable.

“Will United regain No. 1? Who knows?” Karnik said. “And in some sense, who cares?”

Perhaps an appropriate perspective for the height of 233 S. Wacker Drive, as well.