How Has Consolidation Helped Improve Airline Industry’s Financial Health?

6.19
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Last year, the U.S. airline industry posted its fourth consecutive profitable year. This is in sharp contrast to the decade prior to these years, when the industry was posting huge losses. Till as late as 2008, U.S. airlines were struggling to post operating profits. In 2008 alone, U.S. airlines posted operating losses of $5.6 billion. That however improved to operating profits of over $5 billion in 2012 and the profits in 2013 were even higher. [1] In 2014, airlines are on track to continue growing their profits.

This period from 2008 to 2013 also saw four major airline mergers. That of Delta-Northwest in 2008, United-Continental in 2010, Southwest-AirTran in 2011 and American-US Airways in 2013. In this article, we analyze if this consolidation helped improve the airline industry’s financial health. And if yes, then exactly how.

See our complete analysis of American, United, Delta and Southwest here

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Consolidation Made It Easier For Remaining Airlines To Exercise Capacity Discipline

In our opinion, consolidation did play a key role in helping extract the airline industry from losses. But, it is important to understand exactly how consolidation helped the industry. In our opinion, consolidation made it easier for the remaining airlines to maintain capacity discipline. This capacity discipline in turn enabled airlines to fly fuller planes as well as raise their air fares more freely. Higher occupancy levels and higher fares helped improve the airline industry’s financial health.

Prior to the financial crisis of 2008-09, airlines were freely adding capacity to their networks in an attempt to grow their market shares. As the supply of seats was exceeding the demand for flights, the airlines’ ability to charge profitable fares was being undermined. As airlines persisted with this strategy, they continued to post losses. The economic crisis forced airlines to adjust their capacities in line with demand. So, the period from early 2008 to late 2009 saw many airlines slash their flying capacities heavily. As a result, flying capacity in the overall domestic U.S. air travel market fell significantly during this period. Data from the Bureau of Transportation Statistics shows that available seat miles – a measure of flying capacity – in the domestic U.S. air travel market fell from 744 billion miles in 2007 to 667 billion miles in 2009. [2]

At the same time, burdened by excess capacity, the financial crisis hit airlines pretty hard. In the following years, many airlines including United and American filed for bankruptcy before merging with carefully selected rivals. In our opinion, this crisis taught airlines the importance of capacity discipline as many airlines were not able to fully utilize their airplanes during the crisis due to the sudden decline in demand for air travel and under utilization of airplanes impacted airlines’ bottom lines. After the crisis, as the global economy began to recover, the hard learnt lesson of capacity discipline prevented airlines from adding capacity rapidly. It is here we figure consolidation helped as consolidation made it easier for the remaining airlines to exercise restraint while adding capacity in response to recovery in the demand environment.

Consolidation Did Not Substantially Reduce The Average Number Of Airlines In Most Markets

Now, the common understanding is that due to consolidation, the average number of airlines on routes serving the majority of passengers declined substantially, leading to lower competition and therefore higher fares and profits for airlines. But, a recent report from the Government Accountability Office (GAO), Congress’s investigative arm, shows that that is not the case. The report states that on the 37 busiest U.S. routes, which are traversed by around 83 million passengers a year, the average number of airlines providing service declined marginally from 4.4 in 2007 to 4.3 in 2012. The report considered airlines with a market share of more than 5% on given routes as part of its analysis. Additionally, even on the least-traveled 9,379 U.S. routes, which were traversed by around 82 million passengers a year, the reported suggested that the average number of airlines providing service fell only marginally from 3.3 in 2007 to 3 in 2012. [1] The report goes on to say that in spite of consolidation, the average number of airlines on routes serving the majority of passengers did not decline substantially due to expansion by low-cost airlines such as Southwest (NYSE:LUV) and JetBlue (NASDAQ:JBLU). So, consolidation did not significantly reduce the average number of airlines providing service on routes that are traversed by the majority of passengers.

This conclusion is important as it explains that the airline industry will not continue to remain profitable just because there are fewer airlines serving passengers today. But, the airline industry will continue to remain profitable as long as existing airlines exercise restraint while adding capacity. And, the latter conclusion follows from the analysis of exactly how consolidation helped airlines become profitable, in the first place.

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Notes:
  1. GAO report on airline competition, June 2014, www.gao.gov [] []
  2. Available seat miles data for all airlines, June 27 2014, www.transtats.bts.gov []