Saturday, January 13, 2007

Airline Bankrupcies and Consolidation

From a June 19, 2006 Forbes article, "KLM's Van Wijk Sees Delta-Northwest Merger" comes a bit of prophetic insight. Last week The Wall Street Journal reported that Northwest and Delta might be in talks of a potential merger. If there was an industry that desperately needs consolidation, its the airline industry. Both Delta and Northwest sit in Chapter 11 reorganizations. United has recently emerged and somewhat unsteady. There are six majors in the U.S. and a host of smaller carriers. Far too many.

The problem is this. Airlines require high capital investment to buy planes, and have very high fixed costs, and difficult-to-move, fixed networks. That means the airline business is all about filling seats and making sure they stay full, no matter what. If you do that, you can make money. If you don't, you hemorrhage cash until finally you succumb to your creditors in Chapter 11. Boxed in by unions who'd rather bleed a company slowly than make concessions to stay competitive, the FAA and airport slotting systems, and anti-trust examiners checking each of their mergers and preventing extra-U.S. tie-ups, even successful airlines find it hard to parlay their gains into sustainable competitive advantage.

The reality is that those industries that are global, such as chemicals, airlines, and other heavy industry need consolidation at the global level. However, these firms can't get it because most anti-trust law is regional, meaning markets are defined regionally. Companies bump up against charges of monopoly, when in fact the market is larger than the limited scope of the law's region. A great test of this is to looks and see if the top companies are really making large margins. For airlines, no one in the industry makes adequate returns to have any sort of monopoly power. Two companies in bankrupcy such as Northwest and Delta, can hardly have gotten there by charging prices that were too high.

While companies have tried their best to get around these provisions by outsourcing to regional carriers, and making "alliance" tie-ups globally, what is needed is consolidation. Let's hope if Delta and Northwest decide to try to merge that they aren't stopped by regulators or their unions.