US Airways and American Airlines Merger Essay

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Background



In early 2013, the merger between US Airways and American Airlines became official, and by April 2015, the final regulatory hurdle – FAA approval - had been cleared (Maynard, 2013; Holmes, 2015). The merged airline had significant strategic implications, including US Airways leaving the Star Alliance (Maynard, 2013). The implementation at the time the deal was announced was expected to take between 18 and 24 months, and that time frame remains valid – FAA approval is a precursor to the final operating merger between the two airlines.

The deal was announced in early 2013 was yet another in an ongoing round of consolidations within the US airline industry. The deal was worth $11 billion, and was structure shortly after American emerged from bankruptcy proceedings (Isidore, 2013). American was losing market share prior to the deal, and US Airways was vulnerable as one of the smaller domestic carriers, so there was some strategic logic to the deal. The new airline will use the American Airlines name and will be majority owned by American's creditors (BBC, 2013).

Both companies were among the old legacy carriers in the US. American was founded in 1930 and US Airways in 1939. The merger came against the backdrop of industry consolidation that has reduced the number of competitors, and a challenging operating environment that made turning profits consistently quite difficult. The consolidations are restructuring the airline industry, which for a long time suffered from overcapacity. The restructuring has had the effect of reducing total industry capacity, which in turn is making airlines more profitable in the past few years.

The two companies are in the same business, but complementary in their scope. Airlines will typically operate routes through their own hubs, so between the two companies there are now at least half a dozen hub airports. The routes are a key distribution channel, and these are subject to negotiation with airports. Landing rights can be expensive at major airports. Air travel is a perishable good, so an unsold seat represents a cost for which revenue will never be recovered. Thus, it is important that airlines fill as many seats as possible. This is an industry metric known as load factor. Other key industry metrics are revenue per passenger miles flown, which evaluates how well the airline converts customers into actually revenue, and whether or not that revenue is sufficient to cover the high fixed costs inherent in the industry.

The point of the merger is to rationalize capacity. By doing so, the combined airline expects to have greater efficiency in its networks, resulting in higher load factors. Further, as the industry consolidates in general, much of the overcapacity that has plagued the industry will be eliminated, allowing airlines to charge higher ticket prices, which in turn will allow them to be consistently profitable. Rationalization also occurs in back office functions, such as marketing and ground operations, where the airline might be able to improve its scale. So the synergies expected from this deal lie with increasing load factors by funnelling people from, say, the US Airways route network onto American flights, and eliminating duplicate flights that the two airlines might have flown at roughly the same time. Further synergies on the operating side are also expected to arise from the deal over time, and the combined entity is expected to be more profitable than its predecessors as the result of these efficiencies

The context of the two companies is also relevant to this discussion. American Airlines was once the largest airline in the country, but its market share had been slipping consistently in recent years.

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In 1977, prior to deregulation, the industry was more heavily-fragmented and American was #2 in the market at 12.6%. By 1992, it was the market leader with 20.4%, but began a downward slide in market share since that point. By 2005 it was still #1 in the market, but with 17.5% share. Just seven years later, as it emerged from bankruptcy, it had a 12.9% share and was the #4 airline behind Delta, United and Southwest (Rodrigue, 2015). The bankruptcy was brought about largely because of adverse industry conditions, and the legacy costs associated with pension plan obligations. American was essentially uncompetitive because it had significant obligations, and was unable to meet these through operations while remaining price competitive. Other legacy carriers had already used the bankruptcy process to restructure their costs, and this had put American at competitive disadvantage, one of the reasons its market share was declining (Isidore & Ellis, 2011). The company entered into bankruptcy proceedings, but emerged a smaller competitor and had a mandate to win back its dominant market position while it still had a strong brand. The merger would allow American to regain some of the scale that it had lost since 2005.

US Airways was always one of the smaller major airlines, and its share at the time of the merger is estimated to be just over 8% by a number of vaguely reputable sources. This figure is in line with confirmed numbers from the 2014 year, US Airways had a share of 8.2%, and American 12.4%. The combined company will therefore be the largest airline in the country as the market leader, Southwest, has a 17% share (BTS.gov, 2015).US Airways was thus the #5 player in the market, with the two airlines behind it in market share (JetBlue and Alaska) gaining in market share. Thus, US Airways was vulnerable competitively, and financially. The merger was long-rumored, and apparently only held up on account of legal issues surrounding the American Airlines bankruptcy.

Industry Analysis



The modern era of US airlines began with deregulation in the late 1970s, a move that brought substantially more competition to the marketplace and dramatically increased industry capacity. The resulting environment was incredibly competitive, with at least ten major carriers. The result was predictable – overcapacity and a lack of ability for companies to turn a profit. Airlines have high fixed costs and need to fill capacity as much as possible in order to cover those fixed costs, because planes cost money whether or not they are flying any passengers. The imperative for profitability in the industry is to align supply with demand, and for decades there was too much supply. In addition, the older airlines typically had defined-benefit retirement plans that were a drag on fixed costs. Retirees were living longer, health care costs were exploding and the new competitive environment meant that airlines could not make enough money to pay these benefits. Many benefits dates to union deals from the pre-deregulation era when airlines were significantly more profitable. American reportedly shed upwards of $1billion in pension obligations with its bankruptcy (Johnson, 2011).

Thus, the industry was engaged in successive rounds of consolidation in order to reduce capacity and create larger, more efficient operations. This merger is just one of many in this consolidation process. The airline industry also saw several bankruptcies in the years leading up to American's. The 9/11 terror attacks, persistent high fuel prices, and then the Great Recession all took their toll on the profitability of airlines, with the result being that many sought the protection of bankruptcy in order to.....

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References

AMR 2010 Annual Report. In possession of the author.

AMR 2012 Annual Report. In possession of the author

BBC. (2013). American Airlines and US Airways confirm $11 bn merger. BBC News. Retrieved April 26, 2015 from http://www.bbc.com/news/business-21454925

BTS.gov (2015). Airline domestic market share. Bureau of Transportation Statistics. Retrieved April 26, 2015 from http://www.transtats.bts.gov/

Holmes, R. (2015). American Airlines – US Airways marriage gets FAA blessing. World News Group. Retrieved April 26, 2015 from http://www.worldmag.com/2015/04/american_airlines_us_air_marriage_gets_faa_blessing

Investopedia (2015). Herfindahl-Hirschman Index. Investopedia. Retrieved April 26, 2015 from http://www.investopedia.com/terms/h/hhi.asp

Isidore, C. (2013) US Airways – American Airlines to merge. CNN Money. Retrieved April 26, 2015 from http://money.cnn.com/2013/02/14/news/companies/us-airways-american-airlines-merger/

Isidore, C. & Ellis, B. (2011). American Airlines files for bankruptcy. CNN Money Retrieved April 26, 2015 from http://money.cnn.com/2011/11/29/news/companies/american_airlines_bankruptcy/

Johnson, M. (2011). What the AMR bankruptcy means to American Airlines pension plans. HG.org. Retrieved April 26, 2015 from http://www.hg.org/article.asp?id=24259

Maynard, M. (2013). What to expect from the American-US Airways merger. Forbes. Retrieved April 26, 2015 from http://www.forbes.com/sites/michelinemaynard/2013/12/09/what-to-expect-next-from-the-american-us-airways-merger/

MSN Moneycentral (2015). American Airlines. Retrieved April 26, 2015 from http://www.msn.com/en-us/money/stockdetails/fi-126.1.AAL.NAS

Rodrigue, J. (2015). Market share of the top American airlines, 1977-2012. Hofstra University. Retrieved April 26, 2015 from http://people.hofstra.edu/geotrans/eng/ch3en/conc3en/airlinemarketshare.html

US Airways 2010 Annual Report. In possession of the author.

US Airways 2012 Annual Report In possession of the author.

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