For almost a year, ever since announcing their intention to merge and become the world’s largest airline (admittedly they never promised to become the best), United Airlines and US Airways have behaved as though this was a fait accompli. But the Justice Department saw things another way, forcing the two airlines to abandon their dream.
I shall remember for a long time the frustration I felt on June 11th in Washington DC’s Dulles Airport when, arriving from London on a delayed United Airlines flight, a number of stranded passengers were waiting in line with me, surrounded by banners hailing the advent of the world’s largest airlines, when late at night United Airlines only had one single person at ground staff to attempt to rebook those passengers that had missed their connections and who, like me, were offered no alternative other than to sleep on the airport’s benches.
United Airlines could not, for whatever reason, re-book me on an early flight on the next morning on US Airways, their future merger partner, and sent me to the other end of the terminal to negotiate a flight ticket there, but there was nobody at their desk.
And so maybe it is time to hold airlines to account and request that the service they provide to their customers resembles in some way the claims made in their advertising campaigns. Clearly, the pressure on airlines to contain their costs is harsh, but reducing the competition between airlines on key routes would allow service levels to drop to unacceptable levels. It was bad enough on the return transatlantic flight (delayed by four hours) to have to wait 50 minutes after take-off in business class before even being offered a beverage (most passengers including myself had fallen asleep well before any dinner was served). The very kind and apologetic flight attendant was apologizing for the fact that there were only two of them to attend to a full business flight cabin…
Lack of competition in the airline industry can already be felt within some of the alliances, and the impact on fares for routes that are operated by several operators all belonging to one same alliance is already clear to see. Merging companies would only reinforce what is already an oligarchy when it comes to setting air fares.
The only measure that can effectively counteract a continuing fall in customer service standards is to maintain a healthy level of competition. A big thank you to the Justice Department for having understood this and threatened legal action against United and US Airlines if they went ahead with their merger plan, in order to preserve what they called true market-driven competition.
Greater clarity regarding the merging of major airline operators
For many years, there was clear opposition against the merging of major airlines, but by 2006 it became clear that something had to change in the airline industry after some of the major players had collapsed. This prompted the authorities and justice experimented a little in that field, allowing Continental to merge with United, Northwest to joint Delta, and US Airways to merge with American West. But now, two of the above mentioned airlines turn up again for a second round of mergers and this has clearly prompted new thinking. Breaking away from a trend which had been taken for granted, the Justice Department is now saying “enough is enough”.
Back to the drawing board
United Airlines have lost almost $ 1 billion since the merger deal was proposed last year. US Airways is seeking ways to remain competitive in an increasingly competitive industry. Further mergers between any of the top-top players are unlikely to be given the green light in the foreseeable future; so this means that the further consolidation of the industry will need to focus on sweeping up some of the small or medium sized players, and this is clearly the focus US Airways will be taking.
Loss-making United Airlines had probably best concentrate on fixing it’s own structure, costs and offering rather than add a further layer of complexity to the business by grafting on some other airlines onto its already ineffective business. With little left to save on costs, it is surprising that no major airline in the United States has attempted to differentiate itself on service. From my recent experiences with United Airlines, it would not take much to make flying with them a more pleasant experience than it is at the moment. Probably not very costly to implement, and with a guaranteed noticeable impact for their customers. This could be a good place to start.
Attempting a second policy U-turn in less than a decade – have we gone full circle?
In the country which was the first to liberalise its airline industry some 30 years ago, the U.S. Department of Justice marked this month what could be a 180° change in policy by challenging the proposed merger of US Airways and its ailing rival American Airlines. If this is really a U-turn, it only sets us back to the situation that prevailed at the end of the 20th century when the proposed acquisition of US Airways by United Airlines was fiercely opposed.
The first U-turn actually occurred in 2006, after years of systematically opposing airline mergers, when the regulators allowed Continental to merge with United Airlines, Northwest to join forces with Delta Airlines, and US Airways to merge with American West, to name just the most important transactions that gradually crystallized the consolidation of the airline industry in North America and inspired European airlines to attempt the same.
Disruption : The emergence of a new business model
Until the 1970s, air travel was smart, prestigious, expensive and regarded as a privilege enjoyed by the appropriately named “jet set”. But things were about to change. The liberalisation allowed new players to emerge with a very different business model, cutting the frills that provided passengers with no real additional value, such as glitzy sales offices on Park Avenue, London’s Regent Street or the Champs-Elysées. Low-cost airlines were born, flying their aircraft at close to full capacity and making air travel affordable rather than exclusive.
Next came the smarter strategy of variable pricing, adjusting the offering to the demand at a micro-level and thereby yielding a far better income by selling last available seats at a far higher cost than the first cheap ones on any flight. At first the major established airlines looked down upon those “cheap” nasty would-be competitors and attempted to resist the trend towards flexible pricing. Today, flexible pricing is the norm in air travel, even for business or first class seats. The rest is history.
It only took ten years after deregulation for the airline industry in the USA to become chronically loss-making, as most efforts to adapt to the new market reality were unfortunately off-set by various political crises and downturns in the world economy. Some of us may still have fond memories of Pan-Am, TWA and Eastern Airlines – absolute monoliths in their own time, but all three are gone now, having vanished faster than the dinosaurs did when our planet was hit by a giant meteorite.
The Regulators’ schizophrenic reaction
Faced with the emergence of these new lean competitors, established airlines had two choices : emulate these new players through ruthless cost cutting and the removal of all “frills” in the service provided to customers – which could end up damaging the company’s brand image and is difficult to implement in a highly unionized environment – or aim for a quantum leap in scale to share the cost of the infrastructure required to run a full service airline, by acquiring or merging with other airlines.
The regulators’ first reaction was to oppose all industry consolidation attempts, feeling that these would reduce the number of direct flight routes which consumers enjoy, thereby forcing them to transit though hubs, and that the cost of air travel would rise sharply as soon as the competitive pressure is alleviated.
It took the financial collapse of some of the major airlines for the regulators to realize that full service airlines had no choice other than to transform their cost structure. This prompted the first U-turn, in 2006, which opened the door to frantic M&A activity in the airline industry in North America as well as on the other side of the Atlantic, with Air France and KLM joining forces, British Airways swallowing up British Midland in spite of Virgin Airlines’ vehement protest, and the IAG group declaring its intention to make a series of significant further acquisitions once the British Airways and Iberia merger has been fully digested.
Panic reaction – or strategic U-Turn ?
A merger between US Airways and American Airlines would create the world’s largest airline, and one can understand why the US Department of Justice filed a civil suit against that merger on 13th August. Nevertheless, American Airlines has been under Chapter 11 bankruptcy protection ever since November 2011, so either some form of merger will take place as US Airways and American Airlines have vowed to defend their case, or American Airlines will be torn apart and absorbed in bite-size chunks by the rest of the industry.
Either way, this will represent a significant step towards the consolidation of the airline industry.
The recent reaction of the U.S. Department of Justice was probably more of a knee-jerk than the manifestation of a strategic re-think which would mark a real U-Turn. That Department, together with six state attorneys general, and the District of Columbia, may just have voiced the politically correct antitrust concerns which a merger of this magnitude deserves …
IAG will be observing the situation with interest. If the US Airways – American Airlines merger goes ahead, nobody will be able to oppose the series of acquisitions AIG envisage carrying out in the years to come. And if American Airlines are left to disintegrate, there will be interesting pieces for IAG to choose from.
Let’s watch this space. In the meantime, sit back, relax and enjoy your flight !
As a very frequent user of airline services, I have followed with interest the developments relating to the merger efforts of British Airways and Iberia under the umbrella of their common owner IAG (International Consolidated Airlines Group S.A.). The alliance between one airline which has dragged itself up the ladder of customer satisfaction from being a strike-riddled loss-making state-owned airline to becoming a well regarded brand, with another airline which today is plagued with the ills that affected BA two decades ago, poses a formidable management challenge.
How long will it take for the same medicine to produce a similar turn-around at Iberia? Is it indeed the same medicine that is called for in this case? What is the risk that fixing Iberia will prove a huge distraction which might dilute management focus and ultimately degrade the whole consolidated group ?
Investor’s Logic Versus Customer Benefits
A “Merger Project” document issued in 2010 by IAG describes in a fair degree of detail the legal structure, governance and ownership of the consolidated company, and indeed it seems the investment community still has faith in the substance of what IAG have set out to accomplish. So far, the realization of synergies is reported to be on track, which is probably not too surprising given some of the inefficiencies that were plaguing Iberia at the start of the deal.
In a video interview posted in 2011 on the IAG website, IAG CEO Willie Walsh talks about the rationale for the BA / Iberia merger within the general consolidation of the airline industry, and the long term perspective this will produce for IAG.
He goes on to announce with understandable pride that IAG is on course to deliver on all its promises to its customers, such as better connectivity between the flight schedules of the two companies. So on paper all looks fine, at least from the investors’ side. But is it really ?
The View from the Passenger Window
Since 1997 with the creation of Star Alliance, shortly followed by BA’s “Oneworld”, passengers have been taught to expect these alliances to offer some commonality in terms of service, comfort, product range and network coordination. This development provided real customer benefits in terms flight connectivity and broadened the range of destinations that can be accessed through code-sharing arrangements. It also allowed the airlines to share the cost of expensive infrastructure, airport lounges etc., thereby improving their cost/value proposition for the travelling consumer.
However, looking at what ultimately matters most to the air passenger, namely the flight experience itself (comfort of seat, cabin appearance and cleanliness, attentive staff, punctuality, food and beverage, entertainment, flight safety), the differences that exist between the airlines belonging to a same alliance remain significant.
Numerous passengers express surprise (and disappointment) when boarding a flight that bears a familiar number and prefix but turns out to be operated by a quite different airline. It is reasonable to assume that passengers will expect an even higher degree of alignment between airlines that are co-owned rather than merely members of one same alliance, unless one brand is clearly identified as the charter or low-cost variant of the other. Today, whilst from a business entity perspective BA and Iberia might be integrating towards being a more coherent business, one cannot overemphasize how colossal an effort remains to be made to provide the group’s passengers with a seamless experience when travelling and switching between those two airlines.
Airline Merger versus Airline Alliance
One struggles to see any end-user benefit yet arising from the BA / Iberia merger, in spite of Willie Walsh’s video statement. Let’s take the example of a journey from London to Santo Domingo in the Dominican Republic.
The fastest routes are London-Madrid-Santo Domingo, and London-Miami-Santo Domingo. The route via Madrid, using BA and Iberia, lasts a total of 15:25hrs including a stop-over in Madrid. The route via Miami involves BA and American Airlines, lasting 16:50hrs including the Miami stop-over, costs an additional £ 68 in business class compared to the Madrid route.
Willie Walsh would like the 10% time saving and £ 68 fare difference (rather negligible in regard to total cost) to be the decisive factors that will swing the customer’s choice in favour of flying with IAG-owned airlines. Any passengers on board flight IB 3486 from Santo Domingo to Madrid on 19th February, onto which they had been rescheduled from a previously cancelled Iberia flight, and which crossed the Atlantic with blocked washbasin and toilet drains and soaked carpets in some areas, will now know they made the wrong choice… And this does not even consider the risks associated with the stop-over in Madrid where luggage handling staff were partly on strike. Maybe an additional £ 68 would have been well invested for trouble-free travel on American Airlines and British Airways’ code-shared itinerary.
When Backstage Trouble Hits the Front of the Stage
In the above mentioned video interview, Mr Walsh quite remarkably states that “one of the real advantages of IAG is that we’re detached from the day-to-day operational challenges that the airlines face, which means we can spend more time focusing on the long term strategic issues“. That’s really lucky for Mr Walsh, because beyond the usual airline worries about fuel costs and security, Iberia have a mountain of other operational issues to resolve and there is a true chasm between their company’s image and what the British Airways brand now stands for.
Let’s give credit to Willie Walsh and his predecessor Colin Marshall, who sadly passed away in 2012 as Lord Marshall of Knightsbridge, for having transformed British Airways from its former status of state-owned sloppy airline to what it has become today. So although I am not an airline expert beyond the fact that I fly between 80 and 130 times a year, I am confident that Mr Walsh not only knows what is right for his investors, but also understands what his customers expect and how to run an airline effectively. Even if things have not always been easy at British Airways and industrial relations are tense at times : there is a clear sense of “The show must go on” and customer service levels are maintained as much as possible, even through difficult times.
Not so at Iberia, where the conflict has broken out into public display, prompting any reasonable air passenger to turn to other airlines to avoid the disruption, cancellations and general ill-ease of being served by such disgruntled staff. This can only compound the problems of the ailing airline into a downward spiral. The coming months will be crucial in determining IAG’s ability to manage industrial relations in a South European country where the rules of play are markedly different to those that apply in the UK.
A Sour Lesson from Past Experience
I trust Mr Walsh to be smarter than the management of Swissair who in the late 1990’s thought they could transfer the know-how, reputation and quality of what had until then been an exceptionally well regarded airline, onto a series of acquired entities to gain a pan-European or possibly global scale, resulting of the lamentable collapse of Swissair in October 2001.
Back then, based on a “hunter” strategy developed for them by McKinsey & Company to protect the airline against possible isolation resulting from Switzerland’s reluctance to engage in any form of integration with the rest of Europe, Swissair embarked (without the support of their consultants during the crucial implementation phase) on a series of investments or outright acquisitions of poor-quality often loss-making airlines, including Portuguese TAP and Belgian Sabena.
Rather than testing and learning from one acquisition before broadening the scope of this aggressive growth programme, Swissair somehow thought that process improvement and a sense of quality would automatically percolate across their rapidly expanding group, thereby ignoring some of the most basic fundamentals of Change Management.
The high levels of debt resulting from the expansion programme, coupled with the management’s inability to simultaneously address the issues they faced very rapidly brought the emerging group to its knees. The rest is history.
IAG’s ambitions are high. The group is not just about the merger of British Airways and Iberia, but aims to acquire many more. Willie Walsh said prior to IAG’s formation that he had drawn up a list of 12 possible partners from an initial pool of about 40 (source : Bloomberg). BMI was snatched up when it became available, primarily for the purpose of obtaining more slots at London’s Heathrow airport. But looking into the near future, contrary to the view he expressed in his 2011 video interview claiming he would maintain a high-level strategic view and not get sucked into operational matters, I believe that Mr Walsh and his team will now have to take account of some of the operational challenges they need to crack to “digest” the BA – Iberia merger before tackling the next big acquisition.
The dishes of a banquet cannot all be eaten together without the risk of a serious indigestion.
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