From the April 20, 2008 Sunday Times (London)
April 23, 2008
by Irwin Stelzer
Travellers can be forgiven if their first reaction to the proposed merger of Delta and Northwest is to wonder what additional atrocity will be inflicted on them. It can’t be deterioration in the quality of the peanuts offered in lieu of meals. Nor can it be a reduction in leg room: knees-on-chest is already the posture deemed by most airlines to be in passengers’ best interests. It might be a reduction in the value of frequent-flyer points, but since most of these are now good only at 3am on one Thursday each month, there isn’t much to lose on that score. Nevertheless, 54% of passengers expect the merger to result in deterioration in service.
History is on the side of the pessimists, at least in the short term. After every airline merger, chaos is the order of the day – or year. Pilots find that the control panels on the other planes differ; baggage losses mount; merged reservation systems collapse; employees strike, enraged by inferior pension packages, or the degrading of seniority.
All of these are in the new Delta’s future (the Northwest brand is to disappear), with a strike by Northwest’s pilots the largest looming obstacle to a peaceful integration. Delta’s pilots, on the other hand, seem likely to ratify a deal that hands them a 17% pay rise over four years, better pensions, 3.5% of the equity in the new company and guaranteed jobs for two years.
There is a long way to go, though, before the merger is consummated. American Airlines might mount a rival bid for Northwest, especially if United and Continental merge, displacing Delta-Northwest as the world’s largest carrier. The regulatory authorities in Washington or Brussels might kill the deal on the grounds that it would trigger a wave of airline mergers that would unreasonably increase the market power of the surviving carriers.
Which brings us to two key questions. Will the merger result in efficiencies that strengthen the financial position of Delta? And when the initial trauma is over, will passengers be better off?
The new Delta expects to be able to wring better terms from some of its suppliers, to save between $400m and $600m by using the combined fleets better to match supply to demand, and to gain $400m in additional revenue from passengers, especially big corporate accounts, attracted by improved connections and reduced travel times. Total: about $1 billion in claimed “network synergies”.
Shareholders either want more or don’t believe these claims: they have been dumping shares.
With reason. The single largest cost component is jet fuel, and while a bigger Delta might wring concessions from its caterers, it is not likely to persuade Opec to lower the price of oil. Nor will labour costs come down if management sticks to its plan to minimise layoffs.
What about revenues? The airlines’ press releases are careful to pin hopes on “more customers”. Not a word about possible fare increases – which is understandable, given the congressional and regulatory reviews now under way. Those reviews will focus on whether the formation of the largest airline in the world in terms of traffic, with 75,000 employees worldwide, $35 billion in annual revenue, serving 390 destinations in 67 countries with 800 aircraft and hubs in nine big cities, would have what airlines have been seeking since the protective blanket of regulation was removed, leaving them shivering in the competitive market: pricing power.
That doesn’t seem likely. Only 12 of the nonstop city pairs that both airlines serve overlap, so there isn’t much competition to eliminate. Then there are the low-cost, low-fare carriers that already operate about one-third of the industry’s capacity and are ever-ready to challenge incumbents who try to raise fares.
Besides, some cheer leaders for the merger suggest that higher domestic fares would be in travellers’ interests. Both airlines have geriatric fleets. Experts are estimating that it will cost the new Delta about $20 billion to upgrade its fleet. That’s good news for aircraft leasing companies and for Airbus, if Northwest has its way, or Boeing, if Delta’s recent preferences are any guide to future orders. It is not unreasonable to assume that a financially healthier carrier will “accelerate the upgrading of existing international aircraft with lie-flat seats and personal on-demand entertainment”, as the new Delta claims it will.
Nor will Delta, which now serves Manchester and London from its American hubs, have a free hand on international routes. Ed Bastian, Delta’s president, expects international routes to provide “the majority of the growth . . . in this combined entity”. But carriers plying Pacific routes are facing increased competition from low-cost, high-service Asian carriers, and the new “Open Skies” deal opens transatlantic routes to increased competition by allowing European and American carriers to invade each others’ markets.
But remember, the airline industry has not netted a profit over the more than 100 years since the Wright Brothers proved that man can fly. Both Delta and Northwest only recently emerged from bankruptcy, four smaller airlines filed for bankruptcy protection in recent weeks, and most carriers have found themselves under similar financial stress at one time or another. This tough environment hasn’t got any easier.
In the end, we won’t know whether to accept Delta’s invitation to “Come Fly With Me” until the deal is done, new fares are set and we can stretch out in the almost 300 new aircraft on order or under option by the merger partners.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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