American Airlines and US Airways merger a sign of market failure?

American Airlines and US Airways propose to merge to top the list of world’s largest airlines. According to this WSJ article on a 2012 J.D. Power survey, American and US Airways  were near the bottom in customer satisfaction among U.S. legacy carriers, all of which as a group were disliked compared to newer carriers such as JetBlue and Southwest. In fact, US Airways, whose management team will be running the combined behemoth, ranked dead last among all U.S. airlines.

In a free market it would be surprising if the folks who delivered the worst customer experience ended up with the largest market share. So to what can we attribute this spectacle?

  • the airline market is not free: (1) carriers such as US Airways and American that are allocated international routes end up with an almost insuperable advantage over carriers that don’t get these handouts from government, (2) efficient foreign carriers such as Ryanair are prohibited by the U.S. government from taking Americans from New York to Chicago, which they could do for 25 percent lower costs than Southwest and JetBlue
  • the airline market works, but sluggishly due to the long lead time for ordering new airplanes (this seems less plausible given how many airliners are leased from big neutral leasing companies such as AIG and GE Capital and could be moved quickly from one carrier to another)
  • customer satisfaction surveys are meaningless; consumers will fold themselves into the cramped coach seats of a hated carrier such as US Airways or American if it is $10 cheaper

[Separately, for those who are concerned about the apparent lack of fairness in the American economic system, Tom Horton, the guy who impoverished American Airlines shareholders while earning a $3.3 million annual salary (source), will receive an additional $20 million in severance pay (source). Plus, since a guy with $20 million in the bank won’t be able to afford the new fares that American, United, and Delta are able to collude on, he also gets to fly for free for the rest of his life on American. (The shareholders of AMR, who might have invested hard-earned funds as early as 1930, are getting a 3.5 percent stake in the new merged company, worth about $350 million supposedly; when Tom Horton came back to AMR in 2006 the shareholders had something worth about $6 billion (source).)]

Related: http://philip.greenspun.com/flying/unions-and-airlines

4 thoughts on “American Airlines and US Airways merger a sign of market failure?

  1. “In a free market it would be surprising if the folks who delivered the worst customer experience ended up with the largest market share”

    This sounds simplistic to me. True story: I once drove a friend’s BMW M3 series and I was very satisfied with the experience. At the time I owned a Nissan Maxima and I was only moderately satisfied by it; the car was somewhat noisy, the fit and finish were quite modest, it was a front wheel drive so it had some under steer and some torque steer issues etc. When the time came to replace the car I ended up buying … another Nissan. The reasons are the ones you can imagine – the purchase cost was 3x lower, the running costs (fuel, parts, servicing) also much lower, the neighbor envy factor is 10x lower, the reliability is way better and so on.

    Regarding your arguments:

    1) I’m not familiar with how the international routes are allocated, but I thought that the airlines were able to sell those to one another. Are those really given for free by the gov?! That’s not say that there’s no government intervention in these markets but from this to “handouts” there’s a big step.

    2) The free market does work. For example, American Airlines, with their lousy MD-80 planes, has shrunk to half its presence in the Boston market. Oh, and they also had to file for Chapter 11, if you didn’t know. Meanwhile, companies such as JetBlue with their nicer planes, on-board tv and more legroom have made serious gains.

    3) Re. Ryanair – the argument sounds thin to me. Do you seriously believe they could provide the same level of service for 25% less?! If yes, how? Please remember that “same level of service” includes things such as comparable aircraft, comparable schedules, comparable convenience (i.e. flying to Boston Logan not to “Boston, Manchester, NH”), comparable customer service assistance in case the flight gets canceled etc. And why aren’t the various low cost American airline companies able to do this for 25% less money (and still turn a profit)?

    BTW, as far as I know there’s been at least one foreign carrier who has entered the US market: Virgin Airlines.

    4) The customers are price sensitive. Very much so. Just read the stories about how, let’s say, Delta raises the price tickets by $10 and then waits to see if the others will follow or they’ll have to give up.

    Regarding the merger between American Airlines and US Airways:

    1) “The shareholders of AMR, who might have invested hard-earned funds as early as 1930, are getting a 3.5 percent stake in the new merged company”

    You do realize that in a Chapter 11 bankruptcy the shareholders are wiped out and the creditors need to be paid, right?

    2) “since a guy with $20 million in the bank won’t be able to afford the new fares that American, United, and Delta are able to collude on, he also gets to fly for free for the rest of his life on American”

    Let’s look at the full half of this glass. First, there’s a chance this guy might not do this very often. Perhaps he’ll now have enough money not to have to fly commercial. Second, if he does choose to fly on US Airways he’ll essentially get to eat his own dog food so I wouldn’t exactly envy him for that 🙂 And yes, I realize he’d fly at business or first class, not coach. Finally, he wouldn’t be the first CEO to leave the job with such perks. I remember one former CEO of GE having its former employer pay for his toiletry expenses!

    Regards,
    Liam

  2. Liam: Virgin America cannot be a “foreign carrier” or its carriage of passengers from Boston to LAX would be illegal. See http://www.huffingtonpost.com/edward-wytkind/richard-branson-is-quite-_b_1413233.html

    http://www.dot.gov/policy/aviation-policy/international-economic-authority explains how U.S. government bureaucrats decide which airline will be allowed to fly which international route. These routes are the main source of profit for legacy carriers. http://faculty.haas.berkeley.edu/borenste/NBERw16744.pdf notes that “Most international routes remain more heavily regulated, and generally more lucrative for those carriers that are permitted to serve them.” So a carrier that is friendly with the federal government can earn profits while one that does not benefit from discretionary favors will endure losses.

    And yes I am aware that shareholders generally suffer when a management team runs a company into bankruptcy. Which is why some people may perceive it as unfair for that management team to go home with tens or hundreds of millions of dollars in personal wealth.

  3. In regards to the customer survey, my Dad for years flew out of Pittsburgh, which had a large USAir hub. He was in the USAir club, flew insane amounts of miles everywhere, he worked from home and basically had to fly to a customer whenever he left, etc. If one day they decided to not serve food, depressurize all the cabinets, and doing everything short of landing at the wrong damn airport, what else is he going to do? I suppose he might try Delta? I’m assuming his company had some sort of deal with USAir. He’s already racked up thousands of miles with USAir. He knows their system, he won’t make the longer drive to Cleveland, the changes probably aren’t the worst things in the world. So he sticks with USAir.

    (Hell, in college there was a hot dog hut run by one 80-yr old man who’d talk to the guy in front of you for 15 minutes about politics if you riled him up, but every Thursday and most Saturdays, you’d see me and my friends there at midnight in the middle of a mid-western Pennsylvanian winter. What I’m saying is, in plenty of cases, customer surveys are useless.)

    Comedians always talk about airline travel, and one of my favorite quotes is: They try to dress it up with these slogans like “Thank you for flying Delta”; if it were three dollars cheaper, I’d have flown on a kite.

  4. Based on the survey, American and US Airways appear to be the most successful at delivering what their customers truly want. Airline passengers may complain about continually-degrading service. But when it comes to putting their money where their mouths are, they consistently show that they care only about the lowest price regardless of the “consumer experience.”

    The American-USAir merger will surely be a successful one, if you use the metric of degrading the “consumer experience” as the standard. We can’t be sure that the combined entity will be any more profitable, but we can be absolutely certain that flying the new combined airline will be an experience even more miserable than what its “dead last” predecessors. And in that way it may prove a successful financial venture.

    Under the only business model under which the “legacy carriers” seem capable of operating, profitability (or reduced losses) can only be achieved by squeezing. Employees must continually sacrifice their pay, benefits, and working conditions. And passengers must literally be squeezed into even tighter middle seats as dynamic yield algorithms continually adjust fares and capacity to optimize revenue. The only exception, of course, is for the top executives who enjoy a Divine Entitlement to continually increasing compensation regardless of performance.

    Passengers can complain all the want about the continual deterioration of the quality (and quantity) of airline service. But as long as their demand for the lowest fares remains the paramount or only consideration when choosing an airline, executives will (correctly) read their customers’ choices as a request to be treated as self-loading cargo, packed into an even tighter hold.

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