Airline Mergers

The best way to become a millionaire is to start as a billionaire and open an airline - Sir Richard Branson - Billionaire British businessman, Founder of the Virgin Group and owner of the Virgin Airlines There is hardly anything in the world that some man cannot make a little worse and sell a little cheaper. People who consider price only are this man’s lawful prey. It is unwise to pay too much, but it is unwise to pay too little. When you pay too much, you lose a little money, that is all. When you pay too little, you sometimes lose everything, because the thing you bought is incapable of doing the thing you bought it to do. The common law of business balance prohibits paying a little and getting a lot. It can’t be done. If you deal with the lowest bidder, it’s well you add something for the risk you run. And if you do that, you will have enough to pay for something better – John Ruskin I received the following news alert from the New York Times:

Monday, April 14, 2008 -- 8:09 PM ET - Delta to Join Northwest to Form World's Largest Airline After seeing the above headline, I referred to the editorial I wrote on the subject in November 2006, when United Airlines made an unsolicited bid for Delta Airlines. The airline business is undergoing a metamorphosis and the industry seems to be in an acquisition, merger and consolidation spree with all airlines being quoted as potential targets. The airlines have brought in better customer service with more competition, but have not been able to keep their costs down and in control. Despite all these known problems, more and more operators have entered the field in developing countries, resulting in cut throat competition. Ridiculous sales promotion techniques and strategies are employed by some players. Some of them have adopted the no frills concept, but are still incurring losses. The problem became so acute that the Union Cabinet Minister for Civil Aviation in India asked the airlines to tighten their belts and to go in for mergers in the fall of 2006.

United Airlines had filed for bankruptcy protection about 6 years ago. UA received $ 900 million as loan from the Federal Government. It bounced back in a year. It went bust again and back to bankruptcy courts. It bounced back again the second time. It merged with a small, no frill airline America West. The cultural mismatch was evident and industry experts said it will fail. However, it made record profits in 2006 and managed its transition well. It had plans to takeover Delta Airlines, which filed for bankruptcy protection in 2006, by making an aggressive bid of USD 8 billion for it - 4 billion in cash and balance 4 billion in stocks. UAL was rebuffed by Delta.

Delta is a far bigger airline as compared to America West and is bigger than United Airlines. This is a reversal of role in an acquisition and merger process, similar to an insect trying to swallow a lizard. There was an attempt by a European auto manufacturer GAF, a few years ago, to takeover the much bigger British Leyland, which was eventually taken over by the Italian company IVECO, a subsidiary of FIAT. Delta did not show interest and rejected the overture. American airline industry has had its failures of major airlines like Eastern, TWA, and Pan Am in the past. However, UA may not be third time lucky, if it fails. It was also reported by New York Times a year ago that United Airlines was in talks with Continental Airlines which is the fifth largest carrier in USA. Now that Delta has chosen a partner to merge, If UA wants to survive, it better find itself a partner soon. However, not all mergers are made in heaven. Some of them end up in a messy divorce.

The Australian Airlines 'Quantas' was taken over by a consortium led by Macquarie Bank and Texas Pacific in a leveraged buyout. Quantas management had accepted the revised offer of Aus $ 11.1 billion after rejecting the original bid. However, it will be no longer be a publicly quoted company, but does it really matter. It makes sense to merge airlines and become bigger, but leaner and meaner. The sales remain the same but the costs can be distributed over larger number of seats. There will be problems with labor, seniority issues and cultural mismatch etc., in cases of mergers. They have to be overcome. Management gurus say that competition is good for the customer, but what is good for the goose is not necessarily good for the gander, though conventional wisdom says otherwise. With oil prices touching USD 113 per barrel and ATF being the major cost in operations, how can airlines maintain low costs?

There will also be some regulatory problems but regulators will have to balance the economic viability against anti trust or monopoly issues. Some compromise will have to be done on all sides. The governments and regulators must decide whether they want a number of smaller companies bleeding to death or a few large and healthy companies operating in the market and serving the customers well. Let the market forces decide the price. People are not morons. When it comes to spending their own money, they are very smart. In developing countries, 80% of people who fly, do so on expense account or somebody else is footing the bill. 18.8% people who fly are rich and costs doesn't matter to them. Only 1.2% of the flyers who spend their hard earned money really get affected. In any case they are not frequent flyers and do so in grave emergencies.

One more aspect that is disturbing for the airlines is that the highly paid pilots and other unionized employees asking for higher salaries and objecting to such mergers. If they are not reasonable in their demands, there may not be enough airlines and planes to fly. Jobs are based on supply and demand, as in economics. Mergers will always result in loss of jobs. But they are necessary for the organizations to survive in a highly competitive scenario. The unions will have to decide whether they want jobs for some people or no jobs at all. Bailing out bankrupt and badly managed big companies with the tax payers money is not a good solution in the long run for any economy. The unemployed people can always be rehabilitated with far lesser amounts. Many people are under the wrong impression that Chrysler was bailed out during Mr. Lee Iacocca's time. The government did not give any money to Chrysler. The government just gave the guarantee to the loan. Mr. Iacocca repaid the loan ahead of the due date with interest. Unfortunately, there aren't too many Iacocca's around.

We should not forget that in trying to woo the customers, we must not cut our own throats. Will any customer come to our help when we are bleeding to death? Will any customer feed us when we are starving to death? An average customer, given a chance, will demand everything for free. Customers will always ask for more and more and for less and less. We have to be courteous, polite and respectful to the customers, offer value for money, extend the best service possible and try to satisfy them to the best of our ability. If we are sincere and honest there is no reason why we can't make it, otherwise take it as it comes; make a graceful and dignified exit. You can be in any competitive business, yet demand a justifiable price provided you have some strategic advantage. Let the man who decides by the price alone be the lawful prey to some other man as mentioned by John Ruskin.

No business remains a monopoly and highly profitable for long. Competition comes in and the industry becomes an oligopoly for some time and after some more time, when the market has too many players. the smaller players get squeezed out, because they can't sustain themselves and it is back to square one of the 'Snakes and Ladders' game played by kids with a dice. This gets repeated but the players are different. Size is always a strategic advantage in any business but contribution from operations must justify the size. Companies try to get bigger and bigger, but they may not necessarily become better and better. It all comes to Quality, Costs and Delivery known as QCD in management parlance. Quality and Delivery must go up and Costs must come down. It is a never ending battle and easier said than done because big companies will find it difficult to keep their costs down. Smaller companies will be able to do that, but cannot survive for long because they cannot grow due to lack of critical mass. The problem in business is that if you don't grow, you perish. Unless the companies, whether big, medium or small, establish a strategic advantage over competition, apart from size, it will be difficult to survive and grow.

References:

Various issues of the New York Times, USA BBC News, UK NDTV 24x7, India Sky News, UK Google news summary © Copyright, Written Apr 18-08 . Without prejudice. All rights reserved

Airline Mergers - To learn more about this author, visit Madhavan T Gopalachary's Website.

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