Airlines

The American-US Airways Deal: You're Going to Pay More


Tom Horton, president and CEO of American Airlines, at the Dallas-Fort Worth International Airport on Jan. 17.

Photograph by Mike Fuentes/Bloomberg

Tom Horton, president and CEO of American Airlines, at the Dallas-Fort Worth International Airport on Jan. 17.

Update, Feb. 13: American Airlines and US Airways have agreed on terms for a merger, according to Bloomberg News. The boards of both companies still need to approve the deal, which is expected to happen later this week.

After four huge airline mergers since 2005, the looming American Airlines-US Airways deal is the last big piece of a decades-long effort to rationalize capacity in the U.S. airline business and raise fares, closer to the cost of the product. Consolidation is a euphemism for fewer seats, and with fewer seats come higher prices.

The combined airline would be run by US Airways (LCC) chief executive, Doug Parker, with AMR’s CEO, Tom Horton, becoming nonexecutive chairman. The big shock now will be if either side walks away. While the airlines will tout their many strategic opportunities, the biggest point of value likely to emerge from creating the nation’s new largest airline will be the chance to cut flights further.

The last two hub-and-spoke holdouts will have joined the consolidation party, and higher prices will be much more likely.

This wasn’t the case a year ago, when American’s then-new CEO Horton and other AMR managers visited Bloomberg’s headquarters to discuss the bankruptcy and their vision for the reborn airline. It would be stripped of onerous legacy costs and able to offer a world-class product to compete with the likes of the restructured Delta (DAL) and United (UAL), not to mention the luxurious international players. Horton was adamant that whatever merger interest Parker and others had with American could and should wait until after the Chapter 11 case.

So much for that. Over the course of 2012 it became clear that the story Horton was selling of a glorious new American—fresh logo, sparkling balance sheet, and brand-new 777-300s—wasn’t making much headway with the bankers and lawyers who were looking at the numbers. “We believe that the stand-alone plan would have left AMR with a disadvantaged infrastructure, too small to compete effectively with carriers 40 percent larger for business travel, and too large to be a niche carrier and compete with carriers smaller and more nimble,” Sterne Agee analyst Jeff Kauffman wrote Monday in a client note.

Among the wilder concepts in American’s turnaround plan was to focus traffic at five core U.S. hubs and boost capacity by 20 percent to catch rivals. In this day and age, such talk is pure blasphemy.

From 2000 to 2012, inflation-adjusted fares declined 18 percent while consumer prices rose 33 percent, according to the Bureau of Transportation Statistics. Going back to 1995, the year BTS began collecting fare data, consumer prices have risen 51 percent while inflation-adjusted fares have fallen 14.8 percent. That’s what sticks in the craw of an airline executive, especially when hotels can charge $5 or more for a can of soda, to cite one of Parker’s favorite pricing examples. (This is also why the airlines’ lobbying group, Airlines for America, touts the $68 drop in average round-trip fares from 2000 to 2011 in a rotating headline atop its home page.)

“Fares need to move higher,” says Helane Becker, an airline analyst with Dahlman Rose & Co. in New York. “They need to be able to recover their costs—that’s what every other business does, and they have to be able to do the same thing.”

Since Congress deregulated the airline industry in 1978, U.S. airlines have rarely been able to charge customers enough to cover the myriad expenses involved in running a large airline. When fuel was affordable, there was always a new upstart with a business model built on bargain fares: Southwest, People Express ValuJet, Vanguard, National, Skybus, etc. (Most failed quickly.) That dynamic has changed in the past decade, driven by crude oil’s extraordinary volatility and the steep decline in air traffic after the 2001 terror attacks and the 2008 financial crisis. Parker’s America West bought US Airways out of bankruptcy in 2005, followed by Delta buying Northwest, United merging with Continental and Southwest (LUV) snaring AirTran Airways.

Washington, in permitting the mergers, has heeded the airline industry’s pleas to consolidate. And now it appears that American Airlines has as well. Get ready to pay more.

Bachman is an associate editor for Businessweek.com.

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