Opening Remarks May 6, 2010, 1:00AM EST

Airline Mergers Aren't Storybook Romances

The Continental-United tie-up makes sense in a bloated industry, but history shows that big airline mergers yield mediocre results at best

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On May 3, Continental Airlines (CAL) Chief Executive Officer Jeff Smisek, a guy known for driving around Houston at 130 miles per hour, boasted how he'd telephoned his counterpart at United Airlines (UAUA), Glenn Tilton, to break up the potential marriage of United and US Airways (LCC). "I gave Glenn a call and told him I was a much prettier girl," Smisek told Bloomberg News.

It would be unsporting to deny Smisek, 55, his Broadway turn as Maria in West Side Story. Yet the reality of the airline industry is anything but pretty. The vital function of flying passengers for work and pleasure remains a terrible business, and the merger of Continental and United won't do much to solve the problem.

Over the past decade, the domestic airline industry has amassed no less than $60 billion in red ink and shed 160,000 jobs, according to the Air Transport Assn., a Washington trade group. United and Continental each suffered losses for the past two years, and as borrowers they receive miserable credit ratings. On average, journeys between clogged airports take longer than they did years ago because of tarmac delays, circling before landing, and other factors, the ATA says.

Warren Buffett, as usual, has pithily summarized the situation. "You've got huge fixed costs, you've got strong labor unions, and you've got commodity pricing," he told The Telegraph back in 2002. Buffett learned his lesson after a disastrous investment in US Airways in 1989: "I have an 800 number now that I call if I get the urge to buy an airline stock," he said. "I call at two in the morning, and I say: 'My name is Warren, and I'm an aeroholic.' And they talk me down."

Bankruptcy Knack

The one skill the carriers have consistently demonstrated, says Adam Epstein, a consultant and tech financier who flies frequently from his base in San Francisco, is using the Bankruptcy Code to rearrange their money-losing operations. Thirty-seven airlines, including United, have filed for Chapter 11 protection from creditors since 2000, according to the ATA; nine have been liquidated. "Maybe more should have just gone away, rather than reorganize," Epstein says.

Mergers are another way to thin a bloated industry, but the streamlining has been painfully slow and uneven. The trouble with commercial air travel traces to 40 years of government fare and route regulation, which ended in 1978. Unable to compete on prices, the carriers tried to outdo each other on services. The complimentary booze flowed. Federal rules protected profits, so the companies had little incentive to contain costs. Salaries for pilots, flight attendants, and mechanics soared. Labor concessions in recent years have corrected some of the wage distortion, but not all of it.

In the 1980s and 1990s, upstarts such as Southwest Airlines (LUV) challenged the longtime carriers, setting off intermittent price wars, strikes, and egotistical overexpansion. To this day, the industry hasn't gotten control of its crippling fixed costs. Even with sophisticated financial hedging techniques, it has suffered from high and volatile fuel prices. Freak storms, not to mention Icelandic volcanoes, can gouge millions from collective revenues.

After three decades of turbulence and the disappearance of PanAm, Eastern, TWA, and other hallowed brands, the airlines still have too many seats in the air. The dominant system of hub airports—Continental has them in Houston and Newark, N.J.; United in Chicago and Los Angeles—has proven to be expensive to maintain and prone to infuriating travel snags.