Insight Airline Mergers: Is a Standalone US Airways a Viable Competitor? CARLOS BONILLA | SEPTEMBER 9, 2013 Jeff Smisek, then CEO of Continental Airlines and now head of the merged United/Continental airlines was criticized for his choice of words when he pursued a merger with United Airlines which had just rejected a merger with US Airways: I recognized that United is the best possible partner for Continental. I didn't want him [United Airlines CEO Glenn Tilton] to marry the ugly girl; I wanted him to marry the pretty one, and I'm much prettier. Although the language was decidedly un-diplomatic, the message was clear: in an era when many saw continued consolidation in the airline industry as not just desirable but inevitable, US Airways was the weakest of the traditional hub and spoke carriers. United went on to merge with Continental following in the steps of Delta and Northwest which had already completed their merger. This left only American Airlines, which was spiraling towards bankruptcy, and “the ugly girl” without dance partners. The core of the Department of Justice’s objection to the proposed merger between American Airlines and US Airways is its belief that the aviation market will be more competitive with four legacy carriers rather than three and that US Airways is a viable carrier without the merger with American Airlines. There is no denying that more competitors should lead to more competition. But that is only true if those competitors are viable standalone entities over the long run. The Department of Justice, however, presented no analysis of that long term viability and instead relied solely on statements made by US Airways executives as they positioned the carrier to move the merger forward, a merger that was initially rebuffed by American Airlines. But if US Airways cannot be a viable competitor in the long run then the final outcome will be the same as with the merger: three legacy carriers. A major key to US Airways’ recent profitability stems from an internecine battle in its pilots groups that has frozen wages for many pilots for the last nine years. While there is no doubt that US Airways will continue to operate for a number of years even if the merger is denied, one must ask how long it can survive as a viable competitor given both the handicaps it operates under and the size of its competitors. The Source of US Airways Profitability US Airways today is competing vigorously and earning record profits. Executives of both airlines have repeatedly stated that they do not need this merger to succeed. That quote was the total extent of financial analysis on US Airways released by the Department of Justice. In reality, much of this “profitability” at US Airways has been the artificial result of a battle between employee AMERICANACTIONFORUM.ORG groups which has left pilot wages frozen for a decade. The US Airways we know today is the result of a 2005 reverse merger between American West and US Airways which was then operating under bankruptcy protection for the second time in two years. Although referred to as a merger, it was effectively an acquisition by America West. In 2004, faced with a possible liquidation in bankruptcy, old US Airways pilots had agreed to a concessionary contract which reduced their pay by 21 percent and eliminated scheduled annual increases. Since both pilot groups were represented by the same union (ALPA, the Airline Pilots Association), seniority integration pursuant to the merger was to be carried out in accordance with existing ALPA policy. Binding arbitration was agreed to by both pilot groups, yielding a blended seniority list reflecting relative seniority among the former America West and US Airways pilots and the economic position of each airline. These two groups came to be referred to as “West” and “East” pilots respectively. The East pilots refused to accept this seniority list produced by binding arbitration. In general East pilots had more years of service than West pilots, reflecting more than anything the age and growth or contraction of the two airlines. The East pilots, outnumbering the West pilots, ousted their union representation, formed a new collective bargaining unit, USAPA (US Airlines Pilot Association), and then rejected the arbitration results they had once agreed to. The alternative seniority plan put forward by USAPA placed the vast majority of West pilots at the bottom of the seniority ladder. Not surprisingly, litigation ensued, and continues to this day. Absent an agreed upon seniority list, no new contract has been possible. As a consequence each separate pilot group continues to operate under, and get paid according to, the contract then in force. For new US Airways this means that East Pilots are operating under a nine year old concessionary contract agreed to in bankruptcy and are the lowest paid in the industry, while West pilots are operating under 2003 contract agreed to just two years after America West was forced to secure a loan guarantee from the Federal government’s Air Transportation Stabilization Board, an entity created to provide liquidity to airlines unable to secure credit in the market place in the wake of 9/11. Since pilot expenses are a major cost for any airline, this has allowed US Airways to book a level of profits it could not otherwise have earned. Airline Profitability As the Department of Justice notes, US Airways has indeed reported healthy profits in recent years. Nevertheless, over the past five years it has reported a cumulative loss of over $1.2 billion. Delta, by all accounts the most successful of the legacy carriers, has reported a cumulative loss of $7.7 billion. Every carrier except Southwest (which does not operate on a hub and spoke basis) has reported cumulative losses since 2008. So while the Department of Justice is correct in reporting “record” profits, the airline industry as a whole, is far from demonstrating that it can turn a profit over a full business cycle. Strip out Southwest’s earnings and legacy carrier losses balloon to almost $23 billion over the last five years. AMERICANACTIONFORUM.ORG Market Pay Rates and US Airways Profits The airline industry is a highly unionized one, and is characterized by pattern bargaining. Collective bargaining units strive to achieve parity with their more highly paid peers, typically setting the most recently agreed upon contract as a benchmark target. In 2012 Delta Air Lines, the airline which operates under the most recently negotiated pilot contract, had cockpit costs of $941 per hour. At US Airways this number is $564. As a first approximation, had US Airways been paying Delta cockpit rates its “record” profit in 2012 would have fallen by 80 percent to $206 million. US Airways is well aware that the gap between what it pays it pilots compared to the rest of the industry will not last forever. Consequently, an agreement between US Airways and its pilots union would see their pay rise to that currently in effect at American Airlines upon completion of the merger. But this is only possible with the higher revenue that is earned on American Airlines route and hubs. That and a successful merger implementation (which is never guaranteed). When adjusted for operational differences (Stage Length Adjusted) American Airlines earned 17 percent more System Passenger Revenue per equivalent seat mile than US Airways. This is what allows “the ugly girl” to avoid a death spiral when its wages ultimately go to market. AMERICANACTIONFORUM.ORG.