Barriers to Entry

Airlines have spent a lot of time talking about how consolidation has helped the industry raise air fares and begin earning a profit.  It is constantly promoted as a very positive development and that is generally not refuted by anyone out there most of the time. 

But let’s take a look at the landscape and see what is going on.  In 2004, we had as major airlines the following:

  1. American Airlines
  2. United Airlines
  3. Delta Airlines
  4. Northwest Airlines
  5. Continental Airlines
  6. Southwest Airlines
  7. Alaska Airlines
  8. jetBlue Airlines
  9. Airtran Airlines
  10. America West Airlines
  11. US Airways

These are in no particular order but each of the above could be described as viable operating entities that served large regions of the United States if not on a national basis.   Of the 11 listed, 5 were really completely national airlines, 3 were semi-national and 3 were regional. 

Now, if we consider recent mergers and the recently announced Southwest Airlines – Airtran merger, we have:

  1. Delta Airlines
  2. United Airlines
  3. American Airlines
  4. US Airways
  5. Southwest Airlines
  6. jetBlue
  7. Alaska Airlines

Of these listed, 5 are national airlines (With Southwest moving from “semi national” to “national” in my opinion) and 2 which are really regional airlines primarily.  The 2 which I call “regional” do have flights outside of their core strengths but you can’t really call them even semi-national. 

I see 2 problems arising from this new landscape.  First, the top 3 airlines range in annual revenues between $23 Billion to $29 Billion.   US Airways had about $11 Billion in revenue, Southwest earned about $11 Billion and Airtran enjoyed roughly $2.5 Billion in revenue.  In other words, going forward US Airways and Southwest Airlines will be roughly half the size (in terms of revenue) that the top 3 enjoy.

Alaska Airlines, generally a good performer, earned about $3.5 Billion and jetBlue, also generally a good performer, earned $3.3 Billion.  They are each roughly 1/3 the size (in revenue) of the tier above them. 

My point is that there is a great inequality between the now extremely dominant SuperLegacy airlines and the tiers below them.  Between US Airways and Southwest, US Airways clearly remains an “at risk” airline due to the markets it continue to try to be dominant in.   Indeed, with the Southwest-Airtran merger, US Airways will see yet another market (Washington D.C.) finally being intruded upon by Southwest.

 There is little left to challenge the largest airlines in a region.  They will compete with themselves and it will take many years before you see Delta trying to encroach on American territory or United encroach on Delta territory.  Each of these SuperLegacy airlines needs to settle down.

My second point is barriers to entry.  Airlines have grown both in revenue and network so much now, there is a barrier to entry for new airlines or even existing airlines to enter new markets.  A 2nd tier airline has some chance of competing regionally but 3rd tier airlines are now faced with competing against SuperLegacies that can quite literally bury them with both capacity and staying power. 

In other words, going forward, it will be very difficult for airlines to be started that have any hope of competing in marketplaces because any marketplace that may have high air fares is also going to be dominated by SuperLegacy airlines that can fight off that competition with capacity and the ability (via revenues) to stay the long course with that strategy. 

Starting and operating an airline is a highly capital intensive affair.  It is possible to start an airline and build a network inside a region with fast growth.  jetBlue did it in a market that was highly competitive just 10 years ago.  However, while going from zero to 50 aircraft is somewhat doable still, growing beyond that is very expensive and difficult.  It’s hard to find investors willing to capitalize airlines with enough money to sustain that growth to a network that is served by 150 or more aircraft.

Furthermore, it’s difficult for airlines to make that leap from small to medium and keep their operations stable.  It often requires entire systems changes that stop growth and start a period of mediocrity that is often difficult to work past.   (Hello jetBlue)   In addition, it’s difficult to imagine the required resources to make the leap from medium to a truly national player because, so far, it really hasn’t been done except via mergers and that resulted in an airline (US Airways) that remains tied to cities that aren’t the most attractive for being a major player.  Just look at where US Airways isn’t a player such as New York City, Atlanta, DFW, Chicago, Denver, San Francisco (and arguably Los Angeles.) 

That means that SuperLegacies and major nationals are likely to go unchallenged for the foreseeable future.  Unchallenged airlines usually mean air fares that are high enough to slow economic growth in areas and service levels that will continue to be reduced over time.  It’s not good for customers and it isn’t good for the United States.

I wouldn’t argue that we need 6 SuperLegacy airlines (in terms of size) but I do think we need more national airlines (a la US Airways or Southwest) so that competitive pressure remains in place.  Even new regionals in the form of a jetBlue or Airtran would be good but . . .

How do they get started?  How do you make an argument to investors that capitalizing an airline with the intent of competing even on a regional level is a sound business investment at this point?  It was hard to do before the last 3 years but now it is almost ludicrous to enter a conference room an argue that you can sustain a bruising battle for market share on a profitable route with the remaining top 5 airlines.

In addition, we have tacitly endorsed airline systems that are inherently economically inefficient.  The hub and spoke systems just got a shot in the arm but they do not lend themselves to lean operations and high aircraft utilization.   But the sheer size of the networks we have agreed to now make it possible for those same inefficient operations to enjoy new life for a decade or longer now.

I do think airlines should enjoy profits.  I do not think they should enjoy profits just because they say they should.  The argument that airlines couldn’t enjoy profits in the US anymore without consolidation is refuted by the very performance of other airlines operating under a different model:  Southwest, jetBlue, and even Alaska Airlines and Airtran.  I just named 4 airlines who did enjoy profits on a pretty consistent basis over the last 10 years by not engaging in the SuperLegacy hub and spoke (only) operations systems.

I ask myself where innovation may come from to challenge existing airlines in the next 10 to 15 years and I presently don’t see any encouraging developments.  I don’t see any new David Neeleman’s looking at these conventional systems and thinking outside of the box when it comes to aircraft, routes or labor.   How does a brand new airline argue for competitive prices when shopping at Boeing or Airbus when compared to the SuperLegacies who can make a “top off” order larger than a new airlines’ initial order?

Airline fans can shout about the renewed prospects for earning money presently but I do wonder what we, as a country, have to shout about when we discover that lack of innovation in a few years.

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