The Stengel Angle

You might recall a piece I wrote in September criticizing the Department of Justice for attempting to block the American Airlines-US Airways merger on the grounds that the airline industry should be allowed to run its course and that consolidation would bring about benefits for everyone, air carriers and consumers alike. Given the recent reports from many North American carriers reviewing their first quarter 2014 financial performance and that merger activity has seemingly hit its peak, I thought it would be a good time to review how consolidation has impacted the industry and if those benefits have been realized by looking at the competitive landscape before and after all the activity.

The best part: it can all be depicted in ONE chart.

Ok, that might be stretching the truth. It’s actually four charts with the same data but with different phenomenons being highlighted. Anyway, here it is. This is a plot of Passenger Revenue per Available Seat-Mile (PRASM) versus Cost per Available Seat-Mile (CASM), adjusted for inflation, for fourteen key U.S. carriers in 2007 and 2013, with the data in each year also fitted with a linear curve.

We can see here that there have been two major results of consolidation on the airline competitive landscape in the United States. First, the breadth of carriers has expanded from a very dense and crowded area to one that is more spread out. Prior to the consolidation wave, the border between low-cost carriers (LCCs) and larger legacy carriers (e.g. American, Delta, United, Continental, etc.) was very blurry since they all operated more or less in the same cluster. Following consolidation, these clusters have expanded to allow for stronger and more distinct competitive differentiation (more on this at the end). By focusing on the top seven carriers in each year, the cost and revenue differentiation is clearly highlighted before and after consolidation.

The second result is that the “Ultra Low Cost Carrier” (ULCC) concept is a growth area that is flourishing in the vacuum of consolidation. Despite the Department of Justice’s fears that consolidation would mean higher fares and less choice for travelers, the landscape has actually stretched to the right, instead of translating towards the right. This means that the low-cost carrier segment is still being addressed and the traveling public actually has more choice today than in 2007. In fact, one could argue that the ULCC segment potentially has room for more competition. Below, we can see that the same competitive space held by thirteen different airlines in 2007 is now addressed by only three carriers that have taken advantage of the wake left behind by consolidation. Two of these  carriers, Spirit and Allegiant, are the most profitable airlines in this analysis in terms of operating margin (15.8% and 16.4%, respectively)!

While I boiled the results of this merger mania down to two results, there are many subsequent impacts. One is that air carriers across the spectrum now have stronger, more well-defined value propositions, and are generally healthier. Ultra low-cost carriers are thriving as they claim the space once held just six years ago by all airlines by delivering very low fares and charging for anything else. Low-cost carriers differentiate themselves from ULCCs by having a stronger focus on customer service while operating limited networks, mostly point-to-point in niche markets. Meanwhile, the largest network carriers are taking advantage of larger economies of scale through a broad network with a hub-and-spoke route system that offers global connectivity. Network carriers will have higher fares, but they are justified with the wider array of services. All of these changes have trickled down to consumers, who now have more options for air travel and can pay lower fares with the emergence of ULCCs if they choose. Consequently, the outlook for air carriers and travelers is seemingly bright.

[UPDATE 04/28 15:03, CHARTS UPDATED TO ACCOUNT FOR INFLATION]