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Transcript of United Airlines and the transformation of global aviation Hubert Horan Northwestern University...
United Airlines and the transformation of global aviation
Hubert HoranNorthwestern University
Kellogg School of ManagementEvanston, 16 May 2013
Horan economics of consolidation 17 May 2012 Page 2
Radical consolidation since 2004: biggest changes in aviation historyTotal Domestic USA 1991 1999 2005 2013
Concentration-top 4 67% 63% 58% 87%# Competitors (>4%) 8 8 8 4Total North Atlantic 1991 1999 2005 2013
Concentration-top 3 35% 47% 47% 97%# Competitors (>2%) 15 11 9 3
Did consolidation improve industry economics?Is the industry more efficient with fewer competitors?
Did consolidation improve industry economics?Is the industry more efficient with fewer competitors?
Horan economics of consolidation 17 May 2012 Page 3
Framework for understanding the biggest changes in aviation history
Industry structure/competition and efficiency/profitability
Economic drivers of different airline business models US airline profitability trends since deregulation Economics and historical performance of airline
mergers Airline bankruptcy process and capital restructuring Global Alliances and Intercontinental competition Antitrust reviews of merger/antitrust immunity cases Consolidation of domestic US aviation; the US-AA case Long term outlook for industry growth
Total Domestic USA 1991 1999 2005 2013
Concentration-top 4 67% 63% 58% 87%# Competitors (>4%) 8 8 8 4Total North Atlantic 1991 1999 2005 2013
Concentration-top 3 35% 47% 47% 97%# Competitors (>2%) 15 11 9 3
Horan economics of consolidation 17 May 2012 Page 4
My perspective on airline competition and industry structure
Developed original NW/KL alliance network Shut down multiple unprofitable alliances
Consolidation via Alliance Antitrust ImmunityConsolidation via Alliance Antitrust Immunity
PE, NW, HP, SR, SN, UA, US, HA, TZ, AA
Direct experience including cross-border mergers
Congressional and DOT testimony recent Transportation Law Journal article on
ATI
Bankruptcy RestructuringBankruptcy Restructuring
Industry consolidation in the last decadeIndustry consolidation in the last decade
Airline Responses to Deregulation and LiberalizationAirline Responses to Deregulation and Liberalization
Post-deregulation shakeout, 90s profit recovery
European/Asian liberalization
Horan economics of consolidation 17 May 2012 Page 5
Any industry analysis implies a model of airline competition and growth
Industry supply/demand balance Only serve markets where you
have a sustainable competitive advantage
Rigorous ROI justification for capital spending
Narrow view—Airline financial/
competitivesuccess requires:
Narrow view—Airline financial/
competitivesuccess requires:
Longer view--Profitable
Industry growthrequires:
Longer view--Profitable
Industry growthrequires:
Profitable industry growth requires continuous innovation, productivity gains
Profitable industry growth requires continuously reallocating capital to more productive uses
Horan economics of consolidation 17 May 2012 Page 6
US airline profits historically weak, very sensitive to supply/demand shifts
60s aircraft driven boom; went way too far 90s capacity discipline abandoned (dot-com
era)
54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
(12%)
(10%)
(8%)
(6%)
(4%)
(2%)
0%
2%
4%
6%
8%
10%
12%
14%
US Airline Operating Margins 1954-2010
Recessions>
Strong profitsget underminedStrong profits
get undermined
3 big collapses:overcapacity,ignore cycles
3 big collapses:overcapacity,ignore cycles
80s: deregulation entry boom hits recession 90s: hub boom/national expansion hits
recession 00: post dot-com boom recession
Horan economics of consolidation 17 May 2012 Page 7
InnovationProductivityLower fares Demand growthScaleEntry/growth
10
15
20
25
30
35
40
45
50
Real US Domestic Yields (2010 cents)
54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 080
100
200
300
400
500
600
700
US Domestic RPMs (billions)
InnovationLower Fares
60s/70s—aircraft technology
80s/90s—network/business models/
IT systems
InnovationLower Fares
60s/70s—aircraft technology
80s/90s—network/business models/
IT systems
Fares stoppedfalling 10 years ago
90s—artificial (dot-com)growth
00s—stable/rising fares stifle growth
Fares stoppedfalling 10 years ago
90s—artificial (dot-com)growth
00s—stable/rising fares stifle growth
Horan economics of consolidation 17 May 2012 Page 8
Industry structure & competition driven by political/regulatory rulesSIX MAJOR CATEGORIES
SAFETY REGULATION Airline/Aircraft Operating authority, Maintenance oversight, Pilot and Mechanic licensing/training
CORPORATE LAW Taxation, Financial Reporting, Corporate Governance
BANKRUPTCY LAW Asset/Debt Restructuring, Creditor/Debtor rights
LABOR LAW Collective Bargaining, Pension Rules
CONSUMER/COMPETITION LAW
Antitrust, Advertising Rules, Consumer Protection
ECONOMIC REGULATION Entry/Fitness requirements, Route Authorities, Pricing Regulations, Airport Slot/GDS rules
1944 ChicagoConventionAll aviation companies/rules tied strictly to nationality
1944 ChicagoConventionAll aviation companies/rules tied strictly to nationality
postwar CAB/IATA Cartel
postwar CAB/IATA Cartel
1978-1990sliberalization1978-1990s
liberalizationindustry
consolidationindustry
consolidation
Powerful incumbents can block challenges
Loosened entry, pricing rules to weaken power of incumbents
Horan economics of consolidation 17 May 2012 Page 9
“Liberal” industry structure can also drive growth, improved capital allocationInnovation andProductivityInformation technologyAircraft technologyAirline Business ModelsSupply Chain Efficiency
Innovation andProductivityInformation technologyAircraft technologyAirline Business ModelsSupply Chain Efficiency
StructuralGrowthStructuralGrowth
LowerFarescustomer value
LowerFarescustomer value
Pressure to continuouslyimprove capital allocationPressure to continuouslyimprove capital allocation
HIGHLY LIBERAL MARKET COMPETITION/REGULATION
Pricing/market entry freedom No labor market distortions
Independent capital markets Limited ownership barriers
No artificial competitive barriers
Efficient bankruptcy process
Open corporate control market No political barriers to exitREQUIRES Let Markets pick winners, how many airlines (not
governments)
PUBLIC POLICY Maximum Gains Economy-Wide (not individual companies)
FOCUSED ON Maximum Benefits for overall (not specific) Consumers/Investors
Horan economics of consolidation 17 May 2012 Page 10
“Creative destruction” requires conflictbetween industry, individual stakeholders Profitable industry
growth required failure of hundreds of companies; painful reallocations of capital assets and jobs from weak to strong
Fundamental conflict between incumbent interests and new entrants
Biggest industry problem throughout history: “Barriers to exit”—protections for weak managers, unproductive assets, vested interests
80 82 84 86 88 90 92 94 96 98 00 02 04 060
200
400
600
800
1000
1200Growth of Global
Pax Airlines since 1980
airlines
entrants
exits
Excludes third level airlines with less than 10 aircraft
Horan economics of consolidation 17 May 2012 Page 11
Intercon/Shorthaul: different businesses, different drivers, different competition
IntercontinentalMegahubs
USA Domestic(mix big hubs/LCC)
Most non-US LCC shorthaul (no hubs)
Ultra-LCC+charters
proven airlinebusiness models
proven airlinebusiness models
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
0
100
200
300
400
500
600
700
800
900
Tota
l Pax A
irlines,
excl
udin
g v
ery
sm
all p
ropeller
opera-
tors
Intercontinental sector:zero growth in 30 yearsdue to huge entry barriers(both political, economic)
Intercontinental sector:zero growth in 30 yearsdue to huge entry barriers(both political, economic)
shorthaul sector—(domestic/regional airlines)Vibrant, dynamic--accounts for 100% of industry-wide competitive growth
shorthaul sector—(domestic/regional airlines)Vibrant, dynamic--accounts for 100% of industry-wide competitive growth
Horan economics of consolidation 17 May 2012 Page 12
US Aviation in the 90s—strongly profitable, highly competitive
70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99
(8%)
(6%)
(4%)
(2%)
0%
2%
4%
6%
8%
10%
12%
US Airline Operating Margins 1970-1999
Legacy competition
DL UA AA CO NW US+HP
2004 market share 16% 15% 19% 12% 10% 10%
Strong Megahubs ATL ORD DFWMIA
EWRIAH
MSPDTW
PHLCLT
International--Strong Atl Atl Lat Atl Atl
--Middling
Pac Atl Pac AtlDeregulationhad:
Intensified price/ network competition Spurred management innovations Significantly increased capital market discipline Generated a stronger industry structure
Horan economics of consolidation 17 May 2012 Page 13
Some early 80s mergers worked but all later “scope/scale synergies” failed80: Pan Am/National Synergy/Scope FAILURE—largely liquidated
82: Texas Intl/Continental
Hub consol (IAH)
FAILURE—quickly bankrupt
85: Southwest/Muse Bankruptcy Profitable—cheap acquisition
85: People Exp/Frontier Synergy/Scope FAILURE—soon bankrupt
86: TWA/Ozark Hub consol (STL)
Profitable—Created viable hub
86: Northwest/Republic Hub consol (MSP)
Profitable—Created viable hub
86: American/Aircal Synergy/Scope FAILURE—totally liquidated
87: Continental/PE/NY/FL
Synergy/Scope FAILURE—soon bankrupt
87: Delta/Western Synergy/Scope FAILURE—largely liquidated
87: Continental/Eastern
Synergy/Scope FAILURE—soon bankrupt
88: USAir/PSA Synergy/Scope FAILURE—largely liquidated
88: USAir/Piedmont Synergy/Scope FAILURE—soon bankrupt
Initial 80s mergers attempted to “fix” CAB-imposed network limitations--only worked when merger created a viable hub (STL/MSP)
Every merger based on expanded scope/scale failed--given failures, only one Scale/Scope merger attempted in two decades after 1988
Initial 80s mergers attempted to “fix” CAB-imposed network limitations--only worked when merger created a viable hub (STL/MSP)
Every merger based on expanded scope/scale failed--given failures, only one Scale/Scope merger attempted in two decades after 1988
Horan economics of consolidation 17 May 2012 Page 14
Original mid-90s Collusive Alliances: real consumer benefits in competitive markets
AMSZRHAMSZRH
DTWATLDTWATL
original Collusive Alliances KL-NW (92), SR-SN-DL (95)
and UA-LH-SK (97)
original Collusive Alliances KL-NW (92), SR-SN-DL (95)
and UA-LH-SK (97)
but these network/consumer gains fully exhausted by 1999but these network/consumer gains fully exhausted by 1999
Measurable Consumer Benefits: Thousands of markets got online service, discount fares for the first time
Driven by Network Economics: Alliance connections totally displaced traditional interline connections—not pursued outside North Atlantic where comparable network opportunities did not exist
The North Atlantic remained robustly competitive
1991 1993 1995 1997 1999 2001Concentration-total North Atlantic market (55 million annual pax)
top 3 share 35% 42% 42% 45% 47% 47%number of US-EU competitors with minimum departure share of 2%
15 15 13 13 11 11
Horan economics of consolidation 17 May 2012 Page 15
Control battles, bankruptcy key to capital market discipline in the 90s
Fair success rate when larger incumbents challenged/replacedMajor Capital
reallocationMajor Mgmt/Control change
82: Texas Intl/Continental Hub consol (IAH) -FAIL-quickly went bankrupt
83: 1st CO bankruptcy major cost restructuring -FAIL-No mgmt change
85: TWA-Icahn takeover Led to OZ merger -FAIL-Weak mgmt, no new capital, no improvements after OZ
87: Texas Air (CO)-Eastern -FAIL-Little integration -FAIL-Weak mgmt
89: NWA-Wings takeover(92 virtual bankruptcy)
After initial missteps led to major network restructuring
Major change (but new mgmt entrenched; bankrupt in 2003)
90: 2nd CO bankruptcy After initial missteps led to major network restructuring
Eliminated failed management
91: AWA bankruptcy major restructuring Major change
92: TWA bankruptcy -FAIL-didn’t fix capital Major change
94: United ESOP -FAIL-ended Allegis but didn’t improve United
-FAIL-Mgmt not improved
85/91: Pan Am liquidation Assets more productive N/A
Nearly 100% failure rate when big incumbents buy smaller competitors DL/WA, US/PS, AA/OC/TW, CO/PE/FL
Horan economics of consolidation 17 May 2012 Page 16
Profitable mid-90s US industry equation destroyed by Legacy mismanagement
Mid 90s profits tight capacity
Price disciplineAtlantic alliances
Mid 90s profits tight capacity
Price disciplineAtlantic alliances
DotCom late 90smad growth rush:
allows LCCsto expand
DotCom late 90smad growth rush:
allows LCCsto expand
2000-2004Huge Collapseovercapacity +
recession
2000-2004Huge Collapseovercapacity +
recession
2004-2008Financial Bubblebut weak profits;fuel prices spike
2004-2008Financial Bubblebut weak profits;fuel prices spike
Source: DOT Form 41 data
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
(20%)
(15%)
(10%)
(5%)
0%
5%
10%
15%
US Airline Operating Margins by sector 1993-2010
Legacy
LCC/Other
1980s-big deregulation
driven innovation;90/92 recession
1980s-big deregulation
driven innovation;90/92 recession
% industry rev 1998 2004 2010 Legacy 86% 75% 72%Regionals 3% 10% 9%LCC/Other 11% 15% 19%
Dot-com bust biggest in airline history $36 billion in Legacy losses 2001-2009 Huge Legacy market share losses to LCCs
Horan economics of consolidation 17 May 2012 Page 17
Legacy collapse—ignored supply/demand, competitive advantage, need for ROC
Source: BLS CPI deflator applied to DOT Form 41 data
Legacy revenue base way down, but no capacity cuts until 2007 Legacies assumed profitable growth despite declining
productivity
1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 20
100
200
300
400
500
600
700
Domestic ASMs--Legacy and non-Legacy
LEGTOT-DLCCTOT
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 0
20
40
60
80
100
120
Growth in Real Domestic Revenue 1993-2010 (in $2010bn)
INDTOT-D
LEGNET-D
LCCTOT
Horan economics of consolidation 17 May 2012 Page 18
United’s 2002 collapse: obvious problems readily addressed in bankruptcy
UAL hugely valuable--absolutely no risk of liquidation Strongest network in industry, huge customer base and brand
Liquidity, balance sheet problems due to unprofitable expansion
Short term (self-inflicted) damages from failed ESOP Chapter 11 ideal for asset restructuring, contract concessions
Poor management, network/financial underperformance Continental merger plan addressed management, fleet and network Creditor interest in competing reorganization plan
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
(25.0%)
(20.0%)
(15.0%)
(10.0%)
(5.0%)
0.0%
5.0%
10.0%
15.0%
Legacy Airline Operating Profits 1993-2007
LEGNET-S UA-S
Horan economics of consolidation 17 May 2012 Page 19
United spent over 3 years in bankruptcy avoiding solutions for these problems
$1 billion for lawyers/consultants Senior management team stayed in
place Claimed UA would liquidate if Tilton lost
exclusive control of reorganization process
Tilton—total warfareto keep exclusive
management control
Tilton—total warfareto keep exclusive
management control
Court—blockedcompetitive bids,
basic creditor rights
Court—blockedcompetitive bids,
basic creditor rights
Blocked CO merger; Creditor economic rights effectively transferred to Tilton
PBGC wouldn’t fightpension terminationPBGC wouldn’t fightpension termination
After extensive lobbying from Tilton Huge taxpayer liability
Indefensible plan butPilots, Boeing blocked
other creditors
Indefensible plan butPilots, Boeing blocked
other creditors
Tilton plan assumed suspension of laws of supply/demand, permanently cheaper fuel but maintained unprofitable flying and included new aircraft order
Future value of frequent flyer credit card used for financing to protect Tilton control
Surrendered hugevalue to JPMorganSurrendered hugevalue to JPMorgan
Horan economics of consolidation 17 May 2012 Page 20
Transforming industry competition—step 1--United’s bankruptcy
Historically drove capital development and strategic/management change in order to maximize creditor recovery
Historic 21st Century
Chapter 11process objective
Redeploy capital, change strategy/management in order to maximize creditor recovery
Block competing bids and challenges to existing business practices in order to protect incumbent owners/managers
Capital marketdiscipline
Bankruptcy focus on new sources of at-risk capital, competitive bidding
Creditor access to competing independent bids preempted by short term financing
Reorganizationplanning focus
Reorganization plans must identify and address causes of collapse, demonstrate greater productivity and returns on investment
Same operations, competitive approach as before—zero-sum wealth transfer from labor/suppliers to company owners
Justification for major creditor cramdowns
Only when absolutely required for successful reorganization
Wherever managers assert it is necessary
Horan economics of consolidation 17 May 2012 Page 21
United’s weak reorganization plan depressed industry earnings for years
United’s draconian labor cuts did not produce promised profits Excess capacity depressed RASM, profits industry wide
Greatly worsened excess supply of high-cost regional jets Weak industry profits despite huge financial bubble
But United’s plan served as template for all following bankruptcies including Delta, Northwest, USAirways and American Incumbent management protected, little change to business practices Labor cramdowns far greater than required for successful reorganization
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
(25.0%)
(20.0%)
(15.0%)
(10.0%)
(5.0%)
0.0%
5.0%
10.0%
15.0%
Legacy Airline Operating Profits 1993-2007
LEGNET-S UA-S
Horan economics of consolidation 17 May 2012 Page 22
In late 90s, North Atlantic was both highly profitable and strongly competitive
AMSAMS
PARPAR
LONLON
SFOSFO
LAXLAXDFWDFWIAHIAH
CVGCVG
ORDORD
DTWDTW
MIAMIA
ATLATL
IADIADPHLPHL
EWREWRJFKJFK
BRUBRU
MUCMUC
CPHCPH
MADMAD
FRAFRA
ZRHZRHMXPMXP
FCOFCO
2001--7 viable competitive
positions
2001--7 viable competitive
positions
3 non-alliance positions withMegahubs in largest markets
--CO @EWR, --BA @LHRUS@PHL
3 non-alliance positions withMegahubs in largest markets
--CO @EWR, --BA @LHRUS@PHL
4 Hub-to-Hub positionswith Collusive alliances
--NW/KL(AMS)—DL/AF(CDG)--UA/LH(FRA)—AA/SR(ZRH)
4 Hub-to-Hub positionswith Collusive alliances
--NW/KL(AMS)—DL/AF(CDG)--UA/LH(FRA)—AA/SR(ZRH)
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
(25.0%)
(20.0%)
(15.0%)
(10.0%)
(5.0%)
0.0%
5.0%
10.0%
15.0%
20.0%
Legacy profit margins Atlantic vs Domestic 1993-2007LEGNET-D
LEGNET-ANorth
Atlanticalreadystrongly
Profitable
NorthAtlanticalreadystrongly
Profitable
Horan economics of consolidation 17 May 2012 Page 23
“Industry Consolidation” misinformation PR campaign led by United’s Glenn Tilton
There has been no independent (regulatory, media, academic)scrutiny of these “Industry Consolidation” claims
There has been no independent (regulatory, media, academic)scrutiny of these “Industry Consolidation” claims
Inevitable trend towards industry consolidation
Industry growing for decades“Trend” just biggest Atlantic carriers
Industry consolidation driven by market forces
All from government actions; Capital markets not interested
Consolidation OK—lots of competition remains
shorthaul competitive; Intercon always stagnant/getting and worse
Consolidation justified by big scale/scope synergies
No previous merger found synergies; United isn’t too small to compete
ATI always drives lower consumer fares
No verifiable evidence of any consumer benefits since 1999
Alliances create FF and other consumer benefits
Branded alliance benefits falsely attributed to Collusive Alliances
Horan economics of consolidation 17 May 2012 Page 24
North Atlantic Cartel triggered in Europe; United led charge in North America 2002--EU aviation policy shifted from liberal competition to
governmentally managed LH/AF duopoly 2004 AF/KL merger eliminated meaningful price
competition in EU-intercontinental markets United led PR drive and orchestrated sequence of DOT
Antitrust Immunity cases and follow on US mergers
EUEU
Air France-KLM merger 2003/4
US DOT AntitrustImmunity
(pre-mergers)
US DOT AntitrustImmunity
(pre-mergers)
eliminate international competitionDL-NW 2004/07UA-CO 2008AA-BA 2008
US (DOJ)formal
mergers
US (DOJ)formal
mergers
eliminatedomesticcompetitionDL-NW 2008UA-CO 2010AA-US 2012
Horan economics of consolidation 17 May 2012 Page 25
All recent Star/Skyteam/Oneworld ATI depended on DOT’s disregard for the law DOT disobeyed Clayton Act requirement for market power test
No analysis of any pricing data, entry barrier or market contestability evidence
DOT ignored legal requirement for objective evidence—DOJ said DOT merely “copy/pasted” Star applicants unsubstantiated claims
Willful DOT regulatory fraud to justify “public benefits”—rule that eliminating competition automatically cuts consumer fares 15-25% “Double Marginalization” rule—sole basis for every Star/Skyteam/Oneworld
ATI grant—fabrication of a United consultant hired by Glenn Tilton Falsely claims connecting fares fall $200-300 every time ATI granted
(regardless of market condition)—no actual evidence of ATI consumer benefits since 1999
DOT falsely claimed UA consultant paper was settled view of economics profession, thus “rule” allows DOT to ignore any contradictory empirical evidence on prices
Newest DOT regulatory fraud—”metal neutrality” designed to extend collusion to large overlapping nonstop O&Ds Rule created by same UA consultant who fabricated “Double Marginalization”
Horan economics of consolidation 17 May 2012 Page 26
Huge risk to consumers once Cartel, 95%+ concentration in place
Power to drive prices up across the entire North Atlantic
Oligopoly power to make capacity/service cuts cuts airline costs; consumers won’t have a choice
Market “Uncontestable”—zero potential that future new entry could discipline anti-competitive Cartel abuse
Price gouging, oligopoly schedules, creates large pool of artificial, anti-competitive profits for Cartel members
1995 1997 1999 2001 2003 2005 2007 2009Concentration levels of US-Continental Europe market (40 million annual pax)
top 3 share 47% 55% 56% 61% 67% 85% 88% 97%Concentration levels of total North Atlantic market (55 million annual pax)
top 3 share 42% 45% 47% 47% 54% 68% 66% 97%number of total North Atlantic competitors with minimum departure share of 2%
13 13 11 11 9 7 6 3
RapidlyIncreasing
Concentrationafter 2004
RapidlyIncreasing
Concentrationafter 2004
PermanentCartelwith huge
entry barriers
PermanentCartelwith huge
entry barriers
Healthy, Profitable Competition,
even with Alliances
Healthy, Profitable Competition,
even with Alliances
SeriousSerious HUGEHUGEvery lowvery low
concentrationconcentration
Risks toConsumers
Risks toConsumers
Cartel with95%
share
Cartel with95%
share
Horan economics of consolidation 17 May 2012 Page 27
1993199419951996199719981999200020012002200320042005200620072008200920102011201280
90
100
110
120
130
140
150
160
North Atlantic Passenger Fares Rose 3X Faster Than Domestic Fares after radical consolidation began in
2004
DOMESTIC rev/pax
Form
41
Pax R
even
ue/E
mp
lan
em
en
t--in
dex 1
99
3=
10
0
Post-2004 Consolidation createdhuge anti-competitive market power
North Atlantic 1991 2001 2011
Concentration-top 3 51% 47% 98%# Competitors (>2%) 15 11 3
Horan economics of consolidation 17 May 2012 Page 28
Goal is Cartelization of Intercontinental aviation worldwide
DeltaNorthwestUnitedContinentalUSAirwaysAmericanTWAFinnairAustrianSASAlitaliaSwissLOT
Air FranceKLMLufthansaBritish AirIberiaBrusselsAir CanadaAer Lingus VirginTAPCSATurkishBMI
LH-ledCollusive Alliance
AF-led Collusive Alliance
BA-ledCollusive Alliance
26trans-Atlanticcarriers
26trans-Atlanticcarriers
DeltaNorthwestUnitedContinentalAmericanHawaiianCathay PacAir ChinaChina EastChina SouthHainanAir CanadaPhilippines
SingaporeThaiMalaysianJALANAKoreanAsianaChinaEVAQantasAir NZV AustraliaAir Pacific
26trans-Pacificcarriers
26trans-Pacificcarriers
Pacific:Sham US-Japan
“Open Skies”
Pacific:Sham US-Japan
“Open Skies”
Unlike original 90s “Open Skies” designed to massively reduce competition, facilitate subsidies, slot rules and other distortions
Cartel using its control of longhaul access to the huge EU/US markets
worldwide:artificial market
power is key
worldwide:artificial market
power is key
Horan economics of consolidation 17 May 2012 Page 29
Transforming industry competition—step 2—Intercontinental Cartelization
Historically drove capital development and strategic/management change in order to maximize creditor recovery
1980s/90s 21st Century
Who determines number of Intercontinental airlines?
Winners/losers should be determined by consumers, investors
Competition should be governmentally managed
Level of competition vsconsolidation
Maximization of consumer welfare
Protection of large, politically organized incumbents
Key drivers of competitive success
Efficiency, service quality, network
Rent extraction tied to control of alliance franchise; political influence
Purpose of “Open Skies”
Opening longhaul markets to new competitive entry
Massive reductions in competition
Horan economics of consolidation 17 May 2012 Page 30
Transforming industry competition—step 3—Cartelizing US Aviation
Legacy network airlines can’t survive without North Atlantic; DOT ATI rulings gave huge franchise value for 3 companies; totally destroyed the long-term value of the other 3
NW forced to sell itself to DL at near-liquidation value CO could not survive, but had leverage for better merger
terms AA bankruptcy plan assumed cheap US acquisition Legacy precedent led to elimination of LCC competition
(WN/FL)
Big efficiency reduction—capital assets moved to less efficient usesBig efficiency reduction—capital assets moved to less efficient uses
Few anti-competitive pricing impacts until permanent oligopoly secure Few anti-competitive pricing impacts until permanent oligopoly secure
Atlantic ATI meant only 3 of 6 Legacy carriers could survive;huge anti-competitive destruction of competition & corporate value
Atlantic ATI meant only 3 of 6 Legacy carriers could survive;huge anti-competitive destruction of competition & corporate value
“Market forces” did not drive changes—totally due to powerful incumbents petitioning government for reduced competition
“TBTF” airlines—huge barriers to exit, no possibility of new entry
Horan economics of consolidation 17 May 2012 Page 31
AMR’s bankruptcy Nov 2011-Aug 2013
2011 AMR Bankruptcy plan identical to 2002 UAL approach Labor exclusively to blame; labor cramdowns drove all P&L
improvements Assumed exclusive control of reorganization process Absolute protection for incumbent managers, existing strategies Massive new fleet investment despite losses, industry supply/demand
issues Intention to acquire US post-bankruptcy
AMR plan collapsed almost immediately; US merger plan in place in March 2012 Suggests UAL Tilton plan would have also collapsed if challenged Bankruptcy process took another 16 months
US-led merger finalizes Cartel, but better outlook than AA-led Stronger focus on supply/demand, competitive advantage, capital
allocation Process illustrates critical flaw in industry Cartelization
process
Horan economics of consolidation 17 May 2012 Page 32
Counter-revolution vs liberal competition--biggest change in aviation history
Total Domestic USA 1991 1999 2005 2013
Concentration-top 4 67% 63% 58% 87%# Competitors (>4%) 8 8 8 4Total North Atlantic 1991 1999 2005 2013
Concentration-top 3 35% 47% 47% 97%# Competitors (>2%) 15 11 9 3
Not just radical consolidation—complete reversal of economic thinking behind deregulation
Critical role of United Airlines and Glenn Tilton Managing laws/regulations as a political process Attacking entire legal framework (antitrust, bankruptcy,
labor law) purporting to represent the “public” interest Focus on wealth transfer and rent extraction Undermine external discipline of capital markets
Horan economics of consolidation 17 May 2012 Page 33
StructuralGrowthStructuralGrowth
LowerFarescustomer value
LowerFarescustomer value
Pressure to continuouslyimprove capital allocationPressure to continuouslyimprove capital allocation
Innovation andProductivityInfo technologyAircraft technologyAirline Business ModelsSupply Chain Efficiency
Innovation andProductivityInfo technologyAircraft technologyAirline Business ModelsSupply Chain Efficiency
No political barriers to exitOpen corporate control market
Efficient bankruptcy process
No artificial competitive barriers
Limited ownership barriersIndependent capital markets
No labor market distortions
Pricing/market entry freedom
HIGHLY LIBERAL MARKET COMPETITION
Counter-revolution against the drivers of capital allocation and growth
FOCUSED ON
PUBLIC POLICY
REQUIRES
Maximum Benefits for overall (not specific) Consumers/Investors
Maximum Gains Economy-Wide (not individual companies)
Letting Markets pick winners (not governments)
Horan economics of consolidation 17 May 2012 Page 34