The Possibility for a Merger between US Airways and American Airlines - Essay Example

? I. Introduction The airline industry is currently in what can be identified as the shakeout phase as indicated by late growth rates. This is empirically represented through waning growth. Survival has encouraged industry consolidation tactics by organizations in order hold on to certain domestic markets and to expand into new international territories. Delta’s consumption Northwest, and the merger between AirTran and Southwest have spurred negotiations between other companies including US Airways and American Airlines. The airline industry has dramatically changed since the US began to deregulate in 1978. Before this governments believed this was a nascent industry that needed its protection. However, over the last three decades the industry has become highly competitive forcing many carriers to operate on thin margins. In fact, four of the six legacy carriers filed for Chapter 11 bankruptcy over the last ten years. American Airlines and Continental were the only two that did require bankruptcy protection (Harrison, 2010). US Airways is experiencing aggressive growth which is a consequence of its recent negotiations with other firms within the market. Specifically the Delta Slot Transaction whereby US Airways entered into a mutual asset purchase and sale agreement with Delta (Esterl, 2010). Pursuant to the agreement, US Airways would transfer to Delta certain assets related to flight operations at LaGuardia Airport in New York, consisting of 125 pairs of slots currently used to provide US Airways Express service at LaGuardia. Delta is expected to transfer to US Airways certain assets related to flight operations at Washington National Airport, including 42 pairs of slots, and the authority to serve Sao Paulo, Brazil and Tokyo, Japan. The agreement is structured as asset sales and is anticipated to be cash neutral to US Airways. The net benefit to the transaction is the restructuring of U.S Airways to focus its strategy and meet the growing demand. The agreement must be approved by the U.S. Department of Justice, the DOT, the FAA and The Port Authority of New York and New Jersey. If approved, this transaction will significantly increase US Airways’ capacity in the Washington, D.C. market and improve profitability(Gibbons, 2007). US Airways is experiencing slow growth coupled with an improving competitive market position. This means that US Airways is going through a phase of concentrated growth. The Frequent Traveler Program is a great method for the company to focus on their local hubs and create loyal consumers in those markets. This will undermine the low transfer cost and incentivize ticket purchasing through their company. This program helps generate a loyal consumer base and helps differentiate between airline services. Focusing on this program is key to brand development for US Airways. The Dividend Miles program credits passengers who fly on US Airways and Star Alliance carriers. Credits can be redeemed for travel on US Airways or other participating partner airlines, whereby US Airways assumes the fee. The incremental cost method is used to account for the portion of frequent traveler program liability related to mileage credits earned by Dividend Miles members. This creates an obligation to provide future travel when credits are redeemed (Gross, 2007). II. Company Strategy The possibility for a merger between US Airways and American Airlines have been stifled twice before, but renewed interest in the merger possibility has been created as a result of economic re-stabilization. But the two companies are currently in merger talks that would make US Airways the second largest airline. The industry reported a $60 billion dollar loss since 2000 which has spurred interest in consolidation. Even with the dramatic declines in capacity by airlines collectively, in recent years, experts believe that there are too many airlines and a shortage in travelers. A merger could help both increase the earnings per share in a smaller timeframe than either company can accomplish alone. The industry is fragmented alongside of a oligopoly where power is concentrated at the top of the industrial organization. The viability of substitutes is contingent on the capacity of consumers to consume as well as the distance of expected travel. Despite the excessive capital requirements for new entrants into the market; the industry remains attractive to new entrants because of the ability to fund starts through the accumulation of liabilities. The industry offers moderate purchasing power to consumers. This means that the supply side of the industry benefits from consumer interactions. Aircraft manufacturers, fuel providers, and laborers have substantially more bargaining leverage than consumers (Gonzalez, 2007). The population growth rate for key cities within the U.S. have shown signs of renewed growth. As the replacement ration for the cities have began to tip over the 1:1 indicator of absolute stability, the domestic population has recently experienced birth rates exceeding the mortality rates. The opportunity that increased populations offer the airline industry it the potential for increased demand for air travel. In terms of operations management, companies can easily identify new markets and restructure to be more competitive in such markets. The U.S. Census bureau predicts that over the next 20 years this growth will be concentrated in the South Eastern region of the U.S. Price wars, supply side leverage, operational costs, and economic interconnectivity force individuals within the industry to maintain profitability. Shifts in the economy are extremely effective in terms of their impact on consumers in the airline industry. Airline companies operate on the margins of the cash flow without providing any buffer room in the organizational cash flow. The industry is also expected to realize new growth potentials over the next 5 years and demand is expected to exceed it current capacity to supply which means that incumbents are able to expand which makes the market more attractive. But the industry remains unpredictable which is a primary factor contributing to their unattractiveness. The weakest of the major airlines, US Airways is positioned to become a major player in the airline industry. This is specifically because the organization remains flexible and is capable of adjusting to meet new population trends. Additionally the propensity for mergers and codeshare agreements make the market potential for US Airways greater. A merger between U.S. Airways and American Airlines would benefit both companies and create one of the largest fleets in the airline industry. U.S. airways has a dominant presence on the East Coast of the U.S. and has a great base for international flights. American Airlines offers the potential for the company to expand westward and capitalize on a greater share of the market (Gilbertson, 2007). As air travel becomes increasingly competitive. US Airways is considered the financially weakest of the major American carriers. With a focus city at Ronald Reagan Washington National Airport, US Airways has struggled to capture a definitive corner in the airline industry. To accomplish those ends, the US Airways considered a merger with a leading competitor, United Airways. Unfortunately, those negotiations fell through in April of 2010. In terms of the organizations future ability to compete in a market that experiences rapid patterns of change and restructuring, the inability to merge their future is unpredictable, which consequentially makes their stock appeal more speculative. But experts argue that this leaves the door open for a potential merger with American Airlines which is perhaps a more stable fit in terms of the company that would emerge post merger (GAI). III. Regulation Airlines purchase assets that have low levels of liquidity because airplanes are difficult to sell. The fact that exit strategies are difficult to implement within the industry, investors are less likely to pursue the risk associated with the airline industry. This also means that access to equity is unlikely in the airline industry. Since firms are less likely to exit the market it makes mergers and alliance membership more attractive to its members. Utilization of fixed assets is critical to profitability in the airline industry (Galunic, 1998). Certain costs within the industry are fixed against corporate revenue which means that expenditures for airline companies are fixed and they must operate above those levels. The maintenance of fixed assets is costly for airline companies as organizations are routinely required to spend capital on the upkeep of their fleet. Assets owned by US Airways accumulated depreciation as a percent of PPE at a rate of 24%. That reporting is 4% higher than the lowest of the top 5 major organizations. The PPE is more indicative of the age of a fleet as opposed to the efficiency of the company as a whole. The managerial staff should focus on increasing the efficiency of its existing fleet before it attempts to consider fleet expansion through mergers or the purchase of new assets (Gates, 2006). IV. Justification Mergers in the airline industry have been difficult to pull off, in part because complex labor contracts can offset the promised cost savings (Hoffman, 2011). Delta and Northwestern recently merged, creating the nation’s largest carrier after two years of implementation. William S. Swelbar, (research engineer at ICAT based at MIT) explained that “The success of the Delta-Northwest merger is reinvigorating consolidation discussions in the industry,” A factor contributing to the success of that merger was the seniority plan and new collective bargaining agreement with the pilots, negotiated between the two companies, enabling the two companies to integrate their operations faster and more smoothly (Sorkin, 2010). US Airways still has yet to integrate pilot seniority since its merger with America West in 2005. The labor issue could turn out to be the biggest hurdle to overcome in any merger with United. V. Financing Airline companies can optimize their cash flow by accumulating debt. This means organization can purchase more assets and leverage their profitability against the debt accumulated. Companies who have excessive liabilities are less capable of gaining access to lines of credit because of the risk associated with extending them creditor. Even if such companies can gain access to new credit sources the interest is likely to be higher because of the increased liability posed. The following chart indicates this ratio and numbers above 1.0 indicates that the company has a has a negative price per share. The equates to the organization owning more liabilities than assets. In 2009, US Airways reported roughly 3.0 meaning that its debts were roughly 3 times their assets. Since US Airways does not pay out dividends, it retains all of its earnings which means that the companies stock value suffered as a consequence. If they do not improve this ratio they will have a very difficult time accessing the credit markets, which is imperative for them considering their current liabilities exceed their current assets. A two year snapshot of the United States airlines industry forecast a market value of $245 billion, 27.5% over 2008 earnings (Corridore, 2011). In order to accomplish those numbers the airline industry would have to generate and annual passenger volume of 891.7 million, equating to an 11% aggregate demand growth rate from 2008. This is a competitor strength because they are able to expand to meed this demand through merging. Most airlines have contracts with labor unions which makes merging with US Airways complex because its lacks labor constraints. Such constraints may be unattractive to their employees. VI. Defense Tactics US Airways is trailing behind other companies and is considered the least competitive. A merger is key to increasing investor confidence in the company to help procure increase equity thats becoming increasingly finite.The airline industry has been forced to charge consumers for checking luggage in attempts to maximize amount of income per pound. This means that the airline industry could capitalize on the excess in weight capacity and potentially offer more seats per transport. US Airways is unable to compete with the price for luggage check in because its fleet fails to compete in terms of total carrying capacity. VII. Implementation One huge disadvantage to a merger between US Airways and American Airlines is the resulting managerial structure after the merger. There can only be one CEO and neither wants to give of the position. While the board of directors reserves the right to choose the CEO each has a seat on the board at each company. The consolidation of the executive level positions will be critical to keeping the cost down. Another negative aspect of a merger would be the cost of converting to the new name (Hogan, 2007). It would be best to maintain one of the companies brands in order to decrease to collective cost of transition. Uniforms and planes have to be converted as well as signs at the terminal. Finally, it will be difficult to restructure the organization to identify where the new focus hub should be since each company maintains a hub in their own specific markets. VIII. Risk US Airways has the potential to be the most dominant player in the market. Facing a potential supply shortage, the organization would be able to increase its earnings per share through a merger with American Airlines. This could help stabilize the company and would make it the second largest in the industry. It seems that international growth, fleet expansion, and/or merging with legacy member is key to the companies ability to survive the consolidating industry in a contracting economy. Hence the key to success for US Airways and American Airlines will be found in their ability to generate enough revenue to either expand their fleet or to attempt strategic acquisitions of smaller firms operating in strong local markets. IX. Summary Over the last decade the industry has experienced a great deal of volatility due to fluctuating oil prices, deep recessions and unforeseen terrorists attacks and natural disasters. Nevertheless the industry continues to grow and serves an imperative function in our global economy. The airline industry has been forced to balance product quality with prices which is another factor that indicates late growth. US Airways, United, Delta and Northwest were all forced into Chapter 11 bankruptcy between 2001 and 2005. Over the last 5 years the United States airline industry has grown at an annual rate of 9.3%. Analysts anticipate that the domestic airlines industry will service approximately 891.7 million passengers in 2013, an increase of 11% (Datamonitor). X. Conclusion An analysis of the strengths, weaknesses, opportunities and threats facing the airline industry indicates that the opportunities outweigh the threats making it a viable market. But the strength of US Airways also outweigh its weaknesses, which makes it more likely to remain a dominant player in the airline industry for years to come. Specifically, the organizational structure is flexible enough to be integrated into other firms. The lack of labor union contracts makes it ideal because the organization only has to mediate with the labor union of one firm as opposed to labor unions being forced to mediate outside of the firm. This means that US Airways still has leverage over its employees. But also the companies use of codeshare agreements as a platform for expansion has made it a dominant provider of passenger air craft services. References Airlines in the United States Industry Profile."Datamonitor.web.ebscohost.com/online.library.marist.edu (Accessed November 18, 2010). Corridore, Jim . "Airlines- How to Analyze an Airline." Standard & Poors. www.netadvantage.standardpoor.com.online.library.marist.edu/NASApp/NetAdvantage/showIndustrySurvey.do?code=air (accessed April 18, 2011) Esterl, Mike. "More Business Travelers Now Teleconference, Fly Coach." Wall Street Journal (NY), February 19, 2010. http://online.wsj.com/article/ (accessed November 18, 2010). Gates, Dominic (18 May 2006). "Clean engines, wings that fold: Boeing dreams of futuristic jets". The Seattle Times. http://seattletimes.nwsource.com/html/businesstechnology/2002973147_boeingconcepts05.html. (accessed April 18, 2011). Galunic, D.C. and Rodan, S. (1998). Resource recombinations in the firm: knowledge structures and the potential for Schumpeterian innovation. Strategic Management Journal 19. p. 1193–1201. Gibbons, Christia (2007-28-27). "US Airways pilots at odds over contract". The Arizona Republic. http://www.azcentral.com/arizonarepublic/business/articles/0821biz-usairways0821.html. (accessed April 18, 2011) Gilbertson, Dawn (February 1, 2007). "US Airways' hopes dashed". The Arizona Republic. http://www.azcentral.com/arizonarepublic/business/articles/0201biz-usairways0201.html. (accessed April 18, 2011). Gonzalez, Angel(2007-08-30). "Boeing/aerospace | To go green in jet fuel, Boeing looks at algae | Seattle Times Newspaper". Seattletimes.nwsource.com. http://seattletimes.nwsource.com/html/boeingaerospace/2003858756_boeingenergy30.html. (April 18, 2011). Gross, S./Schroeder, A. (Eds.): Handbook of Low Cost Airlines - Strategies, Business Processes and Market Environment, Berlin 2007 Harrison, Steve (August 5, 2010). "Feds approve US Air service from Charlotte to Sao Paulo". CharlotteObserver.com. http://www.charlotteobserver.com/2010/08/05/1604032/feds-approve-us-air-service-from.html. (accessed April 18, 2011). Hilfman. Dave “United Presentation” (presentation at Marist College, Poughkeepsie, New York, October 7, 2010) Hitt, Michael A..Strategic Management: Competitiveness and Globalization, Concepts and Cases, 8th Edition. 8 ed. Mason: South-Western, 2008. Hogan, Donna (2007-01-11). "US Airways ups the ante to woo Delta creditors". East Valley Tribune. http://www.eastvalleytribune.com/index.php?sty=82133. (accessed April 19, 2011). Hoffman, Tony. "U.S. Bans Large Printer Ink, Toner Cartridges on Inbound Flights". PC Mag. http://www.pcmag.com/article2/0,2817,2372313,00.asp. (accessed April 17, 2011). Hofmann, Kurt (12/12/08). "Star adds Brussels Airlines, targets up to 50 members". ATW Online. http://atwonline.com/airline-financedata/news/star-adds-brussels-airlines-targets-50-members-0309. (accessed November 18, 2010). Holder IV, Floyd William (2009). An Empirical Analysis of the State’s Monopolization of the Legitimate Means of Movement: Evaluating the Effects of Required Passport use on International Travel. (M.P.A. thesis). Texas State University-San Marcos. OCLC 564144593. Docket Applied Research Projects. Paper 308. Read More