Potential 2008 Merger: Delta and Northwest
POSTED: Tuesday, January 08, 2008
FROM BLOG: Airline Bulletin - Airline Bulletin offers analysis and commentary about the commercial airline industry in the U.S. and abroad.
The following blog post is from an independent writer and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.
This post is the first in a yet-to-be determined number of part series on potential mergers scenarios that may play out over the next 12-18 months. It's important to note that whatever speculation this post may contain may be nullified by a merger announcement, which could include details of the combined operation that conflict with what is written.
Delta is a great merger partner with any legacy carrier for several reasons. The carrier has a very large fleet of widebody aircraft, perfect for profitable international expansion. The carrier also has a large fleet of regional jets, which, despite their higher unit costs (cost per seat to operate) compared to a larger aircraft such as a 737, are preferred in some smaller markets where fuel prices are forcing airlines to use the capacity at their disposal very efficiently and generate both higher yields and load factors. Moreover, the company has a very large hub in Atlanta, facilitating connections to hundreds of destinations, and smaller hubs in Cincinnati and Salt Lake City, both of which are very profitable because the relative lack of competition in both markets (but especially Cincinnati, which has some of the highest airfares in the country), allowing Delta to charge very high fares. Also, Delta is growing its presence in New York City, a perfect market for business travelers, who typically pay higher fares for seats. Finally, because the company has recently exited bankruptcy, its labor costs are relatively low, helping the company to move back into the black even with higher fuel prices.
Delta and Northwest has been talked about somewhat as a possible merger scenario, and it's one that makes a lot of sense. The company, which has exited bankruptcy but still faces challenges with its labor groups and its aircraft fleet, may be one of the more troubled U.S. carriers. Difficulty in securing pay cuts, as well as management arrogance towards employees have resulted in lowered employee morale, as well as a great deal of outsourcing. Northwest still has a lot outstanding of pension obligations that need to be resolved, and that's creating worry in the financial community. But perhaps Northwest's biggest challenge, like that of most airlines right now is soaring fuel prices. And Northwest is in a worse position in this regard than virtually any other US carrier. Primarily because of its aging narrowbody aircraft fleet, as well as its reliance on regional jets, the company uses more fuel than any other major US airline to move passengers one mile. Northwest has a large fleet of DC-9 aircraft, many of which were made over 30 years ago and are very fuel-inefficient, as well as very costly to maintain. With soaring fuel prices, these aircraft will become an increasing burden on the carrier. Top all this off with some of the industry's worst customer service and low loyalty from business travelers, and you get an airline in serious trouble.
Northwest seems to be preparing for its future by increasing its foothold in the Midwest. The company is trying to acquire a large stake in Midwest Airlines, helping to prevent any serious low-cost competition in the region from eroding yields. Northwest has also ordered new aircraft, 76-seat regional jets, for its regional subsidiary Compass, which will serve cities throughout the Midwest with lower labor costs than Northwest's mainline aircraft. Moreover, the company already has a very strong position in Asia, and in particular China, and plans to increase its Chinese presence in the coming years with additional 787 aircraft. Like Delta, Northwest is well-positioned to take advantage of international growth opportunities in the coming years, but unlike Delta, is not well-prepared to deal with many of the other challenges coming its way.
If a merger between the two carriers occurs, there will be numerous changes in the route structure of the combined carrier. Detroit, Salt Lake City, New York JFK and Atlanta will almost certainly be kept as hubs, and Minneapolis is also likely to stay a hub city, though in potentially a smaller form than it's in now. Cincinnati and Memphis are the two wild cards in all this hub reshuffling. Cincinnati is immensely profitable for Delta, and an important base for their Comair regional jet operation, which the company has not spun off yet (although that's certainly possible in a merger deal, as Delta tries to reduce unit costs by flying fewer small regional jets). It's unlikely that Delta will eliminate many of its nonstop flights to larger markets from Cincinnati, but some routes that are operated with regional jets only could get the ax as the new carrier redirects that traffic to Detroit and Atlanta.
Memphis has a much tougher case to be kept. As a city very close to Atlanta, the largest hub in the route structures of both Delta and Northwest, it's in a very poor geographic location for a hub operation. Moreover, Memphis generates relatively little origin and destination traffic, making most of its regional jet service unsustainable if it were to not have many connection opportunities. I expect that the combined carrier will maintain some limited focus city operations in the city, but unfortunately, it may lose a great deal of air service. With domestic growth still slow or nonexistent, and passenger yields lower than on international routes, the new carrier may be reticent to keep many flights from Memphis since the city can't support much point-to-point service, domestic or international. Flights to New York, Washington D.C., Chicago, Los Angeles, as well as some Florida markets may be the only point-to-point service the combined carrier will keep in the city.
The carrier would likely increase its presence in Asia, and use Northwest's Tokyo hub to launch additional flights. Moreover, the combined carrier will move further into Europe and the Middle East. One advantage the company has is that Northwest's Amsterdam hub has nonstop service to many major US cities, and it can be used as a launchpad for services to Africa, the Middle East, and India, competing with major national carriers like British Airways (assuming that the combined carrier could get traffic rights to new routes from Amsterdam, which is not a given). Atlanta and JFK will be increasingly used as international gateways for Europe and South America, and the combined company may develop its Salt Lake City hub to use as a US gateway to Asia, or use one of Northwest' s focus cities (such as Seattle/Tacoma, Los Angeles, or Honolulu) for this purpose.
Fleet-wise, the biggest priority at the carrier is to realign its domestic narrowbody fleet. Northwest operates primarily DC-9s as well as Airbus single-aisle aircraft on domestic routes. Delta, on the other hand, operates MD-88s, as well as Boeing single-aisle aircraft on domestic routes. These two fleets unfortunately are not that compatible, and this will require some reworking. I would expect that given the challenges of high fuel costs, the carriers will develop an accelerated retirement plan, covering older aircraft, and in particular, smaller planes such as the DC-9 or MD-80. Both Northwest and Delta have relatively old 757s that aren't as fuel efficient as newer planes of a similar size, but these are needed for transcontinental traffic as well as some international services and won't likely be dumped soon. The carrier may expand its fleet of 76-seat regional jets, in order to add new jets to Northwest's Compass operations for small-to-medium sized markets. I suspect that while separate subfleets of 737s and A319s/A320s will have to be maintained for the time being, the carrier will eventually shift to the 737 fleet, because it is more versatile, and because Delta owns all their 737s (instead of leasing), and it might be challenging to profitably sell over 70 planes on the used market. Moreover, the carrier may add to its long-haul fleet with additional 787 aircraft (Northwest has already placed an order for 18 planes and placed options for 50 more). If the deal goes through, many of those options could be exercised.
The new carrier will likely shed the Northwest brand and adopt the Delta name. Moreover, it will likely introduce some sort of amenity/product realignment to bring consistency across the fleet. Northwest offers some of the fewest amenities of any US carrier, offering on domestic flights no free food or snacks, no in-flight entertainment (even at a price), and no pillows, blankets, or other comfort amenities. Delta, meanwhile, offers very good in-flight entertainment, including audio, video, and games on all transcontinental flights and many others, as well as new seats in coach on many aircraft. Moreover, Delta offers a higher-quality international business class cabin, with better amenities and service. It's likely that the product will be brought up to Delta standards on many of the newer aircraft in the Northwest fleet, including its A319s, A320s, and A330s.
With a merger, the new carrier will face difficulties competing in the marketplace. For one, the carrier will need to attract the loyalty of more business travelers, who currently flock to several of its competitors including American, United, and Continental. This will need to be done by improving the product offered to customers, especially in premium classes on international flights, as well as improving the frequent flyer program to make it more friendlier to business travelers and easier to redeem for free flights. The elite status program of the new carriers' combined frequent flyer program will have to be made more attractive in order to stoke the loyalty of business travelers who may have been reticent to use one or both carriers in the past. Finally, the company will have to completely refocus itself on making customer service its top priority. The new carrier won't be able to attract more travelers, especially in an increasingly competitive market, without doing a much better job at serving premium class customers on the ground, as well as managing delays for all passengers, given their increasing frequency due to our broken air traffic control system. If the airline can stick to the strategy discussed above, however, then it will be very competitive in the future, both domestically and internationally even with the new reality of high fuel prices.
POSTED: Tuesday, January 08, 2008
FROM BLOG: Airline Bulletin - Airline Bulletin offers analysis and commentary about the commercial airline industry in the U.S. and abroad.
The following blog post is from an independent writer and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.
This post is the first in a yet-to-be determined number of part series on potential mergers scenarios that may play out over the next 12-18 months. It's important to note that whatever speculation this post may contain may be nullified by a merger announcement, which could include details of the combined operation that conflict with what is written.
Delta is a great merger partner with any legacy carrier for several reasons. The carrier has a very large fleet of widebody aircraft, perfect for profitable international expansion. The carrier also has a large fleet of regional jets, which, despite their higher unit costs (cost per seat to operate) compared to a larger aircraft such as a 737, are preferred in some smaller markets where fuel prices are forcing airlines to use the capacity at their disposal very efficiently and generate both higher yields and load factors. Moreover, the company has a very large hub in Atlanta, facilitating connections to hundreds of destinations, and smaller hubs in Cincinnati and Salt Lake City, both of which are very profitable because the relative lack of competition in both markets (but especially Cincinnati, which has some of the highest airfares in the country), allowing Delta to charge very high fares. Also, Delta is growing its presence in New York City, a perfect market for business travelers, who typically pay higher fares for seats. Finally, because the company has recently exited bankruptcy, its labor costs are relatively low, helping the company to move back into the black even with higher fuel prices.
Delta and Northwest has been talked about somewhat as a possible merger scenario, and it's one that makes a lot of sense. The company, which has exited bankruptcy but still faces challenges with its labor groups and its aircraft fleet, may be one of the more troubled U.S. carriers. Difficulty in securing pay cuts, as well as management arrogance towards employees have resulted in lowered employee morale, as well as a great deal of outsourcing. Northwest still has a lot outstanding of pension obligations that need to be resolved, and that's creating worry in the financial community. But perhaps Northwest's biggest challenge, like that of most airlines right now is soaring fuel prices. And Northwest is in a worse position in this regard than virtually any other US carrier. Primarily because of its aging narrowbody aircraft fleet, as well as its reliance on regional jets, the company uses more fuel than any other major US airline to move passengers one mile. Northwest has a large fleet of DC-9 aircraft, many of which were made over 30 years ago and are very fuel-inefficient, as well as very costly to maintain. With soaring fuel prices, these aircraft will become an increasing burden on the carrier. Top all this off with some of the industry's worst customer service and low loyalty from business travelers, and you get an airline in serious trouble.
Northwest seems to be preparing for its future by increasing its foothold in the Midwest. The company is trying to acquire a large stake in Midwest Airlines, helping to prevent any serious low-cost competition in the region from eroding yields. Northwest has also ordered new aircraft, 76-seat regional jets, for its regional subsidiary Compass, which will serve cities throughout the Midwest with lower labor costs than Northwest's mainline aircraft. Moreover, the company already has a very strong position in Asia, and in particular China, and plans to increase its Chinese presence in the coming years with additional 787 aircraft. Like Delta, Northwest is well-positioned to take advantage of international growth opportunities in the coming years, but unlike Delta, is not well-prepared to deal with many of the other challenges coming its way.
If a merger between the two carriers occurs, there will be numerous changes in the route structure of the combined carrier. Detroit, Salt Lake City, New York JFK and Atlanta will almost certainly be kept as hubs, and Minneapolis is also likely to stay a hub city, though in potentially a smaller form than it's in now. Cincinnati and Memphis are the two wild cards in all this hub reshuffling. Cincinnati is immensely profitable for Delta, and an important base for their Comair regional jet operation, which the company has not spun off yet (although that's certainly possible in a merger deal, as Delta tries to reduce unit costs by flying fewer small regional jets). It's unlikely that Delta will eliminate many of its nonstop flights to larger markets from Cincinnati, but some routes that are operated with regional jets only could get the ax as the new carrier redirects that traffic to Detroit and Atlanta.
Memphis has a much tougher case to be kept. As a city very close to Atlanta, the largest hub in the route structures of both Delta and Northwest, it's in a very poor geographic location for a hub operation. Moreover, Memphis generates relatively little origin and destination traffic, making most of its regional jet service unsustainable if it were to not have many connection opportunities. I expect that the combined carrier will maintain some limited focus city operations in the city, but unfortunately, it may lose a great deal of air service. With domestic growth still slow or nonexistent, and passenger yields lower than on international routes, the new carrier may be reticent to keep many flights from Memphis since the city can't support much point-to-point service, domestic or international. Flights to New York, Washington D.C., Chicago, Los Angeles, as well as some Florida markets may be the only point-to-point service the combined carrier will keep in the city.
The carrier would likely increase its presence in Asia, and use Northwest's Tokyo hub to launch additional flights. Moreover, the combined carrier will move further into Europe and the Middle East. One advantage the company has is that Northwest's Amsterdam hub has nonstop service to many major US cities, and it can be used as a launchpad for services to Africa, the Middle East, and India, competing with major national carriers like British Airways (assuming that the combined carrier could get traffic rights to new routes from Amsterdam, which is not a given). Atlanta and JFK will be increasingly used as international gateways for Europe and South America, and the combined company may develop its Salt Lake City hub to use as a US gateway to Asia, or use one of Northwest' s focus cities (such as Seattle/Tacoma, Los Angeles, or Honolulu) for this purpose.
Fleet-wise, the biggest priority at the carrier is to realign its domestic narrowbody fleet. Northwest operates primarily DC-9s as well as Airbus single-aisle aircraft on domestic routes. Delta, on the other hand, operates MD-88s, as well as Boeing single-aisle aircraft on domestic routes. These two fleets unfortunately are not that compatible, and this will require some reworking. I would expect that given the challenges of high fuel costs, the carriers will develop an accelerated retirement plan, covering older aircraft, and in particular, smaller planes such as the DC-9 or MD-80. Both Northwest and Delta have relatively old 757s that aren't as fuel efficient as newer planes of a similar size, but these are needed for transcontinental traffic as well as some international services and won't likely be dumped soon. The carrier may expand its fleet of 76-seat regional jets, in order to add new jets to Northwest's Compass operations for small-to-medium sized markets. I suspect that while separate subfleets of 737s and A319s/A320s will have to be maintained for the time being, the carrier will eventually shift to the 737 fleet, because it is more versatile, and because Delta owns all their 737s (instead of leasing), and it might be challenging to profitably sell over 70 planes on the used market. Moreover, the carrier may add to its long-haul fleet with additional 787 aircraft (Northwest has already placed an order for 18 planes and placed options for 50 more). If the deal goes through, many of those options could be exercised.
The new carrier will likely shed the Northwest brand and adopt the Delta name. Moreover, it will likely introduce some sort of amenity/product realignment to bring consistency across the fleet. Northwest offers some of the fewest amenities of any US carrier, offering on domestic flights no free food or snacks, no in-flight entertainment (even at a price), and no pillows, blankets, or other comfort amenities. Delta, meanwhile, offers very good in-flight entertainment, including audio, video, and games on all transcontinental flights and many others, as well as new seats in coach on many aircraft. Moreover, Delta offers a higher-quality international business class cabin, with better amenities and service. It's likely that the product will be brought up to Delta standards on many of the newer aircraft in the Northwest fleet, including its A319s, A320s, and A330s.
With a merger, the new carrier will face difficulties competing in the marketplace. For one, the carrier will need to attract the loyalty of more business travelers, who currently flock to several of its competitors including American, United, and Continental. This will need to be done by improving the product offered to customers, especially in premium classes on international flights, as well as improving the frequent flyer program to make it more friendlier to business travelers and easier to redeem for free flights. The elite status program of the new carriers' combined frequent flyer program will have to be made more attractive in order to stoke the loyalty of business travelers who may have been reticent to use one or both carriers in the past. Finally, the company will have to completely refocus itself on making customer service its top priority. The new carrier won't be able to attract more travelers, especially in an increasingly competitive market, without doing a much better job at serving premium class customers on the ground, as well as managing delays for all passengers, given their increasing frequency due to our broken air traffic control system. If the airline can stick to the strategy discussed above, however, then it will be very competitive in the future, both domestically and internationally even with the new reality of high fuel prices.
