Why are airlines always merging?

Previously published Slate articles made new.
April 16 2010 1:20 PM

Why Are Airlines Always Merging?

It's an industry that can't stop moving around.

A Continental airplane. Click image to expand.

Continental and United Airlines are discussing a possible merger this week, as are United and US Airways. In January, Japan Airlines filed for bankruptcy. Five years ago, Daniel Engber tried to explain why the air travel industry always seems to be in turmoil. The column is reprinted below.

Daniel Engber Daniel Engber

Daniel Engber is a columnist for Slate

Delta Airlines and Northwest Airlines declared bankruptcy on Wednesday. United and US Airways are already in Chapter 11, as are the smaller companies Aloha and ATA. Continental went bankrupt in 1983 and again in 1990, and TWA filed three times before disappearing for good. In all, more than 100 airlines have filed for protection against their debtors since the late 1970s. Why do airlines go bankrupt?

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They can't compete with younger rivals. Airlines almost never went bankrupt in the old days, when a federal board controlled every aspect of the industry, including ticket prices and routes. The board would also step in when an airline was about to go under. That kind of government oversight ended with the United States Airline Deregulation Act of 1978, which opened the runways to upstart competitors. Though many of these new airlines went out of business, they had—and continue to have—several advantages over the "legacy carriers" from the pre-1978 era.

The free market pushes business toward the airlines that have the lowest operating costs and thus can afford to have the lowest ticket prices. The legacy airlines—United, Northwest, Delta, Continental, American, and US Airways—pay more to fly their planes than less venerable companies like JetBlue and Southwest. They tend to have an older workforce, with more veteran employees who earn higher salaries and more retirees who get pension benefits. Their union contracts, which are based on a long history of labor-management negotiation, often include more restrictions on how much each pilot or mechanic can be asked to work. Given these higher costs, the legacy carriers have more difficulty competing on ticket prices.

Though some of the big airlines (like Delta and United) have created low-cost subsidiaries, they can't always cut costs enough to be competitive. Rising fuel prices add to their problems; a history of credit troubles makes it more difficult for legacy carriers to guard against oil price hikes by locking in guaranteed contracts.

Airlines seem to go bankrupt more often than any other business, but companies in other deregulated industries, like telecommunications, have followed a similar pattern in recent years. Bankruptcies are also common in commodity industries, where customers are most likely to buy at the best price—steel is steel, no matter who's selling. In the deregulated aviation industry, airline tickets are like a commodity—since multiple carriers serve the same routes, customers will go with whoever's the cheapest.

Why do airlines declare bankruptcy? By filing for Chapter 11 protections, a company gets time to devise a new business plan to pay off its creditors. A bankruptcy judge can impose a new contract—and new wage cuts—on a union, approve the transfer of pension obligations to the federal government, and agree to eliminate some debts altogether.

That said, businesses do what they can to avoid the high costs of bankruptcy. The debtor must pay for its own legal advisers as well as for those of its creditors; the total price of an airline bankruptcy can be hundreds of millions of dollars. If the company can't find enough cash to pay back loans and cover legal fees, it gets liquidated.

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Explainer thanks William Rochelle of Fulbright & Jaworski, Deborah Thorne of Barnes & Thornburg, and John Weiss of Katten Muchin Rosenman.

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