Wednesday, April 16, 2008

Bigger is not better

Reading about the proposed Delta-Northwest merger brings the reminder that bigger is not always better.

Big companies (like Cisco or Oracle) buying little tiny companies allows the small companies liquidity, distribution, end-to-end integration and economies of scope. The buyer can (and often does) botch it up, but there’s a possibility there for creating value.

Big companies buying other big companies is almost always a losing proposition, with myriad potential incompatibilities such as corporate cultures, information systems, sales channels and incentive systems. The CEO gets to move up in the Fortune 500 rankings, but other than that, there’s rarely anything to recommend it.

When you merge airlines, you get to add union troubles and equipment maintenance. Northwest and Delta still haven’t solved their union problem — and for that matter, neither have US Air and America West, which merged in 2005. Meanwhile, the two airlines have the most incompatible fleets in the country, with 800 planes spread across nearly every Airbus, Boeing and McDonnell Douglas plane made. Despite what the management claims, having differing planes add complexity, inflexibility and limits knowledge reuse for pilots, mechanics and maintenance hubs, among the most important assets of any airline. Added to that is that some Northwest DC-9s are more than 40 years old, fuel inefficient and long overdue for replacement.

Scott McCartney of the WSJ this morning has a marvelous article about all the problems of mergers over the past 40 years. (An article that the WSJ is sharing free). Here are the payoff paragraphs:

"The track record of airline mergers is checkered, with few examples delivering on promised benefits," Standard & Poor's airline analyst Philip Baggaley said in a research report.

UAL Corp.'s United Airlines bought Pan American's Miami hub and South American routes -- and lost all of it to competitors. Delta bought Western Airlines and a hub in Los Angeles, and has little to show for it except a nice, underutilized terminal at Los Angeles International Airport. Delta/Western carried 12.4% of all passengers at LAX in 1988, the first full year after their 1987 merger. Last year, Delta had just 7.6% of the passengers at LAX. And Delta/Western is considered one of the more successful airline mergers.

AMR Corp.'s American Airlines bought AirCal and Reno Air to compete up and down the West Coast, but nearly all of that flying has gone to other carriers. US Airways Group Inc. bought Pacific Southwest Airlines on the West Coast and wiped the smile off of PSA planes. The result was the same -- US Airways retreated from the West Coast.
In McCartney’s article, one expert flatly predicts “If Delta and Northwest merge, in a couple of years they will be smaller than they are today as separate entities.”

The lesson for airlines is the same as for tech mergers: if you have a troubled company prior to the merger, the merger isn’t going to fix the underlying problems. But it will introduce confusion, chaos and uncertainty to a company that already has problems. And perhaps introduce ambiguity about CEO performance that allows him (her in the case of Carly Fiorina) to keep his/her job for another few years.

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