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Mergers in midair

Kai Ryssdal Dec 13, 2006

KAI RYSSDAL: Conventional wisdom for industries in a downturn has been bigger’s the way to go. There was some validation of that today in aviation. More talk of a merger between United and Continental. U.S. Airways has already made a play for Delta. But even within the business there’s no agreement about whether bigger’s better. We’ve called economist Allen Michel at Boston University. Professor Michel, good to talk to you.

ALLEN MICHEL: Good to talk to you!

KAI RYSSDAL: What we would have here, if United and Continental do get together — and we all understand that that’s a very big maybe — is the world’s biggest airline. And the theory goes that when you have the world’s biggest anything, you get a lot of economies of scale. Does that model apply with airlines?

MICHEL: When you really take a look at airlines over the past couple of decades, what you see is that there have been lots and lots of bankrupties. And surprisingly, a lot of those backruptcies have come from airlinenes that have been very, very big. The whole notion of ecomomies of scale and overcapacity is to some degree mythical. And the reason I say that is because there’s not one amount of capacity. Capacity changes — for example, in a lot of the – on a lot of the routes, when you introduce a low-cost carrier, they bring down the prices and you get more, more passengers flying.

RYSSDAL: If everybody agrees that air travel’s essential to the ecomomy — and everybody does — why is it so hard to make money?

MICHEL: The reason that it’s hard to make money is because it’s a prototypical commodity. When all of a sudden, on a particular route, you see some profits, and it’s very easy to get into this business. You know it might seem to the ordinary person listening to the show that Jesus, it’s a lot of money to get into this business. But there’re a lot of people willing to put up money for planes. In tise biz, since 1978 when we had deregulation we’ve had far in excess of 100 carriers file for bankruptcy. And the reason for that is because there’re always these new carries that come in and they say “Let me grab some of those profits.” And the profits get eliminated. There are no consistent long-term profits in this industry.

RYSSDAL: You know it’s interesting you mention deregulation, cuz I was talking to a guy the other day who knows a little bit of something about airlines, and he said — his theory is the only way that anybody’s ever gonna make money in aviation ever again is if the govt steps back in and re-regulates.

MICHEL: Well I think re-regulating is certainly a possibility, however re-regulating is not the answer for the traveling public. The traveling public’s gonna be worse off. When you, when you take a look at air prices today, the price of going from Boston to California to Chicago to Florida, when you take a look at those prices, those prices are low — very low. And what’s caused them to be low? New entrance into the industry.

RYSSDAL: If these mergers do go through, if United and Continental and Delta and US Airways — are we somehow working our way back to the days of the huge legacy carriers?

MICHEL: Surprsiingly I don’t think that’s gonna be the case, because what’s gonna happen is we’re gonna have these big airlines, and then we’re gonna have numbers of people who’re gonna say “You know, there is the possibiliy for us to get into this business,” and before you know it, those profits are gonna be gone, and we’re gonna have competition again.

RYSSDAL: Alan Michel’s a professor of finance and economics at the School of Management up at Boston University. Professor Michel, thanks a lot for your time.

MICHEL: Well thank you, it’s been a pleasure.

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