United Airlines may have 787s, a transpacific gateway hub in San Francisco and a $2 billion cost-and-revenue improvement program that entails removing garlic bread and bulk ketchup from some long-haul flights in BusinessFirst, according to thread in FlyerTalk last week.
However, cracks are starting to appear across its route network as it downsizes hubs and revamps several long-haul routes, and it appears that Wall Street is suggesting further spool-down and retreat from critical markets.
While the practice of airlines cutting unprofitable routes and downsizing hubs is a commonplace industry trend, United has been under fire in recent months for taking it to an entirely different level, which underscores some alarming implications over its shaky future from a network perspective.
From First to Worst: a reversal of fortunes?
When United merged with Continental Airlines, the combined carrier created ten distinct hubs: eight were domestic, with five hailing from United and three from Continental, and two were located in the Asia-Pacific region, with each airline contributing one apiece to the overall table. Across its global network, post-merger United’s hubs stretched from New York/Newark to Tokyo with strategic placements in Washington, D.C. at Dulles airport, Cleveland, Chicago O’Hare, Houston, Denver, Los Angeles, San Francisco and Guam in between.
The airline could not have created a more enviable route map, with fortified presences in the most-heavily populated, densely concentrated metropolitan areas boasting some of the highest-yielding domestic and foreign traffic at key U.S. ports of entry. United had hubs in the nation’s capital, as well as the top three largest cities measured by Gross Domestic Product (New York, Los Angeles and Chicago) and the largest transpacific gateway to Asia and technology hub (San Francisco).
Tokyo and Guam, albeit smaller hubs, provided distinct competitive advantages due to geographic location between the U.S. and Asia, serving as viable connecting springboards to the Pacific Rim. Guam provides critical feed to military destinations as well as lucrative cargo and mail traffic to small Islands in Micronesia.
Although United lacks a distinct hub in Europe, its transatlantic joint venture agreement with the Lufthansa Group and Air Canada, known as A++, covers all of the airlines’ North Atlantic routes and associated connecting flights in a collective revenue-sharing agreement.
Pre-merger Continental and United had not made any drastic changes to their individualized networks during the 5 years leading up to the merger (which closed in 2010). The overall outlook of their respective hubs appeared relatively healthy on paper, and a combination would close gaps across all respective regions, both globally and domestically, once the two airlines merged.
Continental, for instance, was weak on the U.S. West Coast while United lacked fortification in New York and the U.S. South. Outside of the U.S., Continental provided a robust Latin American and Trans-Atlantic network from its Houston and Newark hubs while United did the same across the Pacific from San Francisco.
The trend in the U.S. airline industry, particularly over the course of the past decade, has seen individual airlines exit Chapter 11 bankruptcy protection with revitalized cost structures that enable them to grow their networks, revamp their fleets and defend their marketshares. Following this, consolidation with another airline, such as US Airways and America West, followed by Delta and Northwest, then United and Continental, fills the rest of the holes and allow them to become bigger, more powerful players.
However, mergers, unlike bankruptcy exit, usually do not lend themselves to overall network growth. In fact, quite the opposite occurs: airlines consolidate redundancies across the merged network, swap out aircraft and routes and chase higher yielding traffic from the hubs that generate the highest margins. Obviously, there is a lot of fat to trim as well.
No doubt, medium-tier hub cities are bound to become the first lose out, which is why airports like Pittsburgh, St. Louis, Memphis, Cincinnati and most recently, Cleveland, have all lost their respective hub statuses dating back to 2005. These decisions are tough, painful and yet completely unsurprising.
Generally, most of the wearing is completed within 2-4 years of the merger closure. Delta has chosen to whittle away at Memphis and Cincinnati longer than most people expected, pouring its resources instead towards creating a new hub at Seattle to grow its Asia-Pacific gateway. More recently, United has dumped its Cleveland hub, but alarmingly, the cuts do not seem to stop there.
Although the Cleveland hub remains its most visible, high-profile reduction, there have been other cuts around its network that appear to indicate that its once healthy network is falling into the yellow zone.
In the past 12 months, United has canned three major trunk routes from its Tokyo Narita hub to Hong Kong, Seattle and Bangkok, while down-gauging capacity to Seoul. United has also withdrawn from Doha, Qatar, which it served as a tag-on from its Washington Dulles – Dubai route. From Newark, United has dropped service to Buenos Aires and Istanbul.
Across the Atlantic, United has made seasonal adjustments to several markets in Europe, including converting several routes to Italy and the British Isles from year-round to seasonal. However, it is also cancelling service from Newark to Stuttgart, Germany, which only competes with one other US route on Delta to Atlanta.
Granted, United has added plenty of international markets as well over the same period of time, including Houston to Munich and Tokyo, San Francisco to Chengdu, Tokyo Haneda and Taipei, Houston to Santiago, Los Angeles to Melbourne, and Guam to Shanghai.
However, investor confidence appears to be more focused on which hubs and markets United should cut, or has shrunk, rather than the ones it should grow or is in the process of growing.
That, to me, is problematic, especially in context of an airline that will be entering its 5th year post-merger closing in October 2014. It reflects a gradual loss of faith in network planning decisions, and a grim realization that United’s cost woes and operational deficiency will not permit the carrier to survive against its competition in strategically important markets like D.C. over the long run.
Does it really make sense to shut down, or sizably scale-back, the Dulles hub?
Airline and aviation-affiliated internet interest sites, as well as popular airline business blogs and websites, have been abuzz over the past week over Wall Street analyst claims that United should consider shutting down its Washington Dulles hub, with others stretching further to say that Los Angeles, and possibly Denver, should go along with it.
The voice behind the reason was Bob McAdoo, Imperial Capital analyst and long time veteran who has held several positions at various US-based carriers, from People Express to American. McAdoo contends that Dulles’ close proximity to Newark renders its redundancy, and that the loss of US Airways to American and OneWorld, which operates a robust domestic hub at the more favored Reagan airport closer to D.C., also shifts a large concentration of elite traffic from Star Alliance to OneWorld, thereby eating away at its local loyalty base at Dulles.
At first glance, McAdoo’s thesis was hotly contested by many, but the more and more one analyzes the data, it sort of makes sense. A well-written analysis by Cranky Flier author Brett Snyder provides a good insight into why.
Unquestionably, Washington Reagan National airport is the preferred entry for domestic O&D travelers heading in and out of the metro D.C. area. Dulles provides critical mass to connect international travelers to markets around the globe, but besides O&D, Dulles filled the role of United’s East Coast gateway hub during the pre-merger days.
Since then, times have largely changed. With the domestic short-haul O&D traveling out of Reagan airport, Dulles has lost its ability to sustain traffic to short-haul markets on United. In his research, McAdoo made a comparison between United’s Dulles hub and its former Cleveland hub, arguing that United’s rationale to cut a slew of nonstop markets to Cleveland based on low PDEW (Passengers per Day, each Way) numbers could be similarly applied to Washington Dulles, meaning that United is carrying an ultra-low level of O&D traffic to D.C.
Without the domestic O&D to feed its long-haul operations, United is likely struggling to maintain the entire hub operation at a profitable level.
In theory, one could blame all of this on the nature of competition, but I believe that the real finger pointing should be directed at United management for simply allowing the hub to slip out of their grasp. Even if the Dulles hub was maintained in the pre-merger days to compete with Continental at Newark, the latter is a slot-constrained, highly congested airport that also competes with another major international gateway port into New York at JFK.
The problem gets exacerbated by two potential forces that could weaken United even further at Dulles. The first being Frontier, which plans to add a slew of domestic markets from Dulles to key business markets such as Atlanta, Charlotte, Chicago O’Hare, Detroit, Minneapolis and St. Louis, among other U.S. cities. While Frontier positions itself as a low-fare, ultra-low cost airline, it does feature mainline aircraft and a product pricing and bundling strategy that could appeal to more premium traffic over the likes of someone like Spirit. Compare this to United, who overwhelmingly serves domestic spoke markets from Dulles on 70-seat regional jets, and you have a potential problem.
The next force could be American itself invading Dulles by adding a few key long-haul and transcontinental O&D flights to markets such as London, Frankfurt, Paris, Amsterdam and Tokyo, and suddenly, United feels its long-haul routes at Dulles under severe pressure. The nail in the coffin will be further devaluations with MileagePlus to essentially zap any remaining loyalty ties to United’s program from local D.C.-area residents.
Similar logic could be applied to United’s hub at LAX, which is concerning
Similar logic could be applied to a show-down of American vs. United at LAX further on down the road. Its merger with US Airways has given American the title of #1 carrier at Los Angeles by seats. American has added a slew of regional markets to LAX over the past few years, which are gradually being upgauged in frequency and aircraft, indicating strength of the hub.
In that sense, if American plays its cards correctly, it can cause some real damage to United in Washington, D.C. and Los Angeles. It already has its foot through the door in D.C. from a domestic perspective; all it would need to do is add a few key long-haul trunk routes from there, a la Delta at Seattle, and engage in an all-out marketing blitz.
Unlike Seattle, however, American does not have the advantage of pooling resources into one single airport. Still, metro D.C.-residents need to fly to long-haul markets, and they can only do so from one airport: Dulles. American also has experienced operating split-hub operations in New York between JFK and LaGuardia.
In LAX, the tides already are starting to shift. United operates a large number of high-CASM regional jets and Embraer 120s to small markets along the west coast. As long as United’s unit costs stay as high as they have been in recent quarters, one can guarantee these routes will not stick around much longer in the near future.
When will United executives silence the consultants and researchers and actually take matters into their own hands?
Holly Hegeman, editor of Plane Business Banter, was asked to give her opinion on the matter when a reader asked her in July 7th’s issue of PBB whether McAdoo’s theory had merit to it. Hegeman hit the nail on the head by summarizing it in a single sentence: management consultants can only “fix” so many things:
As Hegeman wrote:
Alas, I fear that a part of the reason the airline continues to struggle here goes back to an argument we’ve made for years. It’s a people/communications/team leadership/we’re in this together problem. Not a problem of spreadsheets, costs, or lines of responsibility. Oh, and then there is the ever-present IT frustrations.
As for the IAD idea, I think there is merit there, yes. I think the airline has been way too slow to change on a network level. To shed the smaller jets. To move to upgauge. And as Bob wrote last week, IAD was originally created to compete with EWR. And it still does. That makes no sense whatsoever.
As time wears on, United continues to lose grap over running an efficient operation. Its #2 competitor, Delta, has been eating its lunch for years now. Its #1 competitor, American, can look to it as a spectacle of what NOT to do as it consumates its merger with US Airways.
In fact, I still maintain that the new American is looking at the situation going on at United and seeing much of its former self. Yet, unlike pre-merger American, United cannot afford a second and third chance at reinvention by merging with another airline and revamping its entire operation. Moreover, the discord between legacy Continental and United employees continues to be bitter and ugly.
When it comes to the structure of its hubs, United was given much more in its post-merger environment than either Delta or American received. The decision to de-hub Cleveland was passable, but Washington, D.C. is not.
United can make some alterations to its Dulles hub, but if it loses its strategic hold on the market to American over the next 3-5 years, that will be an all-time embarassment.