Mergers Might Save the Airlines

A partner of Smith, Barney & Company, WILLIAM BARCLAY HARDING is a member of an investment banking family. His great-grandfather, Jay Cooke. of Civil War fame, started with canal financing and later financed railroads. His father was active in railroads and highways. Mr. Harding’s main interest is air transportation.

WILLIAM B. HARDING

Nor long ago, after visiting Los Angeles, I trudged the quarter-mile path through one of the new terminal buildings and returned to New York aboard a big jet almost half empty. Our airborne passenger load was exactly 54 percent of capacity, which tells the familiar story of too many airlines, too many seats, and too few passengers. In the golden era of jet travel, the airline industry is deep in the red. Huge stakes are involved in this paradox: deficits supplanted profits while revenues ran above those of pre-jet years.

Everyone who can read, look at television, or listen to radio now knows about the jets themselves — 600-mph speeds and statistically safer than before. But not so many people realize that for these technological masterpieces, each costing roughly from $5 to $7 million, large segments of the industry have stretched their financial credit to the limit. Or that — and this is more significant — it is proving hard to stem industry-wide losses, which reached $36 million for 1961.

There have been three revolutions in air transportation. Lhe first occurred in the 1930s, when a cross-country and overseas passenger system was developed from pioneering airmail contracts. In the aphorism of Wilfred Owen of the Brookings Institution, we attained the capability of going everywhere because the air is everywhere.

The second revolution was the explosive growth of the 1950s. As the airlines overtook buses, steamships, and trains, piston-engined aircraft by their efficiency carried more and more human traffic more and more economically. Then, with handsome earnings and overoptimism, the airlines zoomed into the jet age, eagerly overbuying the new planes. Because of rapid technological progress and intense competition, the companies are almost forced to buy new equipment as soon as it is available, just to keep even in the competitive race. As Ralph Damon, former TWA president, once said, “When you’re running an airline you always seem to be in a race between technology and bankruptcy.” Soon there were 130 passenger seats for each 100 hitherto available. Meantime, the government, through the Civil Aeronautics Board, permitted the rivalry for air routes to be sharpened to a razor-honed edge.

We are caught up in the third revolution today, with all major airlines compelled to reduce costs, to beg for new markets, and to improve the reliability of service. Of all the difficult problems with which the industry has to cope during this period, the most difficult is the high degree of competition, one solution to which might be healthy mergers; and this is becoming more and more apparent to an increasing number of people. The logic points to the eventual conversion of our eleven domestic trunk lines into five or six resourceful, vigorous operators, and of our overseas operations to a single international carrier. But between our present predicament and the promised land, where fewer airlines mean better air transportation, there are, as we shall see, stubborn obstacles.

In any reorganization we begin by acknowledging that our national defense depends on the airlines as a key communications network and a ready reserve of men, equipment, experience, and skills; in short, an industry whose well-being at all times is crucial to the security of the United States. Nor does it take a professor of economics to prove that the punctually scheduled transportation of men, mail, and matter by air is vital in peacetime to the daily bread of each of us, whether we fly or not.

Today the airline industry employs 171,000 persons. Dependent on it for jobs are hundreds of thousands employed in the manufacture of aircraft and electronic gear and in supplying component equipment, fuel, and supporting services. And also deeply concerned, and entitled to a fair return, is the multitude of investors who have become shareholders in the airline companies, directly or indirectly. Banks and insurance companies, with their millions of depositors or policyholders, have lent airlines more than two thirds of the money with which to buy equipment. They, too, have a big stake in air transportation. It is often said that no other major industry relies so much on borrowed capital.

THE airlines, as policed by the Civil Aeronautics Board, do not function under free-market conditions. The CAB determines which ones are allowed to operate over what routes and at what fares. From its 1938 origins, the enabling law charged the CAB to provide “competition to the extent necessary to assure the sound development of an air transportation system properly adapted to the needs of the foreign and domestic commerce of the U.S., of the postal service and of the national defense.”

Exerting its powers to spur competition, the CAB put five or more carriers on twelve major routes, and one route, New York to Washington, had as many as nine. Carefully examining CAB decisions, Federal Judge Henry J. Friendly observed that “competition to the extent necessary” thus became “competition is necessary unless proved to be unnecessary.” As time passed, the CAB gave weak systems good routes in direct rivalry with the strong lines, not so much because additional service was required, but mainly in the hope that this would divide up the available traffic in a way that would help the weaker carriers to survive. Too often this policy hurt both the weak and the strong. Again and again it seemed like tearing up the floor for kindling and, even so, failing to keep the house warm.

Yet much of what went on was rooted in emotion and provocative experience within the industry. It became almost a habit for executives who wondered how far airlines might develop to feel that they had only to glance back at how far they had come and how swiftly, and then project that rate of growth into the future.

By any gauge, the majority at the top were and are aggressive men. William A. Patterson, who heads United Air Lines, our largest carrier; Juan T. Trippe, president of Pan American World Airways; C. R. Smith, president of American Airlines; and Captain Eddie Rickenbacker, our ace of aces in World War I and chairman of the board of Eastern Air Lines, all had exactly the blend of courage, belligerency, and foresight necessary to their trail-breaking roles.

It is difficult to assess the influence of the maverick Howard Hughes, who is both an aviation pioneer and a veteran motion picture producer. The only certainties about him are his wealth, his eccentricity, and his desire to exercise a very personal brand of control over anything in which he has an interest. He owns 78 percent of TWA and a controlling interest in the industry’s misfit, Northeast Airlines. Financing the high cost of new jets led to repeated crises for Mr. Hughes; there was an enforced interruption of his management of TWA, and now a court battle is in progress, the outcome of which will determine whether he can again hold sway over America’s fourth largest air carrier.

For years, throughout the whole air-transportation industry, there has been hot competition among individuals to stake out more and more air routes for conquest or self-defense. Captain Rickenbacker, for example, first proposed a southern transcontinental route and fought a long and exhausting battle to obtain it, only to see the CAB award it to two rivals. As if the intensely competitive pattern compounded by the CAB were not problem enough for the sixties, it is now also plain that some prime sources of traffic were mined out, though perhaps temporarily, nonetheless at precisely the juncture when more and more jets were ordered in anticipation of what was thought to be a limitless growth rate.

At once, many began spending more energy and money to win passengers away from one another. Surveys explored what perfume stewardesses ought to wear or whether the regular passenger likes his steak bleu rare. Special gifts of money clips, change purses, compacts, or any momentary novelty were used to tempt passengers. Battles raged over the quality of free champagne, and even over the size of a sandwich. Elaborate ticket offices were scattered around major metropolitan areas, their neon signs glaring at each other from opposite street corners. Very expensive, too, were the companies’ efforts to outdo one another in lavish terminals, sometimes so ornate they resemble world’s fair exhibits and so large that your feet are worn out when you reach a $70,000 loading ramp, on which your final steps are cushioned in red carpet. At heavy cost, a multiplicity of aircraft designs are tailored to the engineering tastes of the individual lines to set up small differences in speed or seating. On their longest flights, two companies have shown first-run movies, although, on questioning, one sponsor surmised that the films annoyed more people than they pleased. But, he concluded, it is a wonderful new gimmick for competitive advertising.

Judging by results, one is justified in challenging this conclusion. Only a marginal portion of the market is deceived by excessive luxury, much less by transparent gimmicks. Last year more than half of all first-class air travelers shifted into the lowerrate coach class. It seems to be dawning on everybody concerned that most people do not choose an airline for its cuisine. Nor are many travelers sold by published promises of slightly faster journeys among jet equals. Writing in the Reader’s Digest almost forty years ago, Earnest Elmo Calkins, with deep insight, pointed out “the remarkable effects of advertising upon those who use it. It lays the advertiser under the necessity of living up to his advertising.”

I know that when I check an airline’s on-time performance and allow for the intervening traffic patterns and transit to and from airports, I am not convinced that the slightly faster airplane will necessarily deliver me earlier to my destination. It is a truism, being grasped at long last, that people fly to get from one place to another with reliability, convenience, and reasonable cost. Speed is, of course, the primary product that the airlines have to sell; but as advances in technology shorten the flight time between terminals, the frills and extras become less important.

Within recent years, airline executives have been aware that an endless fight over wasteful frills could perpetuate deficits, and that airlines.by neglecting earnings, would risk losing the indispensable confidence of investors. But the intensity of the competition, which the CAB has so far failed to recognize as excessive, has prevented the airlines from doing much to change their ways. Those who carry the heavy responsibilities of management spend sleepless nights wondering if the airlines will followthe pattern of the railroads, inviting chronic illness, decay, closer regulation, political panaceas, and the rest.

For 1961 the traffic growth rate was only a fraction of that of 1959. Sharp gains in the fifties had largely resulted from the switching of passengers away from buses and trains. But all the common carriers are now faced with increasing competition resulting from the expansion in intercity travel in private autos, which has been made possible by the superhighway program. Looking ahead, the airlines, whose traffic is 65 percent business travel, see and ponder the effect of telephones with picture tubes attached which will show, right in the office, who is buying or selling on the other end of the line.

DESPITE these negative factors, the potentials are still very great. Seven out of every ten adults have never been off the ground, and perhaps nine out of ten are not yet habitual air passengers. Approaching them, the industry requires a clearer use of the one-two-three rhythm of an apt product, market research, and mass selling. Of this the industry is well aware. But most important of all to the development of a mass market is cost, and cost reduction is stymied by excessive competition.

Walter H. Johnson, Jr., one of the better-known marketing experts experienced in air transportation, has wisely cautioned against the false concept that fare reductions alone will attract profitable traffic. He said. “Lowering of fares has to be accompanied by something that makes people want to fly. Without that, you could have a futile exercise of impressive fare cuts so sharp and radical the industry can’t economically afford them.”

An example of a successful compromise is the shuttle of Eastern Air Lines, every hour on the hour, carrying about a million passengers a year, or 42 percent of all flying between New York, Washington, and Boston. Passengers make no reservations but are always sure of a seat; they wheel out their own baggage, pay a moderate fare on board, and if they toast the highly punctual record, it is done in plain water. For the peak hour on one holiday, six extra sections were scheduled beforehand. By itself, the shuttle, says Eastern, is “solidly profitable” to carrier and customer. Some enthusiasts have looked upon its growth and called it the greatest invention in air transportation since the airplane.

Fundamentally, despite clearer objectives and applied ingenuity, some airlines are beset with overcompetition to such an extent that mergers may be the only solution to their problems. C. E. Woolman, president of Delta Air Lines, sixth largest of the airline companies, once said: “If you put three cows in a pasture where there is only grass enough for two, they all get thin.” Delta itself ably serves much productive mileage with moderate competition, but Mr. Woolman’s pithy remark well expresses the necessity for merger actions to reshape the industry.

Last year, when Capital Airlines faced bankruptcy, the requisite CAB approval permitted its absorption by United Air Lines, thereby making UAL the largest carrier, serving a quarter of the domestic traffic carried by major airlines. (Allowance for local service and nonscheduled traffic would reduce the figure slightly.) In a frank view, UAL was interested only if permitted to take over Capital’s full routes, which the CAB had successively inflated. And at the time of Capital’s crisis, the CAB found no practicable alternative to the merger.

When these words are read, the CAB will be nearing its decision on the pending merger of Eastern with American Airlines, joining LastWest and North-South services for about a third of the domestic traffic. The economic combination would enable far more effective utilization of fewer planes and eliminate some duplication in routes and facilities. In recent years American has had nominal earnings, and Eastern, heavy losses. American’s President Smith suggests that instead of raising prices, as occurred last February, merger savings either should assure the consumer stable fares or offer him reductions.

The merger has been criticized by its opponents inside the industry principally on the grounds ol size. However, almost all of the industry critics, recognizing the realities of life, are busy talking about mergers of their own.

The idea that size alone assures a competitive advantage is refuted by the immediate experience of some of the airlines. Not only Delta, but Northwest, Braniff, Western, and Continental have proved wrong the frequently made assumption that when two lines compete within the same market, the larger will predominate and make more money. By the earnings of recent years, these smaller five have emphatically done better than their larger rivals. There is no magic formula for redistribution of air traffic equally among five or six combined corporate units. Time and again, the true measure of economic viability and consumer convenience has been shown to be dependent on logical route patterns, good management, and moderate competition.

The sharpest and perhaps most significant attacks on mergers from outside the industry have been those of politicians claiming to defend the little man against some supposed Goliath. It is not generally realized that competition between domestic airlines is almost exclusively an American idea. Domestic air transportation in virtually every other country in the world is a regulated monopoly, like our telephone company. While a policy of competition has been established in this country, the CAB has the power to exempt air carriers from the terms of the Clayton Act and the Sherman Act, laws which give the Attorney General the power he uses to block mergers that may tend to reduce competition in other industries.

On the principle of mergers, Sumner H. Slichter, in the Atlantic in 1953, discussed how larger corporate units rendered a superior quality of competition in terms of benefits to the consumer. Mergers, he said, had enabled management to build enterprises capable of reaching all parts of the vast domestic market, of adapting themselves to market shifts and changes in technology, of riding out the ups and downs of business, and of supporting research and development. And another economic analyst, A. D. H. Kaplan, commented in a Brookings Institution report, “There is no reason to believe that those now on top can remain there any more than their predecessors, short of alert participation in continuous product and market development.”

The merging of U.S. international services is as important as, and possibly more important than, the merging of domestic services, because our international operators cannot long compete effectively with the carriers of all the nations of the world, who are themselves combining in regional groups, while U.S. carrier continues to battle with U.S. carrier, as well as with foreign carriers, for what it thinks is its proper share of the market. Uniting international routes of Eastern and American requires President Kennedy’s approval, above and beyond a CAB decision.

Within ten years the nation will begin gettingsupersonic transports, capable of jet speeds in the area of 1300 to 1400 mph — twice the speed of sound. (It will be technically feasible to reach much higher speeds, but the cost may prevent our doing it in this decade.) For the same number of seats, each supersonic transport will cost three to five times as much as the present jets. In order to provide service at the same cost, they will have to do three to five times as much work. Obviously, the longer the hauls, the better — round trips from London to New York to Los Angeles to Tokyo, for example, as recently suggested by aviation writer Richard P. Cooke in the Wall Street Journal. The advent of supersonic transports, it would appear, will require fewer airlines and larger systems than we now have, perhaps mergers beyond any size yet contemplated.

THERE are many obstacles to mergers, among them two that have already been mentioned: first, the strong political resistance to making big business bigger; and second, the fact that any merger proposal must run the gauntlet of competitor opposition before being approved. (Competitive jealousies are strong, and the legal staffs of the airlines have highly developed blocking tactics.)

Third, organized labor can be expected to oppose automatically any merger, on the grounds that its members will lose jobs. Merging carriers have to work out deals with the unions, and the CAB has adopted some stiff labor-protective provisions, which must be recognized in evaluating the merits of a merger.

Fourth is resistance of some managements to a merger. Daniel Willard, colorful president of the B & O Railroad, was said to have stated, “No executive will willingly merge himself out of a job.” This has been dubbed “Willard’s law” by Bob Beddingfield of the New York Times,

The CAB can increase competition with relative ease, and has increased it beyond the requirements of the Federal Aviation Act. It lacks the power to decrease competition with equal ease. The burden of decreasing competition by consolidation rests to a large degree with the carriers themselves. If they will not get together, the CAB cannot effectively force them to do it.

Nevertheless, the CAB should, in my opinion, provide much more forceful leadership than it has yet given in indicating the type of mergers that it will approve, and it should find ways and means of streamlining its procedures so that carriers which are considering merger may have a much clearer idea than they now have of how long it will take to process an agreement through the CAB. Also, the CAB should find ways and means of giving assurances that the benefits of a merger, once attained, will not be undone by the authorization of additional competition, at least for a substantial period of time.

If streamlining of CAB procedures should require amendment of the Federal Aviation Act, the necessary amendments ought to be introduced as quickly as possible. I believe that much can be done merely by changes in policies, and I doubt that much legislation is required.

If they were willing to work together to the extent allowed by law, about twenty-five leaders of industry and government could perform miracles in the reorganization of air transportation along sound economic lines to meet the urgent demands of the nation. Most important are the President and his brother, the Attorney General, a few key members of Congress, the five CAB members, heads of most major airlines, and a few of their major shareholders.

Most informed observers are chary of predictions and will simply ask questions. Will such militant individualists as the airline chiefs ever find a meeting ground? Will government leaders themselves offer the auspices? If not, will members of Congress propose and even enact legislation to achieve a solution? Will the vital problems pass from business to government control? Or has our air transportation system reached its peak, and will it deteriorate from here on?

No one really knows the answers. I, for one, think that reason will prevail and assure the bright future which air transportation deserves. However, the only certainty is that the year ahead will be one of the most interesting, and possibly the most revolutionary, in the history of air transportation.