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Airlines and the Incredible Shrinking Hubs

As the airline industry works its way through a decade preceded by bankruptcies across the industry, carriers are eager to begin cutting costs and streamlining networks. Looking through the past several years, it becomes clear where a major component of this will come from: network rightsizing and hub reduction.

Network consolidation
Coming off a record wave of mergers, the airline industry is eager to make full use of its cost-savings potential. When there were many competitors in the industry, airlines often operated near overlapping flights from nearby hubs. Additionally, having a lot of different airlines, each run by their own management team, made controlling total capacity far more difficult.

In 2008, we saw the merger of Delta Air Lines and Northwest Airlines, which created the current Delta Air Lines (NYSE: DAL  ) . Two years later, another airline merger took the crown for the world's largest airline as United Airlines and Continental Airlines joined to form United Continental Holdings (NYSE: UAL  ) .

Fairly soon after the merger, Delta began to reduce its operations at its Cincinnati Northern Kentucky hub, moving many of the flights to the former Northwest hub in Detroit. But not all former Northwest hubs grew after the merger: Memphis lost its hub status in 2013 along with much of its service as Delta found having a second hub so close to its massive Atlanta operations to be uneconomical.

The latest move
United Continental has been working to finish the merger integration process for more than three years now. Through much of this time, synergies were difficult to realize and even those that did get off the ground were often balanced out by one-time integration charges. But with the biggest obstacles out of the way, United Continental is preparing to show investors what it can do by further streamlining operations and avoiding one-time charges.

Like Delta, United Continental came to the realization that, as a merged airline, it had too many hubs. So last week, the airline made the announcement that it would dramatically shrink operations out of the former Continental Airlines hub in Cleveland.

In a letter to Cleveland's workers, United Continental CEO Jeff Smisek, said:

No city has been more supportive of its hub carrier, and no group of employees has been more dedicated to providing great service, but the demand for hub-level connecting flying through Cleveland simply isn't there. Ultimately, we can't create demand, but we do have a responsibility to react to it. We must make the right business decisions, even when those decisions are painful, so we can continue to compete effectively and invest appropriately in our business.

Ultimately, the shrinkage of Cleveland operations is not a big surprise. When United Airlines and Continental Airlines merged in 2010, an agreement with the Ohio Attorney General at the time, Richard Cordray, limited the levels of flight cuts United Continental could implement at the airport in the interest of protecting Cleveland's jobs. But, as time progressed, the airline would be given more room to cut flights if the airport continued to underperform. With the current performance levels at the airport and United Continental now being able to cut more flights, the current actions in Cleveland are not too surprising.

Another settlement
As the airline industry has consolidated, the merger between AMR and US Airways that formed American Airlines Group (NASDAQ: AAL  ) came under far more scrutiny than past megamergers. Although the lawsuit by the Department of Justice never went to trial, the settlement agreement obtained many of the things the DOJ and the plaintiff states were looking for.

Among the terms is a requirement for the new airline to use all of its commuter slots at Washington National Airport for service to small and mid-sized non-hub communities for the next five years. During this time, American Airlines Group should be evaluating performance for each route to determine which ones stick around after the five years are up.

Fortunately for the hubs now controlled by American Airlines Group, the hubs all appear to have an economic purpose in the network, increasing their chances of sticking around. The hubs of the old American Airlines all serve high volumes of passenger traffic and are a core part of the network. Former US Airways hubs also look to be a good fit as they are in areas where fees are often lower and their location allows American Airlines to direct flights while avoiding busier airports.

Network reorganization
Like any other for-profit corporation, airlines are designed to make money and therefore eager to cut unprofitable flights and make networks more efficient. Expect airlines to continue using this as a way to cut costs over the next several years; after all, cost cuts are a primary benefit of mergers.

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Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

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  • Report this Comment On February 04, 2014, at 9:35 PM, gwatsof195577 wrote:

    Denver, my home, seems to be growing.... for now.

  • Report this Comment On February 05, 2014, at 2:13 AM, Tyeward wrote:

    American and USAirways most certainly came under more scrutiny, and to be honest it was the right thing to do regarding that. The big difference between this merger and previous mega mergers is that just about all the hubs are strategic. What alot of people are not paying attention to is the fact that cities such as Miami, LAX, and JFK/LGA are not hubs for the combined carrier. Those cities are cornerstone cities under the old American´s cornerstone strategy. They still are viable, however CLT, PHL and PHX fit more into a hub strategy for the combined carrier. You might see some readjusting here and there, however US/AA would be foolish to give up ground at any of these hub cities to their competition, and under Doug Parker, I don´t see that happening. The cornerstone strategy was designed to focus mainly on major metro areas and their O&D market. That´s the reason why cornerstone cities are not really hubs. They have minimal connection to free up available seats for direct and point to point from these cornerstone cities. Having 3 additional hubs now in the mix actually gives American more flexibility, and to an extent offer passengers more options on where they wish to connect (I usually insist on Charlotte when I connect).

    These abandoned hubs are actually opportunities for LCC´s to expand and create their own hub networks. CLE, PIT, CVG, STL, BNA, RDU, and MEM. Now that´s alot of room for expansion if they wish it. Eastern is supposedly coming back on line and would probably need a connecting hub eventually, and I an quite sure some LCC´s would eventually find logic in creating their own fortress hubs in one or two of these cities if the price and labor costs are right (STL and PIT come to mind initially). We will see how the future pans out however I am not so convinced that it´s as dim as people are making it out to be. The way I´m looking at it is these abandoned hubs are an opportunity to expand options and competition in the airline industry by introducing some new majors into the mix if they can get off the ground and make it happen.

  • Report this Comment On February 05, 2014, at 10:12 AM, Inspectigator wrote:

    The airlines live by their networks. Many (most?) regional/feeder routes are not profitable, but are beneficial to the network as a whole. The reason United has begun to cut routes and markets is because the airline industry has begun to shrink. From Smisek's letter to employees: "Although this is an industry issue, it directly affects us and requires us to reduce our regional partner flying, as several of our regional partners are beginning to have difficulty flying their schedules due to reduced new pilot availability. We need to reduce that flying in our most unprofitable markets, which unfortunately are out of Cleveland."

    Cleveland is not the first to lose service, the trend is accelerating. Great Lakes Air has gone from over 300 pilots to under 100, and most regionals are losing pilots to larger airlines faster than they can hire. 90% of students at large aviation schools are foreign students, the supply of pilots for U.S. airlines is almost zero while they are ramping up to hire more pilots than they've ever hired over the next decade.

    Airlines that rely on "regional partners" are going to see those partners cutting back severely, and a bidding war for their remaining capacity. It will get ugly. Squeezing more productivity out of the remaining pilots could get deadly. These aren't ex-military pilots, these are XBox pilots, trained to push the right buttons in controlled conditions. The Colgan Air accident showed how dangerous that is when conditions deviate from their limited training.

  • Report this Comment On February 05, 2014, at 10:14 AM, Paddlinpals wrote:

    I never really saw the value in either of the two Ohio hubs, and if you travel much. like I do they were probably right up on top of your list of hubs to avoid right along with Charlotte, Memphis, Philly and back in the day the "worst hub ever" Raliegh Durham. Ever get stuck in Memphis due to a late or cancelled flight? Ever have to walk from one side of Charlotte to the other in less than 30 minutes to catch a flight? Or Philly ? If your flight through Cleveland or Cincinallt, was late or cancelled, chances are you were going to be there all day and maybe the next. Good riddance. Hopefully as the newly merged airlines grow, they will grow the hubs that can handle the traffic and make better geographic sense. I

  • Report this Comment On February 06, 2014, at 9:09 AM, Inspectigator wrote:

    Tyeward, I have to disagree, this cannot be an opportunity for expansion or new carriers. In his letter, Jeff Smisek points out that his regional partners are having trouble staffing pilots to fly their routes. This shortage is going to go from bad to severe, and the smaller airlines are already shrinking because of it.

    The growth of small carriers over the past 20 years happened because there was cheap labor available, which gave small carriers a significant advantage over legacy carriers with higher pay. Now the legacy carriers have pay as low as the regionals, and they attract workers from the regionals with better long-term career potential.

    There aren't new pilots coming from schools or the military, and most of the pilots at the major airlines are within ten years of mandatory retirement. There is going to be no growth at the airlines, the industry is going to shrink significantly.

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Alexander MacLennan

Alexander MacLennan is a Fool contributor covering Industrials, Airlines, and Financial companies. He is always ready for a good growth or turnaround story and tries to find them before the market does.

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