Back in May, American Airlines (NASDAQ:AAL) announced that it would drop its Chicago-Beijing route in late October. While this route was considered strategically important, it was losing too much money for management to justify keeping it.
At the time, American Airlines' top network executive warned that flights from Chicago to Shanghai and Tokyo could also find themselves on the chopping block soon. Sure enough, on Wednesday, American Airlines announced that it will cut its Chicago-Shanghai route and reduce Chicago-Tokyo service by more than 50% later this year.
These moves should bolster American's profitability in the short run. However, they risk undermining its long-term competitiveness relative to Delta Air Lines (NYSE:DAL) and United Continental (NYSE:UAL).
American's position in Asia has been suspect all along
It's no secret that Asia is American Airlines' Achilles' heel. Prior to its merger with US Airways, the carrier had dramatically lower market share in Asia than Delta and United. While the merger made American Airlines the largest airline in the world, it didn't help in Asia because US Airways didn't have a single transpacific flight (excluding Hawaii).
Over the past five years, American Airlines has attempted to build up its footprint in Asia with new flights from Dallas-Fort Worth and Los Angeles to tap Asian business markets. However, neither city is well-positioned for serving connecting traffic between the northern half of the U.S. and Asia.
Meanwhile, in Chicago -- American's main premerger transpacific hub -- results on routes to Asia have deteriorated, largely due to industry overcapacity. With American Airlines' overall profitability in a downward spiral, the losses on Chicago-Asia routes were unsustainable.
Exiting more markets
Indeed, according to Vice President of Planning Vasu Raja, even when fuel prices were slightly lower than now, American Airlines needed a $50 million improvement in the annual profitability of its Chicago-Beijing route for it to be "a passable international market." Back in May, he hinted that the Shanghai and Tokyo routes weren't much better.
That led to this week's decision to drop the Chicago-Shanghai route in late October and reduce service from Chicago to Tokyo from daily to three times a week in mid-December.
On the bright side, American noted that its joint-venture partner Japan Airlines will continue to offer daily flights from Chicago to Tokyo, with connections available there to numerous other destinations in Asia. During the summer peak season, Japan Airlines will offer additional flights, so that the two carriers will offer 14 weekly Chicago-Tokyo roundtrips on a combined basis.
A sign of weakness
Today, American Airlines faces nonstop competition from United Airlines on all three of these Chicago-Asia routes. The Tokyo route also is served by ANA (United's Japanese joint venture partner), China Eastern flies the Chicago-Shanghai route, and Hainan Airlines flies between Chicago and Beijing.
Perhaps all of these rivals also are losing money flying between Chicago and Asia. But it seems likely that they are at least more profitable than American Airlines. United has a market share lead at O'Hare -- last summer, it accounted for 45% of the airport's seat capacity compared to 35% for American -- while the others all benefit from connecting traffic in their Asian hubs.
In short, American's problems flying Chicago-Asia routes probably stem from its position as the No. 2 airline in Chicago. The economics of airline hubs means that the largest hubs earn a disproportionate share of the industry's profit. Making things worse, United Airlines has become more aggressive about gaining market share in Chicago over the past couple of years.
As for Delta, it is absolutely dominant in Detroit. In fact, it's the only carrier flying nonstop from Detroit to Asia. That allows it to capitalize on high-margin local demand from the auto sector, as well as connecting traffic from other markets in the Northeast and Midwest.
Pulling back in Asia is risky
American Airlines' routes from Chicago to Asia are money losers, so cutting them will clearly boost the company's profitability in the short run. American is excited about redeploying this capacity on new routes -- mainly leisure-oriented -- to the Caribbean, Hawaii, and Europe.
However, there's a reason why American Airlines has been operating these unprofitable routes for so long. Without nonstop service from Chicago to Beijing and Shanghai -- and with just a few flights a week on its own metal to Tokyo -- American risks losing major corporate contracts in Chicago to United Airlines.
American Airlines also could face broader corporate share losses throughout the Northeast and Midwest. Delta and United can provide much more convenient itineraries for business travelers who need to get from those regions to Asia compared to flying through Dallas-Fort Worth or Los Angeles.
Over time, corporate share loss could be even more painful from a margin perspective than operating a handful of money-losing routes. Five years after its big merger, American Airlines still hasn't found a satisfactory solution to one of its biggest problems: becoming competitive in Asia.