Last week, Fool contributor Jay Jenkins flew non-stop from Rio de Janeiro, Brazil, to Charlotte, N.C., on US Airways (UNKNOWN:LCC.DL) The flight was barely half full. The flight attendant said it's always only about half full.
The other two flights that night leaving Rio for the U.S. were heading to Dallas and New York, two of the largest hubs in the country. Those flights were at capacity.
As a result of conditions set by the Justice Department, the Charlotte hub and other smaller connecting airports used by US Airways will continue flying these routes for the new entity formed upon completion of the merger of US Airways and American Airlines, owned by AMR (UNKNOWN:AAR.DL2).
The new American will have to immediately give up space at major airports to lost-cost carriers such as Southwest (NYSE:LUV) and JetBlue (NASDAQ:JBLU). But in a bit of karmically appropriate irony, the airline will be delayed before fully implementing the full synergies between the old American and US Airways by shuttering these money-losing flights to secondary hubs.
What kind of efficiencies are we talking about?
As investors, before we can really understand what kind of efficiency gains we can expect to see from this merger, we must first break down the basics of airline economics.
At the highest level, airlines are highly capital intensive, meaning they require expensive and specialized equipment and facilities to operate. This is obvious, one supposes, for any airline customer who has boarded a massive 767 or larger plane. Second, airlines are hugely labor intensive, with a tradition of strong unionization across the industry.
Third, it's expensive to operate an airline -- maintaining the planes, fuel costs, labor expense (ground crews, flight crews, customer service, back office, and the list goes on) -- and don't forget that the free ginger ale on your last flight had to be paid for, along with the microwaved chicken dinner.
Lots of capital -- financial and human -- plus high operating costs translate to tight profit margins. And with tight margins come the need to maximize the profitability of each flight, as well as streamlining operations behind the scenes.
The budget carriers like Southwest and JetBlue are very forward with their methods for attacking this problem. They alter seat configurations to maximize the number of possible passengers on each flight. They cut the frills of flying (bye-bye, chicken dinner), and they operate with smaller, more fuel-efficient aircraft.
Further, they keep the operation of the airline more straightforward than their bigger competitors. Typically the budget operators focus on a smaller network of routes they know to be profitable and don't venture too far from their niche. You won't be seeing a JetBlue or Southwest direct connection to Shanghai anytime soon.
And it's in this vein that the new American hopes to find new efficiency and hopefully profitability. To simplify the process, here is a theoretical example.
Assume that there is a constant level of demand for flights from Rio de Janeiro to the United States -- every week the same number of travelers desire to leave Brazil for the States. Currently there are competing flights from the major carriers, some heading to major hubs such as Dallas or New York, and others to secondary hubs such as the ones the Justice Department is requiring the new American to continue operating. All together, the total number of available seats far exceeds the number of passengers demanding the flight.
In three years, after the conditions of the merger expire, the new American will be able to eliminate the redundancy in this route. They simply stop operating the connection from Rio to Charlotte, and funnel those passengers through Dallas or New York. Sounds simple, right? It is, but it's also critical.
According to Airlines.org, one fundamental way to view airline profitability is called BELF -- the breakeven load factor. This calculation takes into account both the fixed and variable expenses of operating the flight as well as the average price paid per ticketed passenger on the flight. The BELF is the percentage of the seats that must be sold for the flight to break even. For most airlines, the BELF is somewhere around 80%, and most flights end up within just one or two passengers of this breakeven.
Just one or two passengers per flight can dictate overall profitability! On Jay's flight last week, which was hardly 50% full, it's a safe wager that U.S. Air lost money.
In the following video, Jay highlights his experience on the Boeing 767 from Rio to Charlotte and discusses his views on the future efficiencies possible for the new American Airlines; despite the delay, the new American could find clear skies for shareholders over the long term simply because the potential efficiency gains are so great in such a thin margin business.