Following a leak to the media, United Continental (NASDAQ:UAL) confirmed on Saturday that it will downsize its flight schedule in Cleveland by 60% this spring, leaving it with just 72 peak-day departures. This will end Cleveland's status as a United hub. The announcement ends years of speculation on the fate of the Cleveland hub, which is the smallest in United's domestic network.
The cutbacks will undoubtedly cost United some market share in Cleveland, as travelers there will have less reason to be loyal to United over other carriers. Nevertheless, from a business perspective, this is definitely the right decision for United. Cleveland's smaller size compared to United's nearby hubs and the high cost of fuel made the hub a consistent money-loser, and nothing short of radical downsizing could have ended those losses.
Doomed from day one?
Hub downsizings are nothing new in the U.S. airline industry. Since 2000, a number of midsize metro areas -- including St. Louis, Pittsburgh, Cincinnati, and Memphis -- have endured huge flight losses due to hub carrier cutbacks. In each of those cases, the problem was the same: Legacy carriers found themselves with duplicate hubs (typically due to consolidation).
The 2010 United-Continental merger put the Cleveland hub in jeopardy from day one. As part of the Continental network, having a hub in Cleveland made sense. Continental's larger hubs in Houston and Newark were well positioned for serving their big local markets and feeding international flights to Latin America and Europe, respectively. By contrast, Cleveland was better located for east-west connecting traffic.
Following the merger with United, Cleveland was now within 400 miles of three larger United hubs in Chicago, Newark, and Washington. All of those metro areas are several times Cleveland's size, creating much larger local travel markets.
Recognizing the risk of cutbacks, at the time of the merger, Ohio's attorney general negotiated an agreement that required United to keep at least 90% of its flights in Cleveland for two years. After that point, the company potentially had the right to make further cutbacks depending on the hub's profitability. United agreed to a penalty of up to $20 million if it reneged on those flight commitments.
Unfortunately, earning a profit in Cleveland was nearly impossible for United. The carrier has tried to compensate for Cleveland's smaller size by primarily using 50-seat regional jets there. However, these planes burn too much fuel per seat to be viable in a high-fuel price environment, as a general rule.
From a network standpoint, losing the Cleveland hub will not affect United fliers that much. For most itineraries, a connection at one of United's other nearby hubs would not add much flying time. Additionally, because of the higher levels of traffic at United's Chicago and Newark hubs (and to a lesser extent, its Washington-Dulles hub) fewer of those flights use the cramped 50 seat jets that dominate Cleveland.
On the other hand, people traveling to and from Cleveland will have to cope with fewer flights, necessitating more connections. This could potentially damage the local economy, as many businesses care about having plentiful airline service. For example, Delta Air Lines' downsizing in Cincinnati was a major factor driving Chiquita Brands to relocate its headquarters from Cincinnati to Charlotte.
From a financial standpoint, the Cleveland downsizing will probably involve some upfront severance costs for United but will allow the company to save a lot of money thereafter. United expects to reduce its headcount in Cleveland by nearly 500 workers. The cuts will also help United reduce its usage of inefficient 50-seat jets, improving its cost structure.
Since its merger with Continental, United Airlines has done everything it could to make the Cleveland hub viable. However, with $3 per gallon jet fuel, it's virtually impossible to operate a profitable hub that relies on 50-seat jets. Given the circumstances, closing the hub was the best option for United.
Cleveland-area travelers have to hope that another carrier picks up the slack, but it could take years for that to occur (if ever). St. Louis has fared well despite losing its TWA hub; Southwest Airlines now offers more than 90 daily flights there.
On the other hand, cities like Pittsburgh and Memphis have fairly minimal low-cost carrier service today despite losing their legacy carrier hubs. For now, Cleveland will join their ranks as another victim of the ongoing restructuring of the U.S. airline industry.
Adam Levine-Weinberg is short shares of United Continental Holdings. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.