Airlines

'We wanted to go first.' Here's what's different in the decade since Delta's merger with Northwest upended the airline industry

Key Points
  • Delta's merger set off a wave of consolidation among U.S. carriers.
  • U.S. airlines are enjoying their longest stretch of profitability in at least 40 years.
  • Airlines are now coming up with new ways to grow revenue amid tepid fare growth.
A Delta Airlines Boeing 747 in flight.
Source: Boeing

On an afternoon in late October 2008, in a conference room overlooking Delta Air Lines' Atlanta campus, Richard Anderson got word.

The Department of Justice had just approved the carrier's some $2.6 billion-merger with Northwest Airlines, a deal that gave birth to the world's biggest airline at the time.

The airline's general counsel told Anderson, the Delta CEO who ran the company until 2016, that it could close in a few days.

"How about now?" Anderson recalls asking. "We want this to be irreversible."

The tie-up, which was unveiled 10 years ago this month, set off a frenzied deal-making decade among airlines. The industries had faced bankruptcies, low-cost competitors, a brutal recession and a spike in fuel prices.

U.S. passenger airlines had lost a record $60 billion from 2001 through 2005, according to Airlines for America, an industry trade and lobbying group. Consolidation was necessary to stabilize, said Douglas Steenland, who was the CEO of Northwest Airlines at the time of the 2008 merger with Delta.

For years, "the public was in essence being subsidized by airline employees through wage cuts and through the shareholders, through loss of their equity," he said.

The merge-or-die mentality eventually shrunk the number of big U.S. airlines from seven to four. Those four companies control three-quarters of the U.S. commercial air travel market. Regardless of how loud cries for boycotts get after on-board incidents go viral — like the violent dragging of a passenger off a flight that was serving United Airlines last year — the industry's merger mania has also left passengers with fewer alternatives.

'Just like the bus'

On average, U.S. consumers have seen lower airfares and more service, which airlines had cut back significantly in the wake of their mergers and the last recession. Commercial airlines operated 3,235 domestic routes in June 2008, and 3,346 were on the schedule for June 2018, according to PlaneStats.com, part of consulting firm Oliver Wyman.

Nationally, airfares fell to about $336 in the third quarter of 2017, the Department of Transportation's Bureau of Transportation Statistics' most recent available data show. That's the lowest since at least 1995. Lower oil prices and cheaper-to-operate aircraft helped.

The consolidation has allowed lower-cost competitors to come into the marketplace, also helping to pressure fares, said Seth Kaplan, managing partner at trade journal Airline Weekly.

And more travelers are taking to the skies than ever. U.S. airlines carried a record 848 million passengers last year — a roughly 14 percent jump from ten years ago before the Delta merger.

"It was unusual for the average person (to fly) unless they had to go to a funeral," said Robert Mann, a Long Island-based aviation consultant who has worked at American, TWA and PanAmerican World Airways "Now, it's become just like the bus."

First dibs

As fuel prices surged and the economy faltered a decade ago, executives from Delta Air Lines and Northwest Airlines wanted to be the first to merge.

"We wanted to go first," said Steenland. That lessened the regulatory hurdles and provided a choicer partner, he said.

"We had to start grinding out the synergies because the industry was in distress," said Anderson, who now heads Amtrak. There, he is dealing with a host of problems, including a recent spate of accidents.

Newly emerged from bankruptcy (Delta and Northwest emerged within weeks of one another and had filed on the same day in 2005) and posting its first full-year profit since 2000, Delta was staring down a U.S. recession and expensive fuel.

Steenland called them "two punches to the gut." Delta's Anderson and his then counterpart Steenland — a former colleague from Anderson's days as CEO of Northwest — hatched a plan to merge in an all-equity deal.

Atlanta-based Delta and Eagan, Minn.-based Northwest announced their deal on April 14, 2008.

A 'Reese's Peanut Butter Cup' merger

The two companies had little route and fleet overlap, and vastly different cultures.

"Northwest was an analytical powerhouse...but labor relations and passenger service were lacking," said Jamie Baker, a senior airline analyst at J.P. Morgan Chase. "Pre-merger Delta, on the other hand, was arithmetically challenged and did little in the way of financial analysis, but they fostered a very strong employee culture and were well-regarded by customers.

"It's the Reese's Peanut Butter Cup of mergers – chocolate and peanut butter, successfully integrated into an investment grade balance sheet," he said. Delta received its third-investment-grade rating last September, from Standard and Poors.

After the Delta-Northwest tie-up, it touched off a frenetic game of musical chairs among airlines.

In 2010, United and Continental merged, followed by Southwest and AirTran in 2011. Finally, American Airlines and US Airways merged in 2013.

As Anderson and Steenland predicted, it faced the most challenges by going last. It faced the toughest government opposition of the four, although the Justice Department ultimately gave the combination the green light, giving way to what is now the world's biggest airline.

"The combination of Delta and Northwest was a notable event, especially inside American's headquarters building," wrote Gary Kennedy, American Airlines' former general counsel in his new book "Twelve Years of Turbulence." The new company had eclipsed American's footprint.

Delta gobbles up Northwest

"There's no such thing as a merger of equals," Anderson said. "There has to be one organization in charge."

The organization in question was Delta, the largest of the two airlines. Combined the two airlines had about 75,000 employees, according to the company.

Merging first has proved helpful to Delta. The combined airline integrated its workforce long before the slew of other combined airlines started the messy and expensive task.

Flight attendants at Northwest were unionized and voted to leave their labor union — Delta's flight attendants were not and are still not unionized, unlike its other large U.S. legacy airline competitors.

While pilot seniority issues persisted after the merger was complete, completing a pilot contract before the deal closed was one less headache for the combined airline to deal with, said Mann, the aviation consultant.

Gobbling up Northwest set the tone for Delta's aggressive international expansion. Northwest forged a joint venture with KLM Royal Dutch Airlines in 1997. Delta had formed its own with Air France, which merged with KLM in 2004.

Delta has reached deals for joint ventures or minority stakes in airlines including Virgin Atlantic, China Eastern, Canada's WestJet, AeroMexico and Brazil's Gol. Late last month, it announced its joint venture with Korean Air, expanding the international footprint of an airline whose roots stretch back to the 1920s when its used propeller planes to dust crops in Georgia, and later in Louisiana and Peru.

Service cuts

Some of airlines' smaller hubs became post-merger casualties over the past decade. In the years that followed, Delta pulled back sharply from its Memphis hub, as well as Cincinnati. It's all part of a trend that left customers in midsize U.S. cities with fewer airlines and routes to choose from, and in some cases higher fares.

Memphis had 8,344 departures in 2008, and has lost three-quarters of them — more than any other U.S. airport, according to PlaneStats.com data. Delta's old hub of Cincinnati lost nearly 60 percent of its departures over the last decade, the second-biggest decline. Service from Continental's former hub in Cleveland is down 50 percent over the past 10 years.

Attracting new investment

U.S. airlines' recent stretch of profitability has drawn investment from Berkshire Hathaway, whose CEO Warren Buffett, had shunned airlines for years after a bet on U.S. Airways soured. It is now one of large U.S. airlines' biggest shareholders.

The airline industry "has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in," he told The Telegraph in 2002.

"I have an 800 number now that I call if I get the urge to buy an airline stock. "I call at two in the morning and I say: 'My name is Warren and I'm an aeroholic.' And then they talk me down," the billionaire investor said.

Since he first disclosed a roughly $1.28 billion-bet on three carriers in 2016, he has added Southwest to the mix, and bought more shares. That's given him a position in the four carriers worth about $7.2 billion, based on a recent filing and Friday's closing prices. Buffett said in February that he wouldn't rule out owning an entire airline.

Source: Delta Flight Museum

Meanwhile, there's little question that the remaining air carriers are as strong as they've ever been. Delta, the largest U.S. airline by market capitalization, has posted a profit every year since 2009.

Its 2017 net profit margin of nearly 9 percent outpaced its closest competitors. American's profit margin was close to 5 percent and United's about 6 percent, according to FactSet data. Delta is slated to report first-quarter earnings next Thursday.

"Delta's current prosperity exceeds even our most ambitious forecasts from the time of the merger," said J.P. Morgan's Baker, an outcome that was helped along by consolidation across the industry, he added.

Delta's stock is up 17 percent over the past 12 months, trading recently at $53 a share, outpacing the S&P 500, which is up around 10 percent over the same period.

Delta and its peers have struggled to convince investors of their value, however. Delta is trading at a price-to-earnings ratio of about 11, roughly half that of the S&P 500.

Flexing muscles

Airlines are also flexing their muscles in Washington. Late last year, Delta and other carriers sent the Department of Transportation a long list of regulations they would like to see repealed. Those include reporting the number of pets that die in its cargo holds to full-fare pricing, which displays taxes and fees to consumers.

The Department of Transportation shelved an Obama-era proposal to request information on transparency of air fare displays, which could include a growing number of fees and other add-ons, a move that airlines requested.

Challenges remain

Still, legacy airlines are confronting a set of problems. Profits and margins among Delta and its competitors have shrunk, even as planes are more packed than ever.

Fare growth, which has proven elusive, has led Delta and others to take launch new classes of service, including basic economy, a no-frills product that airline executives say aims to compete with low-cost airlines.

They also haven't been shy about the goal: That passengers pay higher fares to avoid it.

"A decade ago we knew that providing more choices was going to be part of the business model, but it's something that has continually evolved over the years as we've gotten more feedback from our customers," said current Delta CEO Ed Bastian.

Online travel sites are racing to keep up with the new, restrictive classes of service.

The industry still has strong travel demand on its side, but increases in labor and fuel costs are eating into its margins.

That said, the industry is still enjoying its best stretch of profitability in at least four decades.

Former Northwest CEO Steenland, who is now non-executive chairman at insurer American International Group, said the difficulties just don't compare to those the industry used to face.

"While the business will always be challenging," said Steenland, "dealing with paying dividends and buying back shares is different than whether you're going to make payroll."

— CNBC's Phil LeBeau contributed to this report.