A United Boeing 737-800 with Split Scimitar Winglets. (Credits: United Airlines)

United Airlines’ financial and operational underperformance has been a running theme in the US airline industry in the current 2010-2017 heyday (the best era of financial performance for America’s airlines since de-regulation).

As the chart below shows, United has consistently underperformed Delta since 2010 though the gap has narrowed some. After American’s bankruptcy, the Fort Worth-based carrier surged ahead of United as well.

Many reasons have been prescribed for United’s underperformance, ranging from operational inefficiencies to too many regional jets. But I would argue that there’s an even more fundamental challenge; United doesn’t generate enough revenue from its hubs and its route network, specifically because it flies too much internationally and not enough domestically.

United’s hub network should be a juggernaut

United’s network has always been a bit of a conundrum. If you were going to build an airline hub structure from scratch based on the economic and geographic makeup in the United States, it would probably look a lot like United’s.

United has hubs in each of the four largest US metro areas by GDP (NYC, LA, Chicago, and Houston). The closest competitor is American (LA, Chicago, and Dallas-Fort Worth) who has a true hub in three of the five largest metro areas by GDP.

Delta and Southwest, by contrast, have two apiece (NYC and LA for Delta, Chicago and LA for Southwest) but, where United sets itself apart, is that it also has hubs at the number 6 and number 7 metro areas by this metric (Washington DC and San Francisco) and truthfully SFO’s catchment area is the third largest by GDP as San Jose is split off in the government numbers into its own metro area but functionally sees lots of fliers transition up to SFO.

American once again has a hub in #8 Philadelphia; #9 Boston is a JetBlue stronghold though Delta is building up in the market, and #10 Atlanta is, of course, the world’s largest airline hub. The only United hub outside the top 10 is #18 Denver, which serves unique connecting passenger flows as the dominant east-west connecting hub between Texas and California.

United is overexposed to international operations

Yet despite this hub structure seemingly designed in a laboratory, United’s revenue performance is underwhelming, with American commanding a 3% unit revenue premium and Delta a 9.4% unit revenue premium over United. This is largely because United’s revenue base is far more reliant on international flying than either American or Delta.

For example in Q4 of 2016, United had $2.92 billion in revenue from the international operation, whereas Delta had $2.19 billion and American had just $1.82 billion.

This is despite the fact that both, American and Delta, are substantially larger than United. Put another way, American generates about 21% of its revenue from international flying, whereas Delta is at about 26%. United generates 38% of its revenue from international flying, and that’s a problem because right now international flying is much less profitable than domestic flying.

There are myriad reasons for this situation, most notably the fact that international flights, to and from the U.S., face much more competition, and the fact that foreign currencies have taken a tumble against the U.S. dollar. Both of these effects dampen United’s dollar-denominated international passenger revenues and profits.

United also has an underperforming joint venture partner without access to London across the Atlantic (much in the same way that Delta has been disadvantaged without access to Tokyo), which further hampers its trans-Atlantic profitability.

Despite this, United is heavily overexposed to international flying, and it has missed out on a consolidated and oligopolistic US domestic market with much more favorable pricing dynamics.

United needs to pare back international flights to fund domestic growth

Now the argument and allure behind international routes have been twofold.

First, during positive stretches for the global economy, they are highly profitable up front thanks to business travel demand. Second, international routes, particularly to Asia, are considered “strategic” – basically, the thought is that airlines should get in on these markets now so that when those countries or cities grow they’ll be well positioned to grab the profits. The problem with that is that some of these markets (for example Newark-Belfast) hardly qualify as “strategic” in any meaningful sense, they are routes to developed world markets.

In an ideal world, United would be able to simply add additional domestic flying to take advantage of profitable opportunities, but thanks to Wall Street’s laser-like focus on PRASM (to hear an expanded explanation, listen to the podcast below) United isn’t allowed to do that.

So instead, United is in a position where the only mechanism it has for growing effectively is cutting back international flying.

The math on this is pretty effective thanks to the way capacity is calculated – cutting back one daily roundtrip flight from Newark to Geneva on the 214-seat 767-300ER can fund two daily roundtrips from Newark to Vancouver or five from Denver to Vancouver on the 737-800.

It can also fund (and this is not a joke) 61 additional daily roundtrip flights between Chicago and Rochester, Minnesota (one of United’s recent additions amongst the 31 new flights), without changing United’s headline capacity number. New United president Scott Kirby understands the domestic opportunity that exists, and hopefully, he moves to take advantage of it as soon as possible.

Secondary Europe & Intra-Asia on the Chopping Block

So the question becomes what should be pared back to help fund United’s domestic growth. One immediate option that comes to mind, is about flights within Asia (the two left are Tokyo Narita – Seoul and Hong Kong – Singapore), which are better left to joint-venture partner ANA.

The same is probably true of Honolulu – Tokyo Narita, especially with ANA bringing the Airbus A380 onto that route. Much of the rest of the Asia flying is technically strategic (though the SFO – secondary China routes are probably losing money hand over fist), so it could certainly be left in place.

But another good place to focus cuts, is oil routes from Houston, looking specifically at Houston – Quito, given Ecuador’s economic woes, Houston – Rio, and Houston – Caracas in South America. Houston – Munich, and Houston – Frankfurt also probably don’t both need to exist (Frankfurt could be left to JV partner Lufthansa).

In Europe, Houston – Amsterdam isn’t really a route that makes a ton of sense, as most passengers can easily connect in Chicago, Newark, or Washington Dulles. That brings us to Newark, where there are plenty of cuts to secondary Europe that make sense.

The most notable group is secondary in the UK, which is bound to take a hit thanks to outbound tourism decline post-Brexit. Belfast can be dropped, and the pairs of Glasgow/Edinburgh and Birmingham/Manchester can easily be consolidated (likely to Edinburgh and Manchester).

In Europe, Hamburg isn’t a route that has a ton of strategic value so that’s an attrition candidate as well, and Shannon in Ireland isn’t a huge O&D market.

From Washington DC there isn’t a ton to cut, though Dulles – Sao Paulo seems superfluous with Newark just up the road. With all of those cuts, United can easily fund 80-120 new domestic flights if not more. Unfortunately (thanks to Wall Street) that’s the right move in today’s US airline industry.

How this pays off domestically?

With those 80-120 flights, you could spread the wealth to a variety of hubs targeting two key types of demand.

The first is smaller O&D markets (either long and thin or short haul) that still have high fares without too much competition from ultra low-cost carriers, and the second is connecting markets that are closer to hubs with larger volumes of revenue (this is the Chicago-Rochester profile).

The big hubs that will benefit from more connecting markets are Chicago and Denver, the two mid-continent hubs serving East-West connecting flow. Then there are some North-South routes on the East Coast that make sense to add from Newark. That would be for routes like Chicago – Youngstown, Newark – Charlottesville, or Denver-Fort Wayne.

Then you have the gaps to fill from coastal hubs like Newark and San Francisco, routes like San Francisco – Detroit, San Francisco – Memphis, Newark – Tucson, or Newark – Albuquerque.

This is all right from Scott Kirby’s playbook at US Airways and then again at American. Three hubs are perhaps less likely to see sustained growth. Washington Dulles is suffering from the split airport situation in Washington that pushes all high yield traffic to Reagan National, while Houston is in the throes of a relative economic decline thanks to the collapse in oil prices over the last two and a half years.

Los Angeles is a market where Kirby has made strong statements about resuming growth and is an interesting case. There are probably some trans-con holes that could be filled, but overall United is best served by staying away from a multi-party bloodbath with five large carriers (Alaska, Delta, American, Southwest, and United) all duking it out for passengers at LAX.