Musings From the Last Five Weeks

US Airways - American

$130 here - million I mean.  $100 million there.  Couple hundred here and there.  A chunk of the company for you.  A less than desirable chunk for me.  Hey PBGC, what do you need so we can carry a pension liability on our balance sheet going forward? That’s not a problem since the “old” US Airways terminated its plans!  While we are at it, let’s keep 15,000 more employees than a similar-sized United (each carrier would generate approximately $37 billion in revenue) because, after all, the synergy generation will surely cover it.  It’s the new math - circa 2012.

In its quest to acquire American Airlines, US Airways sounds like a teenager with its first credit card, spending money it doesn’t have.  Paper wealth.  What cracks me up about this “plan” is the new math I mentioned. Critics pan AA’s goal of creating $1 billion in new revenue as bogus because, among other issues, it assumes no competitive response.  Does anyone really think United and Delta are going roll over and let US Airways improve its revenue generation at their expense? Not a chance.

UAL CEO Jeff Smisek said last month a US merger "net, net, that would be good for us." Will there be more competition on certain city pairs?  Yes.  But neither United nor Delta are afraid of competition much less the threat posed by the paper tiger US Airways/American combination.   Smisek and Delta’s Richard Anderson are smart. They know the synergy formula US has seduced some media and AA’s unions with is but a calculation at this point.  Even American’s own pilots admitted in bankruptcy court this week its faux “deal” with US doesn’t include cost assumptions or valuations.

In other words, US is spending money it has no idea whether it will actually have. It is one thing to have a term sheet and quite another to have written contractual language.  My bet is United and Delta see that the first mover advantages created by mergers have already been mined.  For AMR’s creditors – including the labor unions – there are a host of other issues with this proposed takeover.  It is my opinion that US’s new math adds up to the likelihood that they may need to visit out-of-court cost cutting exercises within a very short time to finish the job that they are choosing not to finish during the courting stage – particularly if exogenous shocks again plague the industry.

Showdown in Houston

Most readers of www.swelblog.com know I was asked by United to help study the findings of the Houston Airports System (HAS) report about Southwest flying internationally from Houston Hobby Airport.  HAS and its consultants originally claimed that 23 flights by SWA from Hobby would create in excess of 18,000 jobs and generate more than $1.6 billion in new economic activity for the City of Houston. 

Stratospheric numbers like those don’t pass the sniff test, yet Southwest executives Gary Kelly, Bob Montgomery and Ron Ricks reference the HAS findings as if they were they were gospel.  More on this later.

I believe the HAS study is seriously flawed and is based on what has become known as the “Southwest Effect.”  Problem is, the “Southwest Effect” is a largely a thing of the past.  It got its name from a study completed more than 20 years ago by the U.S. DOT when jet fuel was the equivalent of $30 per barrel.  The fundamental premise is lowering fares will create a disproportionate level of “new” demand in a market. 

Despite the fact Southwest has no experience in flying to international markets, the HAS study assumes traffic will increase 180 percent.  Relevant empirical data shows Southwest’s (135 city pair markets entered since 2006) entry into new markets over the past five years resulted in traffic stimulation of only 10 percent. The latest data shows fares in those markets have actually increased – not decreased.  The HAS study, at a minimum, grossly exaggerates the benefits of a Southwest entry into duplicative markets and is based on a host of unrealistic assumptions. Publicly available cost data shows international flying done by Southwest from HOU would lose more than $76 million per year.  Even Southwest is not flying markets that lose that kind of money despite its self-proclaimed benevolence toward the air travel consumer.

The economic stimulation predicted by the HAS study claims that prices will decrease 55 percent lower than United’s fares.  The truth is, what Southwest calls “stimulation,” is comprised mostly of the cannibalization of IAH traffic which adds nothing to the Houston economy.

The “Southwest Effect” does not drive benefits to local economies as it once did.  Even Gary Kelly agrees.  When pinned down by the Houston City Council on the number of jobs that would be created at Southwest from its limited entry to routes already served, Kelly admitted that total number (nationally) would be 700 and direct Southwest jobs created in Houston would be 50-100. Kelly went on to say that even these 50-100 jobs would be achieved only if Southwest flies the maximum number of flights in its projections several years after entry.  

Even with outrageous multipliers, the number of direct, indirect and induced job creation cannot even begin to approach 10,000 – let alone 18,000.  Not even by relying on the long-obsolete conclusions of a 20 year old study.

The United Pilots

The United pilots are at it again.  While the Delta Air Lines' pilots reached an agreement seven months early, the United pilots are busy building websites whining about outsourced jobs (their term, not mine) and the salaries of United Airlines’ executives. 

Labor leaders in the pilot ranks would have you believe this “outsourcing” (international code sharing and the use of regional flying within the network) is all about management abusing provisions of their collective bargaining agreements to enrich their shareholders. In fact, reducing costs through the relaxation of scope provisions has been labor’s “quid” in return for increases in compensation (or to give less in a concessionary contract) and benefits for 20+ years [the “quo.”]

Among many myths portrayed on the website, United ALPA (Air Line Pilots Association) claims that after the tragedy of September 11, 2001, the management of United Airlines launched a strategic plan to offshore and outsource jobs in an effort to cut costs.  Look no further than the unaffordable contract negotiated between United and its pilots in 2000.  The pilots significantly relaxed scope provisions in return for increased wages, work rules and benefits.  I rest my case.

First of all, the fundamental economics underlying the health of the U.S. airline industry began deteriorating during the second half of 2000.  September 11 ensured that there would be no return to prior industry conditions particularly on the revenue line.  The incursion of the low cost carriers and the use of the internet for airline ticket distribution were every bit as powerful forces as 9/11 in compelling the industry to restructure.  The operating models sought by the network carriers were to find cost savings much like the low-cost carriers – a sector that outsourced a significant portion of its maintenance.  The advent of the regional jet in the mid-1990s was the catalyst driving a reduction in pilot and other costs.  Pilots at all network carriers permitted extensive use of the regional jet well before September 11, 2001.

Perpetuating myths to a public that largely doesn’t care (pilots are much better compensated than the average passenger) is probably a disservice to United’s ALPA members.  Put energy into negotiations like the Delta pilots and you might actually get somewhere.  That requires leadership and telling the entitled pilots at the old United that things are not going to return to the days when the company negotiated contracts it couldn’t afford.  It is just not going to happen.

Concluding Thoughts

Delta Air Lines just continues to do things a little differently.  When it merged with Northwest, Delta made the pilots “buy in” to the concept that consolidation was inevitable and that it was in their best interests to participate.  Delta’s financial performance relative to the industry has been very good quarter after quarter.  Then it buys an oil refinery and negotiates a deal with pilots seven months before the amendable date.  Hell, most negotiations have just completed the uniform section at this point in the proceedings – maybe.

It is clear Delta’s largest unionized group understands industry realities.  That’s a rare thing these days when, too often, reality is sacrificed for political expedience.  Simply look at how much has been made in the media about American’s unions joining hands with US Airways.  That was the easy part.  Which union wouldn’t agree to give up less and suffer fewer job losses?  It sounds great to members and union leaders can knowingly smile and say, at the very least, they’re putting pressure on management.  But reality says they’re weakening their own position, opening themselves up to my favorite term – unintended consequences and simply ignoring the truth that US Airways would have to carry 15,000 more heads than United, while generating the same level of revenue.  That’s not reality; that’s fantasy.

There is little doubt industry consolidation has helped catapult financial results beyond what could have been imagined for the industry based on past performance.  In that reality, my guess is Delta just made it more expensive for US Airways - and United - yesterday by negotiating yet another joint collective bargaining agreement.  US Airways needs those lower labor rates because its network produces below industry unit revenues. So now US is in the position of not only promising American’s pilots increased pay, but having to actually pay its own pilots at Delta +.

But hey, what is a couple of hundred million here and a couple of hundred million there?  After all, the margins for the US airline industry are plentiful.  Right?

US Airways at the Masters: Trying to Win on Thursday?

For those readers who know me well, today marks the beginning of the end of the finest 30 days in sports television.  It starts with the NCAA tournament and culminates with what can often be the best two hours in sports – the back nine at the Master’s Tournament on Sunday. 

Even with the history and the azaleas to occupy my attention, on this tournament Thursday, my mind still wanders to the airline industry and I see similarities in golf, aviation and the games people play.

As is tradition at the Masters, past champions Nicklaus, Palmer and, this year, Gary Player (a.k.a  Delta, United and Southwest) ceremoniously hit the first tee shots to open the playing of 76th tournament at the venerable Augusta National Golf Club. Past champions (multiple winners) at the Masters Tournament enjoy notoriety and historical significance long past their years of playing.

A popular past champion still participating in the Masters Tournament is Ben Crenshaw (American Airlines).  Crenshaw is given little to no chance in this year’s tournament, but the sweet putting stroke possessed by the Texas gentleman keeps Crenshaw a fan (AAdvantage members) favorite. 

Some very good golfers have never attended the Champion’s Dinner. Greg Norman (er US Airways) for example.  Nobody in Masters’ history lost in more heartbreaking fashion than Norman in 1987 when Larry Mize chipped in on the second playoff hole to beat him; or when Norman beat himself in the final round that handed the green jacket to Nick Faldo in 1996.  Norman’s misery is akin to US Airways missing out on consolidation opportunities in 2001(United), 2008 (Delta) and then again in 2010 (United).  US Airways’ strategy to attempt a hostile takeover of Delta while in bankruptcy in 2008 reminds this golf fan of Norman’s collapse in ‘96.

Playing in this year’s field and given a real chance to win are world #1 Luke Donald (Alaska Airlines) and world #2 Rory McIlroy (jetBlue Airways).  The Europeans are also making a strong showing these days, like defending champion Charl Schwartzel and perennial contender Lee Westwood (British Airways and Iberia).

Bunkers, Birdies and Bogeys

Pressure tournaments like the Masters tend to spawn meltdowns even among the very best players. The young McIlroy, in fact, suffered through a sad Sunday in Augusta last year.  Just like airlines have their good years, bad years and critical moments. And just like golfers, the difference between success and spectacular failure in the airline industry depends on how you read the lie. It’s how you think your way around the course, avoiding bunkers like bad decisions, taking advantage of business opportunities (birdies) and minimizing the negatives (bogeys and others) like fuel spikes and bad strategic decisions.

That brings me to US Airways.  

US Airways pursuit of Flight Attendant Hearts and Minds

The Masters is an invitational tournament; you have to be invited by the “committee” [UCC] in order to play.  US Airways is trying to play to the court of public opinion to get an invite to this year’s event.  US Airways had one good round it hoped would help it win an invitation to play in the year’s first major. That was reaching a tentative agreement with its flight attendants.  Unfortunately for US Airways, it couldn’t finish. The flight attendants at the company overwhelmingly rejected that agreement despite the fact it offered significant pay increases.

The flight attendants said in a press release:  "Since the onset of negotiations, Flight Attendants have been steadfast and determined that an agreement must address the needs identified by the membership. Flight Attendants have subsidized the cost of the merger and rising fuel costs for the 'New US Airways.' Management must recognize that our sacrifices have directly contributed to the success of US Airways," said Deborah Volpe, AFA pre-merger America West President and Mark Gentile, AFA pre-merger US Airways acting President.”

It has been nearly seven years since the “Old US Airways” merged with America West and there is still no done deal with either its flight attendants or its internally troubled pilot group. 

And yet before round one has been completed in Augusta, US Airways has allegedly been courting the president of American Airlines flight attendant union, Laura Glading, who is also a member of the Unsecured Creditors Committee (UCC) in order to get that invitation to the year’s first major… a merger with American?

While it’s hard to know exactly who is chasing who in all of the US Airways merging/consolidating with American talk, Glading and the APFA have been anything but shy in their pursuit of an offer from Doug Parker and company. The APFA has boldly stated it thinks there is a better business plan than the one American is offering… mainly because AA’s will freeze pensions and trigger approximately 13,000 layoffs. (Notice no mention of the finer points; that AA’s plan might finally unshackle the company’s ability to compete with other network carriers who rehabilitated under bankruptcy.)

Someone – probably the APFA - has “leaked” stories to specific media about “suitors” talking to the UCC – even though as far as anyone knows the only UCC members actually listening are the unions themselves.

While both the APA and TWU (who are also part of the UCC) have reportedly had serious discussions with AA – and apparently those negotiations might have saved some TWU jobs – Glading has been stomping her feet and pouting about the unfairness of it all.  She’s on record as stating the UCC (or, at least, one particular UCC member) is open to seeing a “better” business plan, thus leading to the flirtation with US Airways.

“Better” to Glading apparently means giving up nothing and gaining everything. But what “better” will she glean from this dalliance with US Airways?  Not to change sports, but Vince Lombardi, the iconic former coach of the world champion Green Bay Packers said:  “the only place you will find success before work is in the dictionary”.  Do Glading and other leaders of American’s unions honestly think US Airways will not seek to make major changes to American’s archaic work rules and collective bargaining agreements? 

In the tentative agreement, the former America West flight attendants were granted a 22 percent increase and the former “Old US Airways” flight attendants were given an 11 percent increase to even out pay rates – finally, after seven years. What then would US Airways have to do in order to put three groups on par with one another? Would APFA members be willing to work more for less? And if so, why wouldn’t they just stay with their own company? Or entertain commercial opportunities that might not involve a seniority integration process?

Maintaining a Cost Advantage Is Critical for US Airways

US Airways suffers from a stage length adjusted unit revenue disadvantage versus its legacy carrier peers – even more than American. But it also enjoys a stage length adjusted unit cost advantage versus these rivals – much more than American. Despite the revenue generating deficiency of US Airways’ network, the Tempe-based airline is producing very good revenue results relative to the industry.

US Airways’ revenue disadvantage is offset by maintaining its cost advantage – and most of that advantage is very low labor costs relative to the industry. As a result, US Airways’ pre-tax margins are impressive given its structural deficiencies. The cost advantage the carrier enjoys cannot be overstated nor can the company hide behind the fact a significant portion of its profit performance can be found in lower labor costs. By contrast, United and Continental are only now beginning to navigate what it might cost to buy labor peace, particularly among the pilot groups. US Airways has not explored what labor peace would cost, probably because maintaining the status quo is more cost effective.  Or did the flight attendants say in their vote that what US Airways could afford was not sufficient to buy labor peace?

US Airways Touting Merger Synergies Before an Invitation is Granted

The most recent version of the US Airways – American merger story leaked to the press suggests the “synergies” of a combination would produce $1 billion in revenue and $500 million in cost savings.  The revenue synergy number stems from the idea other mergers have realized a three margin point improvement in revenue resulting from the combination.  JP Morgan’s Jamie Baker point to the fact American is weak in Albany, Buffalo, Greesnboro, and Richmond to name a few.  What a yawn. In today’s world why are Baker and US Airways not talking about Auckland, Buenos Aires (oh American is positioned there), Guangzhou or Rome?

The strongest example of American’s domestic weakness is that AA is the #4 carrier in the Eastern U.S. in terms of market share and #4 in the highly fragmented Western U.S.  So, the question remains, can AA truly address these structural weaknesses organically or does it need a merger partner?

Problem with adapting previous margin calculation to a US-AA merger is they don’t necessarily apply. Other mergers involved carriers with stronger domestic and – and more important – international networks. US Airways flies to mainly second-tier markets and has little international presence. That might seem like a good thing – each partner filling a need – but there is little synching between the two – but for this observer there is nothing that gets me excited from a network perspective. Domestic calculations are one thing – international are another.  If I were Delta or United, I would be applauding this possible combination because it adds little to what other combinations might add.  And what about the cost savings?  We don’t even know what American will look like once it goes through the full bankruptcy process.  Therefore how can we know what the cost savings will be?

It is just too early to tell because no one knows what AA will be when it gets through the restructuring process.  Stated differently, what if AA wins the ability to have unlimited code sharing in the U.S. domestic market as a result of a changed pilot scope agreement?  Then is US Airways the only choice?  After all, American’s CEO, Tom Horton, has stated publicly he is not averse to a merger, but will only consider such a strategy once the company completes the restructuring process.

US Airways is absolutely not the only option for American.  What about a fully integrated relationship with each Alaska and jetBlue?  These would certainly better address the weaknesses on the west coast and in New York, particularly at JFK – two aspects of American’s not-successful-to-date “cornerstone strategy”. 

The point is, there are options for American beyond US Airways and I might suggest there are better options than the Tempe-based airline – and they do not require a seniority integration process and potentially do not add seats to the capacity fragile U.S. domestic market.  Then again the restructuring needs to be completed in full before we can begin to evaluate options – something that US Airways wants to avoid.  For a company that constantly claims it does not need to merge, it seems to this observer to be incredibly desperate and fearful of not merging with its bigger counterpart.

Concluding Thoughts

As they say at the Masters, and any golf tournament for that matter, you can lose the tournament on Thursday but you cannot win it. It seems to me that US Airways is trying very hard to win the tournament on Thursday.  There is a lot of golf to play in the American Airlines’ bankruptcy case. And until the back nine begins on Sunday, the leaderboard promises to be crowded as American is an important asset to many – most notably employees, British Airways, JAL, the Dallas-Fort Worth Metroplex and Tulsa to name a few. 

If employee members of the Unsecured Creditors Committee are going to believe there is a free lunch (egg salad and pimento cheese sandwiches) with US Airways they are surely mistaken. Simply, if US Airways doesn’t fix many of the structural things wrong with American, then in a few years maybe the “New New US Airways” will have to file for bankruptcy and fix some of the obvious problems their desperate overpromise and sure to under-deliver approach to American’s unions will avoid in order to win the hearts and minds of employees to get a deal done.

Most of the naysayers regarding American’s stated stand-alone business plan have vested interests in the outcome of the game.  Wall Street has made the case that consolidation and strict capacity discipline absolutely need  to be adhered to if the industry is to be stable.  They cite American’s 20 percent stated growth as something to fear.  And it might be.  But what is the 20 percent American has mentioned?  Nobody knows.  What if it is the ability to generate 20 percent more city pairs to sell through code sharing alliances with Alaska and jetBlue that add no new capacity to the system?  Net effect equals zero.  Period. 

Then we have US Airways.  Too big to be small and too small to be big.  Like American, there is a case to be made that their route structure is being marginalized each and every day; therefore a merger is more important to its very success.  For US Airways it’s only shot at a green jacket is to buy one (remember Crenshaw has two and Norman has none) because over a career opportunities to win one have been missed. 

Angst breeds strange bed fellows.  Angst does not win an invite to the Masters Toonament.  And angst does not win an invite to membership.  Yesterday Dustin Johnson had to withdraw from the Masters because of health reasons.  For US Airways this sucks because the Masters does not have an alternate list.  It must earn its way into the 2013 event because angst will not get it into this year’s Masters Tournament.

More to come.

Swelbar Interview With Emirates' Open Sky Journal

It has been 46 days since I last posted a piece on swelblog.com.  That is not to say that I have not been writing.  I have - just not here. To be truthful, I am bored with most things U.S.  I cannot read anymore rehashes of the American Airlines case; or labor forever trying to create leverage where there is none; or who will be AA’s exit partner if there is one; or the United pilots thinking that it is totally incumbent on management to reach a deal amidst union in-fighting and an ignorance about competitive realities. 

But a topic that always has my interest is happenings in the Middle East region when it comes to aviation.  I was asked by the Emirates Airline Public Affairs group for an interview that was included in their February 2012 Open Sky journal release.  It is included below.

Doug Cameron, writing in today’s Wall Street Journal, talks of Emirates intentions to enter a 7^th U.S. point in the immediate future with more to come.  There is no better time for this inevitable next phase of competition to begin as SkyTeam’s European partners report weakening financial results; STAR carrier Lufthansa reports results are down but being buoyed by non-airline assets all the while partner Air Canada finds itself trying to simply hang on and remain relevant; and oneworld’s US partner American Airlines flounders in bankruptcy making it an opportune time for the Middle East juggernaut to begin the process of adding more of North America to its global route portfolio before the third global alliance is a more meaningful competitor.

I am excited to see new competition for the aligned U.S. and European competitors begin in earnest as it seems that employees and other stakeholders just do not take the threat of this obvious evolution as serious.  It is.  The U.S. carriers reported a paltry .3 point earnings margin in 2011 and that is before the new competition begins and ever increasing fuel prices are used to describe 2012.  The work is far from done.

1. Generally, what do you see as the major themes playing out next year in the airline industry?

The health of the global economy generally, and Europe specifically, will continue to dominate headlines in 2012.

The industry can’t just be viable; it must continue to recreate its business model into one that can be profitable on a sustainable basis.  The industry as a whole must find a way to earn at least its cost of capital in order that it can reinvest in itself.

Today’s dysfunctional governments, particularly across the Eurozone and the U.S., must find a way to function.  When it comes to aviation, policy makers must begin to think clearly about what laws, regulations, taxes and fees are necessary for the business to achieve overarching economic and social goals. Too many current governmental decisions claiming to be in the best interest of the consumer are fraught with unintended consequences.

The growth of the Middle East carriers (Emirates, Ethiad and Qatar) will remain a topic of conversation around the world.  Not surprisingly, the response to the Middle East carriers from some parts of the world has been protectionist. First the world wanted to open the skies. Now that the skies are largely open for some/most, the talk has turned to restricting access to markets from new, innovative and vibrant competition. I agree the new competition should not be allowed access to cheap capital that is not available to all. But to limit market access because of presumed subsidy, cheap fuel, little or no airport costs and whatever other excuse to limit the growth of Middle East carriers is just plain wrong.

Of course, the rhetoric over the EU Emissions Trading Scheme (ETS) and the proper policy to ensure that the industry is environmentally sustainable will be a news item throughout 2012 and beyond. 

The price and volatility in the price of oil remains an important theme, albeit much less so in 2012 than in 2008.  [here I may be wrong]  Commodity industries abhor volatile input prices.     

Consolidation will remain an important part of the global airline industry’s vernacular in 2012.  It’s proving to be a healthy tonic for improved profitability in North America, but there are not many logical combinations left in the U.S. unless we begin the process of considering cross-border financial transactions among airline companies.

2. What effect is the Eurozone crisis having on protectionism vs. liberal aviation policies in Europe?

I think it is less the Eurozone crisis and more the fear of new competition from Middle East domiciled carriers that’s triggered increasing calls for protectionism in many parts of the world.   From my perspective, short-term aviation protectionism stands in the way of a country’s long-term global relevance.  Moreover, it seems like a high price for governments to pay in order to coddle a nation’s flag carrier.

There has been considerable consolidation among Europe’s flag carriers over the past five years.  With the obvious buyers of remaining carriers, or stakes in those carriers, struggling financially, I expect fewer future intra-Europe financial transactions.  As a result, the financial resolve of the remaining carriers in Europe will be significantly challenged, especially without hope of a government bailout.  Those governments will be hard pressed to protect struggling flag carriers over the medium term.

Either way, I see Europe as a more protected zone in the coming years rather than embracing liberal policies promoting competition.  The contemporary Europe will likely be anti-airline, except where the industry is viewed as a tax revenue generator and deficit reducing business sector.  The consumer will lose, economies will lose and countries may even likely lose their coveted flag airlines.  Ultimately, the market will win, but not before artificial protectionist barriers are erected.  The good news for Middle East-based carriers is other opportunities for carrier growth are present in emerging markets in Africa, Southeast Asia, China and even mature markets like North America.

In many ways, the European market is going through a similar transition that the U.S industry has been painfully undergoing since the mid-1980s. That shakeout triggered massive change and until the Darwinian process fully plays out in Europe, liberal aviation policy thinking will probably not resume either.

3. Do you foresee any fallout, aero-politically, from the AMR bankruptcy filing?

I do not see any aero-political fallout from the AMR bankruptcy filing.  Rather, I see it as necessary for the Fort Worth, Texas airline to obviate its competitive weaknesses relative to other U.S. network carriers that used U.S. law to restructure their mature operations.

Internationally, American Airlines is oneworld’s one and only link in accessing the world’s largest aviation marketplace – the United States.  A loss of American weakens competition among the three global alliances in a significant way both across the Atlantic and the Pacific.  In my mind, a loss of American would be another reason for politicians to restore the protectionist chorus that would point to the dominant positions held by the remaining two global alliances – STAR and SkyTeam - all the while ignoring the new competition emerging in the Middle East.

Rather than fallout from AMR’s restructuring, I believe oneworld carriers British Airways and Iberia – through their immunized joint ventures with American - will be an important aspect of any plan of reorganization. That plan could very well renew the call for changing foreign ownership rules.  In fact, the continued growth and the competitive threat posed by the Middle East carriers for traffic flows that were once the sole domain of the global alliances is also a triggering event for change in the ownership laws.

4.  What effect do you see from the EU ETS on EU-US relations or otherwise? What will be the knock-on effect?

While this story is in its infancy, there is no question that the global industry must address environmental issues and be a leader in creating a sustainable business.  How to go about establishing the proper policy will be debated for years to come.  It seems odd that the EU would institute potentially billions of dollars of new fees on airlines when finances of the global airline industry and economies around the globe are in such a fragile state.  Less profitable airlines have less capital to invest in technology that will prove to be the best prescription for reducing the carbon footprint over the longer term.

I expect we will see business as usual “under protest” in the immediate term.  Will ICAO act?  Initially, US-EU relations will certainly be strained, but airlines attached at the hip through joint ventures will have to maintain the current course of business.  What is ironic is the European airlines are high-cost producers and just became higher cost producers.  If I was a lower-cost producer, I would be trying to figure out how to use this to my advantage and appeal to the customer through lower fares.  This knock-on effect may finally open the eyes of the EU and other governments that you cannot tax and fee the industry into oblivion.

5.  What is happening in the world of alliances and anti-trust immunities?

I am beginning to fundamentally question whether STAR and SkyTeam are growing/have grown too big in terms of number of carriers under the respective alliance umbrella.  After all, it is the top 5 carriers within each alliance that realize a significantly disproportionate share of the synergy benefits generated.  It is no coincidence these carriers enjoy an immunized relationship.  Moreover, if the primary synergies of an immunized alliance are revenue only, we must be nearing an end to the alliance lifeline where marginal revenues generated by a new member exceed the marginal cost of inclusion of that new member. 

Aviation networks have evolved from linear systems to hubs and spokes with a focus on building regional dominance; to connecting regional hubs creating national/continental networks; and then establishing connections between alliance partner gateways. The evolution of competition has been from city-pair to hub to gateway to network.  Each of these evolutionary steps has led to increased traffic through the stimulation of new local and connecting traffic.

Alliances were originally built to accomplish what no one airline could do itself – create ubiquitous networks ferrying passengers from one point in one world region to another point in another world region.  But are alliances truly ubiquitous?

Emirates is able to combine the use of new technology (the A380), with low labor costs, government policies designed to promote aviation and a unique geography allowing it to compete with global alliances. Should we really concern ourselves with flag carriers to the same extent today that we did 20 years ago or even 10 years ago? Alliances have already caused borders to blur and the colors in some flags to cloud. Emirates, Ethiad and Qatar are simply doing what the oneworld, Star and SkyTeam alliances have already done.

Just like low-cost airlines, the Gulf carriers will place enormous pressure on network incumbents to match prices. That will be a problem for some of those incumbents, whose high cost structures – particularly in Europe - make it difficult to reduce fares even when faced with new competition. Even if some of the carriers within the global alliances or the independents were to fail, the market has demonstrated time and again that, where competition is vulnerable, a new entrant will exploit that vulnerability. Where there are market opportunities, there will be a carrier to leverage that opportunity. And where there is insufficient capacity, capacity will find the insufficiency. Networks evolve because of competition.

I believe the next phase of evolution will do some of the same. The challenge from the three Gulf carriers to the three global alliances will accelerate the discussion about global mergers because the networks being built by Emirates, Ethiad and Qatar are truly ubiquitous. The Gulf airlines are each one carrier, while the alliances are a patchwork architecture designed to circumvent archaic bilateral rules.  Organic growth will again prove to be the right tonic for airline systems to be financially sustainable – because the benefits of cost synergies are not being realized today and must be realized if the full financial potential of carrier combinations is to be appreciated and the resulting benefits are enjoyed by the consumer.

Swelbar: Pondering More of American’s Bankruptcy “News”

So much speculation around what American Airlines might be upon exit from bankruptcy; so many scenario possibilities.  Some media and those with specific interests in the industry are moving pieces around the game board with talk of mergers and acquisitions. I’m willing to play, but with a caveat; no one should take all the recent posturing seriously – at least not yet. And it won’t be tomorrow, or next week, or even next month. More likely the serious gamesmanship will begin approximately 7-8 months from now as creditors evaluate and negotiate American’s proposed plan of reorganization.  Right now, AMR has no choice but to approach the upcoming Section 1110, 1113, 1114 and all other discussions as if it will emerge as a stand-alone entity. 

The world is much more comfortable with the bankruptcy process today than it was even a few years ago.  Lessons have been learned.  Hostile runs on companies in bankruptcy are probably not the answer if a potential suitor really wants to be successful in being a part of the ultimate entity that emerges – unless there is no other option as creditors get close to signing off on some other plan of reorganization.  American will tell stakeholders what IT thinks needs to be done to put the company on a viable path. 

American’s $4 Billion In Cash – It Is Not Quite What It Seems

I just have to get one thing off of my chest:  $4 billion in cash on November 29, 2011 was about to become something much less.  It is one of the reasons why American filed for bankruptcy protection before it was too late.  Can we stop talking about a cash-rich filing?

Reactions ranging from dumbstruck employees to PBGC Director Josh Gotbaum’s comments regarding AMR’s bankruptcy filing with over $4 billion in cash leave me smiling.  The fact is AMR’s $4 billion cash reserve would have depleted quickly had the company continued without bankruptcy – possibly to the point of corporate oblivion.  AMR’s Board of Directors had no choice but to file as the company likely had very little access to affordable credit markets since few of the company’s assets were unencumbered.

Since September 2001, airline companies have significantly increased their liquidity (unrestricted cash plus available credit) as a percent of trailing twelve month revenues from roughly 10 percent to 20+ percent.  In 2011, only American and US Airways held liquidity balances of less than 20 percent.  While American’s cash erosion will be mitigated in bankruptcy, it resembles only adequate operating liquidity not a pool from which to pay large fixed obligations.

With that $4 billion in cash, American faced a pension contribution of $100 million during the fourth quarter of 2011; and $560 million in 2012; maturities of long-term debt including sinking fund requirements were $1.1 billion during the fourth quarter of 2011; and $1.8 billion during 2012.  These obligations should be considered against the backdrop of an airline entity that was burning cash at the operating level and the fact nearly all of its assets were pledged as collateral.  While it is true that some $800 million in assets would have become unencumbered during 2012, the amount is certainly less than necessary to maintain sufficient liquidity and meet fixed obligations assuming American would need to collateralize any credit it would seek.

In fact, if AMR were to pay its obligations with its existing cash balance, it is highly likely that the company would have faced a liquidity squeeze at some point during 2012. And that’s assuming no fuel spikes or world events that might impact airline operations.  I think it can safely be deduced the company did what was prudent to preserve the enterprise. Moreover, employees in denial and a PBGC with its own vested interests should step back and reexamine whether the $4 billion is really $4 billion. 

I don’t think so. The case is clear that a $4 billion liquidity balance is on the low end of optimum for a $22 billion dollar revenue generating airline company whether in bankruptcy or not.

Last Friday’s Bloomberg “News” – A Combined US Airways and American

The cynic in me just loves to read airline news published late in the day on a Friday afternoon.   But that is precisely what we got from Bloomberg last week titled:  US Airways Said To Consider American Airlines Merger To Fill Revenue Gap.  There were no sources to the story, only the classic reference to “people familiar” with the Tempe-based airline’s current activity.  Neither US Airways nor American Airlines would comment.  You know how it goes.  [On the US Airways 4^th quarter earnings call Wednesday the company did confirm the hiring of the advisers to study the matter mentioned in the story]

It has been suggested by some that American needs to pare capacity along the lines of other U.S. airlines in the domestic arena because it hasn’t done enough to date.  US Airways is often used as the example of a company that has demonstrated stringent capacity discipline and now has significantly improved margin results.  Yet the article says American Airlines might have pared too much capacity – to the point where the Fort Worth carrier is no longer attractive to significant portions of the revenue rich corporate travel sector. Someone is right - I guess?

In some circles, both American and US Airways’ networks are referenced as sub-optimal.  My question then:  does sub-optimal plus sub-optimal equal optimal (at least when compared to United/Continental and Northwest/Delta)?  Probably not, but there is the possibility the whole could/would equal more than the sum of the parts and thus generate more revenue. That doesn’t necessarily mean it’s the best-case scenario because there are plenty of questions when considering an American - US Airways combination -- but one can consider such a combination. 

A merged American and US Airways would be the second-largest U.S. airline on paper, but US Airways got out of the mid-continent hub business when it left Pittsburgh. So, how would the Chicago hub fit in? Philadelphia might be the poor man’s JFK (absent sufficient slots at the New York airport), but could Philadelphia prove to be an acceptable surrogate Northeast U.S. gateway to oneworld as it battles STAR and SkyTeam for high yielding east coast traffic?  What happens to the jetBlue relationship forged by American that could certainly be expanded when expected scope relaxations are achieved?  If the carriers combined, is there really a need for both a Phoenix and a Dallas/Fort Worth hub?  I don’t think so.  If not, where would the headquarters be?   

If American’s exit were to include US Airways, would oneworld make US Airways a full partner in each the transatlantic and transpacific joint ventures?  I would think so because, if US Airways’ domestic system is so fertile as to fill a hole in American’s U.S. network as the media stories claim, then it must be every bit as powerful in filling oneworld’s intercontinental revenue deficiencies.  Assuming that, nearly overnight, oneworld would become a more vigorous competitor with SkyTeam and STAR for traffic flows that neither carrier could capture on their own.  There would be a shift of revenue share from STAR to oneworld in addition to new competition.  How might STAR react if there were an overnight shift of 15 points of revenue share to oneworld?  Might STAR – or United - move quickly to make US Airways a full joint venture partner? 

For airline nerds like me, thinking about mergers/acquisitions by only looking at a map is fun. As games are supposed to be.  But reality means there is much more to consider.

Like any other potential bidder, if US Airways were to emerge as a party to American’s exit, the Tempe-based carrier will have to win the hearts and minds of the employees, the PBGC, the rejected Section 1110 lien holders and the unsecured debt holders to name a few along with Boeing and Airbus.  The onus would be on US Airways to demonstrate its plan will ensure higher returns than a stand-alone plan by American or a plan submitted by other interested parties.

Labor will be a key target.  US Airways, or anyone else, will tell labor a combination can offer an option to the cuts AMR is all but certain to require.  While that sounds great, labor will have to weigh any alleged benefits against a certainty it will be forced into a seniority integration process.  And we all know how emotional seniority integration proceedings can be in the airline industry. 

US Airways and its pilots have not negotiated a new collective bargaining agreement because of a failed seniority integration process that started in 2005 and today flounders in litigation – an internal union issue and not the company’s.  Nonetheless, would that mean American Airlines’ pilots could not achieve raises/improvements from the company because the integration of US Airways and America West pilots is not complete?  What about the flight attendants?

The Section 1113 and 1114 process at American all but ensures those employees will take significant cuts in work rules and benefits as those are the areas where AA has the largest competitive exposure.  Even after those cuts, though, some AA employees (like pilots) will still likely make more than many peers at the current US Airways.  So, would the theoretical combined carrier ask AA employees to take less so US Airways employees can get more than they might?  How does that apply to work rules, benefits? There are those who would (and, in fact, are) dismiss these issues saying they can be dealt with later, but that’s short-sighted.

A Combined Delta Air Lines and American

I still cannot get beyond the regulatory hurdles this combination would face, let alone the fact that all of the issues discussed above would also apply.  But here are four things that immediately concern me:

1. There are significant overlapping routes that would need to be addressed by the U.S. regulatory agencies to the point the carve-outs necessary might look and feel like a breakup of American, similar to Delta’s past devouring of parts of Pan Am.
2. Given the current strains between the U.S. and the European Union, combined with the latter’s consternation over the existing alliance construct, I cannot imagine the EU having an appetite for seeing three global alliances reduced to two.
3. The concentration at New York JFK specifically and New York generally.
4. Given the Obama Administration’s expressions of regulatory angst and outright displeasure when #2 AT&T proposed combining with #3 T-Mobile, I find it unlikely that any of the respective agencies would embrace a similar proposition in the airline industry.

As they say in the South, “this dog don’t hunt”.  But let it be clear I respect Anderson, Hirst and the Delta team as they did push a merger with Northwest and the slot swap with US Airways through the regulatory process.  And that is no small feat.

Concluding Thoughts

At this point, three/four names are circulating as having an interest in a restructured American Airlines:  US Airways, Delta Air Lines, TPG Capital and, possibly, IAG.  Whether American emerges from bankruptcy alone or with a partner(s), the case is going to take many twists and turns – some daily.

In pure laboratory conditions where American could restructure without any outside influences, AA would emerge as a much lower cost entity and, therefore, pose competitive threats to other U.S. airlines. 

To mitigate American’s potential cost advantage, other airlines will be sure to muck up the process to ensure that American is not fully successful in achieving its stated result.  Delta is not necessarily just gaming US Airways to cough up more in a bid or vice versa, but as I’m fond of saying, it is the law of unintended – or in this case intended - consequences.  Both are trying to ensure American has to pay more.  The conditions for American will prove anything but pure.

Of course, the game changes if United moves to buy US Airways in order to prevent losing the 15 points of transatlantic revenue share it delivers to the STAR alliance.  I do not believe Delta has a chance unless the Unsecured Creditor Committee (UCC) recommends, and the bankruptcy court agrees, that the parts of American are worth more than the carrier as an ongoing enterprise.  In that scenario, Delta will try to secure as many of American’s assets as it can conceivably digest and still get regulatory approval.  

But there we go again, speculating.  In order of least employee/corporate disruption I rank today’s possibilities as follows:

1. American as a stand-alone
2. American and IAG/oneworld
3. American and TPG Capital
4. American and IAG/oneworld, TPG Capital
5. American and IAG/oneworld, TPG Capital and US Airways
6. American and US Airways
7. American and most anything Delta
8. Liquidation of Assets

The one thing I can positively guarantee, though, is there will be employee/corporate disruption and plenty more speculation to come. Let the games begin.

Swelbar: Just Thinking About A Few Things

Yesterday’s Wall Street Journal

Susan Carey, Gina Chon and Mike Spector report that Delta Air Lines and TPG Capital are separately evaluating potential bids for American Airlines’ parent, AMR.  This story, along with the myriad of others discussing a US Airways bid for the Fort Worth, TX carrier, is just a warm-up for the main event of AMR’s trip through court-assisted restructuring and the ultimate filing of a plan of reorganization acceptable to creditors.

Delta might seem like an odd suitor.  First, we have to accept the fact Richard Anderson’s Delta is not your father’s Delta.  He and his team are aggressive and understand American holds many assets and relationships that are valuable and thus important to Delta (and SkyTeam) like:  Chicago (where Delta has been adding select domestic flying), a relationship with British Airways, a relationship with JAL, a relationship with LATAM, more of New York (this is where regulators will really struggle along with the absolute size of the combination), a deep South America presence, more of Mexico, Miami (where Delta has been adding select domestic and international flying), and a way to defragment Los Angeles. It could also simply be an attempt to keep a restructured competitor from emerging.

Delta is reported to have performed an antitrust analysis that concluded - with certain carve outs - the massive combination could pass regulatory scrutiny.  While I can see such a combination would bolster Delta’s market positions in many areas including the middle and eastern regions of the U.S., across the Pacific and into burgeoning Latin America, there is also a lot of overlap between hubs.  If Detroit and Cincinnati competed before, imagine the hub competition – and redundant flying – with Chicago thrown into the mix.  Nonetheless, just on sheer size alone, I think an American-Delta combination would  prove hard for U.S. regulators to grasp and approve. Delta would also have a difficult task of selling such a merger to an already skeptical European Union.

Fort Worth-based TPG, on the other hand, likes to work with strategic partners according to the Journal.  TPG has strong ties to the current management team at US Airways.  Richard Schifter, TPG partner, served on US Airways Board of Directors.  Schifter is currently a director at Republic Holdings.  Schifter and another TPG partner, David Bonderman, have extensive ties to the airline industry stretching from Continental to Ryanair.  No one should be surprised a private equity concern like TPG Capital might have an interest in a restructured AMR.  For TPG, the strategic partnership possibilities are many and include US Airways, British Airways or any oneworld partner that fears the loss of its only meaningful access to the traffic rich U.S. market.

This Wall Street Journal story highlights something I think is very important; AMR is attractive to strategic buyers as well as a financial buyer like private equity.  Today, the list of names publicly discussed as interested in AMR is three.  That list will grow over the coming months. 

It is also highly likely that this story was leaked by a party to mask something else.  We will see. It is important to remember potential bidders will likely wait a few months until a lot of difficult decisions regarding network and fleet are largely complete. They’ll wait until contentious negotiations with labor are complete – probably including layoffs -  as any new owner will not want to get their fingernails dirty in that process. Potential bidders will also likely wait to see how creditors are treated in a debtor negotiated exit plan.

A question remains however:  will any bid attempt by a strategic or a financial buyer for AMR be friendly or hostile?  US Airways tried an unsuccessful hostile run for Delta. There are a myriad of possibilities here and all that is guaranteed is the debtor has the exclusive right to file a plan of reorganization until the court says otherwise.  That plan may include an offer from a strategic or a financial interest, but at this point, it is all conjecture providing an opportunity to opine.  That said the news reported yesterday officially begins AMR’s journey through bankruptcy.

LAN/TAM

If there is an airline company built with more innovation and creativity than LAN, then someone give me a call and let me know who it is.  Or was it just being in the right place at the right time?  Either way, LAN Airlines has quietly grown into one of the global elite carriers and has earnings and a market capitalization to match.

LAN is an airline I rarely mention, but have a deep admiration for.   Based in Santiago, Chile, LAN’s strategy of taking equity stakes and, in effect, becoming a surrogate flag carrier for a country in an economically struggling region where other airlines have failed, has been brilliant. The strategy has allowed the former Lan Chile to diversify its traffic base away from Chile-only and grow to become the de facto flag-carrier for other countries on the continent. LAN’s ability to take advantage of non-Chilean country bilaterals has produced growth opportunities where a reliance on Chile-only would have only led to diminishing returns.

The carrier began as Línea Aeropostal Santiago-Arica in 1929 before becoming Línea Aérea Nacional de Chile (Lan Chile) in 1932. The Chilean government privatized Línea Aérea Nacional de Chile in 1989, and the carrier absorbed Chile’s second carrier, Ladeco, in 1995. Today, the LAN umbrella covers LAN Chile; LAN Peru; LAN Dominicana; LAN Ecuador; LAN Argentina; LAN Cargo; and LAN Express, among others. Some said LAN refers to Latin American Network. Any way you cut it, LAN is a brand!

LAN was just given authority to complete its merger with Brazilian-based TAM and the combined entity will be LATAM.  To become a true South American airline powerhouse, LAN absolutely needed a significant stake in Brazil, which it now has.

One of the merger problems is each carrier is currently a member of a competing alliance.  LAN is a member of oneworld and TAM is a member of STAR.  If Brazil was essential for LAN, imagine just how important the emerging market is to each of the global alliances.  This story might take on the characteristics of the fight for JAL between SkyTeam and oneworld.  South America is yet another critical geographic area where oneworld is under attack.

American Eagle

Two months ago, most industry watchers were scratching their heads about the investment reasoning for American Eagle as parent AMR intended to spin it off.  High unit costs largely stemming from a very senior workforce, along with a fleet that was built around an archaic scope clause at mainline American Airlines, defined the carrier.  I am confident virtually every carrier comprising the regional industry had little to no fear that Eagle was going to steal any potential business. 

Now with bankruptcy and the freedoms to cut costs, American Eagle may look very different coming out of court-assisted restructuring.  Fleet alignment is sure to occur, and is happening, with any and all 37 and 44-seat aircraft immediately being taken out of service.  Certainly there are numerous out-of-market leases on aircraft controlled by the parent that can be reduced.  In fact, we may see a new market rate established for a 50-seat aircraft that takes into account a $120 per barrel jet fuel environment.  Labor rates and rules are sure to be reduced.  If the ground handling services Eagle offers were the crown jewel pre-bankruptcy, just imagine how much more attractive Eagle’s rates to other carriers will become after the restructuring.

Don’t let the point regarding a new ownership market rate that takes into account the high cost of jet fuel get lost.  While Eagle might be successful, it is likely that Pinnacle will not.  This factor is potentially significant.  If a new rate can be found through the bankruptcy process along with reduced labor rates, suddenly for American, a number of small markets served could be removed from the chopping block and remain a part of the reorganized American network.   

Whatever the size of Eagle when it emerges, it is going to be much leaner than the majority of its competitors.  My guess is SkyWest, Pinnacle, ExpressJet and others are watching this restructuring with bated breath because a new market rate for 50-seat flying, and other flying for that matter, will present itself in the coming months.  And a new competitor for future regional flying will emerge.

American Pilot Scope and Pilot Negotiations at United-Continental

As American and its pilots union attempted to negotiate a new agreement up until the time the company filed for bankruptcy protection, certain aspects of what was being discussed were leaking into the mainstream media.  The game changer being discussed was the new A319 fleet would be flown at rates and rules much lower to reflect the difficult economics of the domestic business and appropriately reflect the market/aircraft size. 

If this is indeed the road American travels down in its Section 1113 negotiations, there are significant and immediate ramifications for the negotiations taking place between United-Continental and its pilots.  As the UA-CO pilots spend more time taking on the company using safety as a hot-button, a new baseline is about to be established as to how pilots work and get paid.  If the UA-CO are hung up on nothing more than 50 seats, then I ask:  what about 115 seats? 

The United-Continental pilots’ strategy to exert a leverage point blew up in their face on November 29, 2011.  Where AA is going is in the right direction as it accomplishes multiple things that will benefit their business:  1) it is better able to match costs with the domestic revenue environment; and 2) it puts an end to the pilot scope discussion.  Regional partners will not be doing any 100 seat flying because, in this seat range, mainline pilots have a better ability to match the cost of flying done by the regionals.

Whether United-Continental pilots either figure it out (or not), the focus then shifts to Delta where scope is already a hot button issue.  In 2013, US Airways pilots are absolutely going to be forced to consider something similar to what the AA pilots are likely to agree to. 

Then you just have to wonder what Gary Kelly is really thinking.  The tables just may be turning.

How the Weeks Ahead Will Shape AMR In The Years To Come

The biggest story in the U.S. airline industry right now is, of course, American Airlines’ parent company seeking Chapter 11 bankruptcy protection. After a flurry of initial filings and some alterations at American Eagle, there hasn’t been a lot of movement from AMR.

The lack of news from it or the bankruptcy court probably has a lot of people - union leaders, media, employees, communities – wondering what is taking so long. That’s the first key to understanding this airline bankruptcy is different and why other airlines such as United, Delta and Southwest as well as the federal government and even regional carriers are keenly watching and waiting.

Unlike all the other airlines that have gone through Chapter 11, American doesn’t have a Debtor In Possession (DIP) lender breathing down its neck. That’s because the AMR board of directors made a strategic decision to file for bankruptcy with more than $4 billion in cash in the bank. That’s more cash than any airline that’s ever entered bankruptcy has had on hand and one of the highest totals in U.S. corporate history.

That gives AMR and American some flexibility to run its business during the initial period of exclusivity, protect its interests and, most importantly, time to ensure that its ultimate plan of reorganization (POR) is the very best it can be. While time is still of the essence to put forth a POR, it gives the debtor (AMR), time to look carefully at its network (mainline and regional partner), its labor contracts, its fleet and then make unhurried and potentially dramatic changes.

When United filed in December 2002, the DIP lenders and creditors demanded interim labor deals within 30 days, some even hammered out on Christmas Day. Delta and the Old US Airways faced similar pressures. As much as is possible in the bankruptcy process, American controls its own fate. It needs to use the time it has to get this right and make sure its labor costs and operations are where they need to be when it emerges. If it doesn’t, I don’t believe American in its current form gets a second chance.

A quick aside: This is usually when AA employees harrumph they gave millions in concessions to management in 2003 and that should balance what other airlines gained in bankruptcy court. I have the greatest respect for what American’s unionized employees tried to do back then, but it was apparent by 2006 those concessions weren’t enough. United, US Airways and Delta’s labor cost competitive advantage continues to pound American. The Airline Data Project (ADP) numbers show American’s employees get paid more, work less and have a range of benefits that are distant memories for peers at other airlines. That’s not an accusation; it’s simply the way the industry restructuring unfolded.

It’s also why all the other airlines, including venerated low-cost carrier Southwest Airlines, are nervously waiting to see what American looks like when it emerges from restructuring.  Following AMR’s Chapter 11 filing, Southwest CEO Gary Kelly posted an open letter to employees saying American, and the other major carries that went bankrupt, did so because of “high costs” and that “Great Customer Service cannot overcome high costs.”

I view Kelly’s letter as an important glimpse into what became American’s inevitable bankruptcy filing and what it means for the rest of the industry.

Kelly said he expected American to become leaner and warned, “If they do emerge from bankruptcy, as I believe they will, they will join the New United, New Delta, and New US Airways as giant, lower-cost airlines. They are, collectively, much more formidable competition than their predecessors. The term “Legacy Carrier” no longer will apply.”

In what had to be a stunning admission to most Southwest employees, Kelly also said, “We currently do not have a sufficient cost advantage to stimulate the market because our fares are much closer to our New Airline competitors.”  In effect, this is what I’ve been saying for years: the “Southwest Effect” is dying, if not dead.

If that’s the feeling in the executive suite at the most consistently profitable airline in aviation history, then I can only imagine how raw nerves must be at Delta, United and US Airways.

American’s filing is the airline industry’s version of “Freaky Friday” with role reversals that have long-term implications. Delta’s pilots are next up in negotiations and, like American did for the last several years, management will essentially be negotiating against itself. Remember, it was just within the last year plus that a significant number of Delta’s pilots began earning more than their colleagues at American… and that was with an infinitely more flexible scope clause that permits the higher pay at the mainline. Delta will be left negotiating improvements to the highest cost pilot contract in the industry knowing American will attempt to emerge from Chapter 11 with significantly improved scope and much lower costs. That’s essentially what American faced from Delta in 2007.

The recent NMB rulings upholding election results afford Delta only a temporary reprieve from unionization efforts. I can all but guarantee Delta will face additional organization campaigns, forcing it to, once again, spend millions to counter labor representation drives with no assurance it won’t be saddled with costly union contracts.

At the new United, the world’s largest airline might be facing world-class headaches. Integrating Continental pilots into the system is already shaping up to be a long, contentious fight, especially as many of Continental crew currently enjoy better pay rates than United peers. Continental flight attendants make considerably more per hour than their United counterparts. Those facts should not only make United’s future negotiations lively, but also mean it will likely have higher costs than a correctly restructured American.

It’s not just big brother that will garner all the scrutiny either. Eagle has already shed leases and announced potential layoffs. When AMR exits restructuring, the once-for-sale Eagle could look completely different and potentially pose real competition to SkyWest, Republic and the apparently spiraling-toward-Chapter-11 itself, Pinnacle Airlines. With American’s fleet purchase plans and a revamped Eagle, momentous change is potentially in the offing for regional airlines as well. I’ll have more on that at a later date.

As I outlined in my last post, American’s payroll is proportionately out of whack compared to its major competitors. A quick glance at the ADP numbers shows every carrier that’s gone into bankruptcy since 2002 has seen a double-digit reduction in workforce within one year of filing. That doesn’t include the nearly 25,000 jobs Delta shed in the four years prior to going into bankruptcy. Those statistics are small comfort to the employees at American who will likely lose jobs, but there is no disguising the pain this type of necessary transformation causes.

Layoffs will get the bulk of the media and general public’s attention, obscuring changes – scope, productivity, benefits – that will have more far-reaching effects. An American that comes out of Chapter 11 with significant changes in those areas potentially sends tsunami-sized ripples through the industry – particularly the flying within the U.S. domestic industry.

Yet the federal government, industry observers and, likely, the media, will spend considerably more time and hand-wringing on another hot button issue: pensions.

Pension Benefit Guaranty Corporation (PBGC) Director Josh Gotbaum has been very vocal about what he thinks AMR should do with its industry-leading pension plans. In short, he doesn’t want them to become PBGC’s problem. Gotbaum is also very quick to point out the additional burden AMR’s pensions could add to the $26 billion deficit the PBGC currently faces.

A couple of things strike me about the pension issue. Gotbaum has questioned American’s commitment to employees, which I find a bit wrongheaded since the airline spent eight years in a good faith effort to keep its pension obligations off the PBGC rolls. 

Gotbaum said American Airlines employees could lose one billion dollars in pension benefits if the airline terminates plans. That’s a bit misleading as all of the carrier’s employee pension plans are not created equally.

Like employees at the other bankrupt airlines, the majority of employees at American will most probably get their pension benefits in full. In 2012, the maximum PBGC payout is going to be more than $55,000 for those who retire at age 65. That’s more currently than the average American ground worker and flight attendant makes. The pensions really at risk will be those of the people who can most afford it – management and pilots. The bottom line is if American terminates its plans, the PBGC will do what it was designed to do: protect the investments of the working class.

AMR’s bankruptcy process will likely dominate the airline industry’s financial and economic headlines in 2012. What happens in the next few weeks and months as the new American (and Eagle) takes shape, though, will be felt by employees, competitors and taxpayers for years to come.

More to come.

If History Is A Lesson – American’s Labor Cuts Will Be Large

There is much anticipation regarding when American will file its petitions for labor relief under Sections 1113 and 1114 of the US Bankruptcy Code.  The clock is ticking in terms of the airline’s ability to get its network and costs in line generally and its labor costs specifically.  This needs to be done without undue rancor and in time to implement a workable plan. 

Further, the bankruptcy road has many unknown twists and turns as experienced by US Airways (not one filing but two), United (a three year stay and multiple approaches for concessions from labor) and Delta (an unsolicited offer to buy the company from US Airways).  American will face surprises along the way as well.

Let’s consider some facts.   Today United/Continental fly 39 percent more ASMs than American, yet its payroll is only 17 percent higher.  Delta flies 27 percent more ASMs than American, yet its payroll is only 7 percent higher.  US Airways is 53 percent smaller than American in terms of ASMs but its payroll is nearly 1/3 the size of American’s.  Any way you consider it, American pays significantly more for labor to fly its schedule than its network carrier peers.

I concluded a recent blog noting that American’s problems are bigger than any check labor could write outside of bankruptcy, but that employees will pay a much higher cost inside bankruptcy.   And that’s a painful situation that might have been avoided if all of the employee groups had the will and found a way to negotiate cost savings the airline requires to survive and prosper.

As APA President Dave Bates told The Wall Street Journal, "Sometimes in life it's easier to have something imposed upon a person than have them agree to it voluntarily." 

UNITED

The same story played out at United in 2002 and, sure enough, the toll on employees was much higher in bankruptcy than what the company originally sought in direct negotiations. Early that year, the company proposed a package of concessions totaling $9 billion over six years – or $1.5 billion per year.  The unions went back and forth for months and ultimately proposed a give of $5.8 billion over 5.5 years as a package they said employees could live with.  But as with the American negotiations, deadlines kept slipping as the unions sought more time to ratify the agreements. 

United, losing millions of dollars a day at a time the carrier was trying desperately to win a loan guarantee from the Air Transportation Stabilization Board (ATSB).  As it was, the ATSB was about the only potential source of capital then available to a company hemorrhaging cash and seemingly unable to control its labor and other costs.

As the clock ticked, the unions finally agreed to the $5.8 billion package, only to have the International Association of Machinists and Aerospace Workers (IAMAW) vote the deal down.  With the ATSB loan imperiled as a result, United filed for court protection 11 days later, on December 9, 2002.

US AIRWAYS

Four months earlier, inside of court protection, US Airways in its first filing asked for $950 million in labor relief per year on a total labor bill of $4 billion.  This was US Airways’ first bite at the labor apple as the company quickly emerged from bankruptcy number one and filed again in 2004 where a subsequent $800 million in concessions were granted.  By the time US Airways emerged from its second bankruptcy and was being merged with America West, the company was half its size in terms of employees and its payroll was 58 percent smaller.

DELTA

On September 14, 2005 Delta Air Lines filed for bankruptcy reorganization.  In the year before Delta’s filing, its payroll was $5.8 billion and it employed nearly 58,000 employees (down from 71,000 in 2000).  Through the bankruptcy stay, Delta shed nearly $2 billion in payroll and reduced the number of employees by an additional 11,000.

WHAT IS THE LESSON FOR AMERICAN?

First, the bankruptcy court proved to be a more effective means to achieving the cost savings than any airline is able to accomplish through traditional collective bargaining.  Remember, United asked for $1.5 billion per year from its labor groups prior to bankruptcy and the unions would agree to about two-thirds of that. Under Section 1113, United asked for, and received, $2.4 billion dollars of an annual labor cost savings over 6 years – for a total of $14 billion in concessions.  And this would only be United’s first of three bites at the labor apple.

The second bite occurred in early 2004 when United filed for relief from paying contractual retiree medical benefits under Section 1114 of the US Bankruptcy Code.  The third bite came in late 2004, with fuel prices beginning their march to $147 per barrel and clear recognition that the company had not cut enough while in bankruptcy, United went back and asked for an additional $725 million per year that would include the employees’ defined benefit pension plans.  These two additional bites at the labor apple cause American to stand out as having benefit packages significantly more rich than the industry and productivity constraints dictated by terms in the existing collective bargaining agreements more onerous.

According to the MIT Airline Data Project, if American’s contract with its pilots union allowed it to match the productivity of Continental’s pilot workforce, American would need 800 fewer pilots to fly its current schedule.  That amounts to $400 million in costs mostly attributable to a labor contract that puts artificially low limits on the amount to hours an American pilot can fly.

If American were to achieve the same flight attendant productivity as Delta, it would require 1,500 fewer flight attendants than it now carries to fly the schedule.

And had American relied even partly as much on outsourcing as does every one of its competitors, American’s maintenance operation, represented by the TWU, would be a fraction of its current size. American today outsources only 24 percent of its maintenance and related work, compared to an average of 40 percent outsourcing among all other carriers.  When United began its restructuring, it outsourced 17% of its maintenance.  By 2007, that had grown to 46 percent.  So it’s not unreasonable to expect something similar when all is said and done in American’s trip through the restructuring process, particularly as its maintenance-heavy Super 80 fleet is retired.

According to AMR, American’s labor cost disadvantage versus the industry now tops $800 million a year.  One of the he main questions outstanding is where the airline cuts, resizes and reconfigures its network to get to a place that it can compete and earn sustained profits.

That plan could, and probably should, contemplate significant outsourcing in the aircraft and traffic servicing department, particularly “under the wing” work in small stations with limited flight activity.

And as the airline rethinks its overall fleet and flight schedule under the watchful eye of its creditors, every position from the flight crews to ground workers to airport agents will be examined to determine how many employees will be necessary to support a resized operation.

How much power do the unions have to “protect” these jobs? If history is any guide, very little. Ultimately, the bankruptcy court will determine the viability of the company’s operating plan based on its ability to balance costs and revenues and return a profit. And if that means fewer jobs, then that’s the reality the court will consider.

This is an admittedly harsh portrait, particularly in light of the $1.8 billion in concessions granted in 2003 by American’s unions – alongside another $2+ billion in non-labor cost reductions that affected employees across the company. 

I have no direct knowledge of what American will ultimately ask of its employees or the other elements of its restructuring plan. But I don’t believe the ask will be light, or easy, and that is more a factor of the economics of the industry and the competitive marketplace than anything American could have done through other means.

Airlines and Airports: Two Different 2012 (and Beyond) Stories

The links between the economy and the airline industry are well documented.  It used to be that when the U.S. sneezed, Europe caught a cold.  The interdependencies between the two economies are clear.  The question today is which side of the Atlantic is most prone to a bad economic cold?

Today’s economic indicators and the relative performance of the airline industry are a bit perplexing.  Real GDP remains below 2007 levels.  Household incomes are at 1996 levels.  Consumer confidence is an oxymoron as it recently hit the lowest non-recession reading in its history.  While manufacturing activity showed strength in the early half of 2011, it is now close to levels suggesting contraction of the sector might be around the corner.

Despite the negative signals surrounding the economic indicators we tend to rely upon for direction of U.S. airline revenues, the industry is performing admirably - albeit still not covering its weighted average cost of capital.  Maybe even incredibly given the economic headwinds it faces.  At the heart of the industry’s performance are the positive results being realized from consolidation and a religious adherence to capacity discipline.

An example of the industry’s improved financial performance can be found by comparing financial results in 2008 and expected results in 2011.  The U.S. airline industry yearns for its earnings to be relatively stable like those of corporate America; steady with minor ebbs and flows based on economic cycles. 

Instead, the airline industry follows a boom and bust pattern – mostly bust.  Look at 2008 and, as oil ran to $147 per barrel, the industry lost 17 cents on each dollar of revenue.  In 2011, the industry is paying more for oil on average than in 2008, yet is expected to earn one penny for each dollar of revenue.  This is a remarkable result particularly given the negative economic underpinnings, the price of crude oil and the price to refine a barrel of crude into jet fuel.  Ancillary fees have helped most airlines, but are still secondary to consolidation and capacity discipline.  

Truth is, without the high oil price trigger, it is unlikely the industry would have had the will or the necessary pressure to cut capacity.  The U.S. airline industry has too often expanded too much during the up cycles and kept unprofitable capacity in place in the down cycles - all in the name of market share.  The industry’s obsession with market share arguably created an airport system too big to be sustained as well.  Today, 97 percent of domestic demand can be found at 40 percent of the commercial air service airports comprising the system.

That brings us to the airport side of the equation that, arguably, has more capacity than is necessary to satisfy profitable demand.   Why should the infrastructure for a consolidating industry not consolidate itself around the strongest airport markets serving any number of regions within the U.S. air transportation grid?  Are all of the airport markets enveloped by larger airport market catchment areas necessary? 

Over the past three decades, aircraft technologies, airline marketing strategies, and one could even say, airport strategies (think Los Angeles with five airports serving one metropolitan area) have all been designed in some way to fragment markets.  Some argue this creates “healthy” competition, but I think it actually is destructive. Look at it this way, current fuel prices caused airlines to cut capacity and, in some cases, retrench in certain markets. Those same fuel prices – which are probably never returning to previous levels – are why examining what airport capacity can be removed from the system without disenfranchising significant amounts of the population is necessary.

2012 begins a period in which the U.S. air service map begins to redraw itself.  There is no way the government will do the right thing and study the nuances of airline service and determine whether one airport is more profitable, or more ”essential,” than another. Politics will not allow it.  The market, though, is already at work determining the survivors.  This is not a process that will happen in one year; I believe the 2012–2020 period will be a shakeout of profitable and unprofitable airport markets. 

Some will say a smaller regional airline network and fewer markets served will have a negative impact on overall demand.  I disagree.  True demand will find its way into the air transportation system even if the highway serves as the first access point.  Think back to the days when iconic airline names were lost and hubs were closed.  Are those hubs like Atlanta and New York smaller today?  No.  Is St. Louis?  Yes, because it does not have the same economic vitality as an Atlanta.  In most markets new capacity quickly replaced capacity lost.  Along the same lines, small market capacity will find its way to larger regional markets within a reasonable drive.

On the other hand, there are a significant number of markets that realized less traffic in 2010 than in 1990.  There are a number of factors why, including the location within the catchment area of a competing low-cost carriers and the fact jet service was replaced with regional carrier service.  This trend will continue as long as the price of jet fuel remains at the equivalent of $120 per barrel.  Don’t forget, Delta announced it was looking to pull out of 24 markets mid-2010.  They won’t be alone in 2012 – 2020 period.

Airport markets with relatively strong local economics and demographics will survive the war of attrition.  Markets with three or more choices of a larger regional airport with a more diverse menu of services within a 2 hour drive may find it hard to keep service.  A look at any airport map shows there is too much duplication of service in the Northeast, Upper Midwest and parts of the Southeast.

The regional airport of tomorrow will offer a mix of networks, low-cost carriers, as well as some “traditional” regional service.  It will not be dependent on the 50 seat jet.  It will also have competition from carriers representing each of the three global alliances.  It may have service from a carrier like Allegiant, but if its traffic makeup is comprised of a majority of ultra-low cost service, it is unlikely to be the airport of choice within a region.

Most airlines are expected to report a profit in 2012 because they have consolidated and adhered to capacity constraints.  But there is still more to do.  Today’s industry only cares about profitable flying, not flying for the sake of pretending to be something for everyone. The regional airport of tomorrow, though, will need to be everything to everyone. 

My outlook is not all doom and gloom.  I see it as the next phase of restructuring being undertaken by an industry badly in need of a fix.  The industry is inextricably tied to its infrastructure and what has become a necessity for airlines might soon become reality for airports.  That is to regionalize, the airport vernacular for consolidate.

American Airlines, Labor Leverage, US Airways and Chicken Little

Labor Leverage and Other Thoughts

Since American’s filing for bankruptcy protection last week, I’ve received many notes asking why I am not writing about American - about a potential combination with US Airways or what I expect the company to win from the unions.  I haven’t written because, frankly, I already talked about the potential consequences of bankruptcy for the airline, unions and the industry in my most recent piece.

On Monday, I intended to write about leverage and how the Allied Pilots Association was seriously misjudging the leverage it thought it had. Tuesday’s filing kind of made that point moot.   As the Sections 1113 and 1114 negotiating process wends its way through a court supervised restructuring, the pilots and all unionized employees will either reach consensual agreements with the company or the company will look to the court to terminate the existing agreements.  Whichever outcome, the new contracts will look nothing like the potential deals the unions could have negotiated at various times over the past five plus years.

I know, I know… “American could have reached a deal if it wanted.” It does take two to tango, but in this round of negotiations, American and its unions were listening to vastly different music. American’s offers provided cost benefits that would be realized over the long-term while still maintaining what can only be described as an industry-best benefits package. That wasn’t going to sit well with analysts and Wall Street types who fervently believed the airline needed immediate gains to remain viable.

The unions, seemingly, wanted everything to magically return to past patterns and routinely called for restoration of the pay and benefits they conceded in 2003 to stave off bankruptcy. A common refrain has been no union members have seen substantial increases in wages since 2001. Peers at other airlines did get raises, but American’s employees were – and are - still better off.  It’s a simple, provable truth and it meant there was no going back to 2003 or 1993. It’s a different industry and a different world.

That’s key to understanding there is no leverage for either side in this round of negotiations. (Are you listening, United pilots?) It’s also why this negotiations cycle has been so difficult. Few agreements have been struck. American will likely get deals well before we see contracts – or even tentative agreements - at United and US Airways.  As the bankruptcy process plays out, the American pilots and flight attendants will no longer have industry leading contracts among the network legacy carriers – Delta will.

And guess who comes up next for negotiation – the Delta pilots.  Like American’s management over the past five years, Delta’s management will have to negotiate improved terms and conditions on the highest cost labor contract in existence. All the while, the United/Continental pilots will spend more time asking who is on first than they will spend at a negotiation table.  Looks to me like all of that “leverage” being created by the United pilots alleging poor safety policies by management is NOT moving the parties quickly toward a deal.

While I expect the Delta pilot negotiations to be complicated and difficult for the company, at least the pilots enjoyed some benefit following the merger with Northwest and the bankruptcy agreements that preceded it.  Delta’s pilots will have the richest compensation package in the industry after American completes its bankruptcy negotiations. That means they won’t have any leverage over the company even as pilots squawk about the liberal scope clause in the current agreement. 

In this process, there is a different kind of “trickle down” theory. Case in point: The TWU employees at American. Talk about no leverage.  The more removed from the flight deck, the more leverage dwindles. American’s below-the-wing employees currently earn a total compensation package of roughly $25 per hour. That work can be outsourced for 40 cents on the dollar.   Add the fact  American outsources the least amount of maintenance work in the industry, and that it has more ground workers than any other airline, well, you get the feeling things are going to change. If you’re a TWU worker, that’s probably no comfort.  

All This Talk About A Merger With US Airways

I am surprised – no, blown away - by just how much attention the US Airways – American merger possibility is getting.  In the first 36 hours after AA filed for protection it seemed the world was suggesting a merger with US Airways was the only viable exit strategy.  I don’t believe it.  American will have the exclusive right to file a Plan of Reorganization (POR) for 180 days – a right that is typically extended multiple times by the presiding judge.

Keep in mind, all three of American’s unions were appointed to the unsecured creditors committee. Any plan of reorganization by a party other than AA will have to convince the committee their plan is better for all stakeholders.  Given the messy labor situation that remains at US – six years after its merger with America West – I sincerely doubt anyone would find a US bid credible… especially American’s unionized workforce.  

That’s why, at least right now, I simply don’t see a merger happening, despite industry analyst Vaughn Cordle’s contention that, “regardless of the ugly nature of merging two suboptimal business models and different unions, American's best option is to merge with US Airways.”  My first question is, why would you even think of merging two suboptimal business models in the first place?  So that you can compete directly against balance sheet and network rich United and Delta?

There is another option I don’t think many analysts have considered.  I could see a competing plan led by British Airways and other oneworld partners that would have the potential to win if the AA case gets to the point where outside parties are free to submit alternative PORs – even at today’s 25% foreign ownership limit.  If you believe AA will become a smaller entity over the coming months, the one sure thing is AA’s network will be optimized to maximize revenue generation with its new joint venture partners.  That’s precisely what STAR is doing through United and SkyTeam with Delta. 

The Sky Is Not Falling

Over at Terry Maxon’s AirlineBiz blog is a letter from TWU President Jim Little decrying American’s filing with $4.1 billion in cash and thus a near term ability to pay its current obligations.  I urge you to read the letter in full and the lack of reasoning throughout.  What did Little expect the company to do when he refused on numerous occasions to step-up and tell his TWU members the cold truth that something is better than nothing?  He has had a number of opportunities over the past five years to negotiate an agreement with American that the company could afford. 

The bottom line is bankruptcy is not a big deal.  This is not the industry’s first rodeo.  American’s problems are bigger than a check labor could write outside of bankruptcy, but sadly, the employees will pay much more inside of bankruptcy.   As APA President Dave Bates told The Wall Street Journal, "Sometimes in life it's easier to have something imposed upon a person than have them agree to it voluntarily."  Sad commentary indeed.

FORT WORTH, Texas: The Longer It Goes, The Worse It Will Get

Another Sunday in the Washington D.C. area means being forced to watch the Redskins if you want to watch some football.  I wanted to watch some football, but catching up on my reading was much more interesting.  As is typically the case, my starting point is Terry Maxon's Airline Biz Blog.  Three of Maxon’s last four posts pertain to the negotiations between American Airlines and the Allied Pilots Association.

Each of the parties issued a statement regarding the decision not to negotiate over the past weekend with both pointing fingers at each other.  The understanding, at least for those of us on the outside looking in, is the company is seeking to reach an agreement in principle with pilots before this week’s regularly scheduled AMR Board of Director’s Meeting. 

I have participated in numerous troubled negotiations between management and labor, and taking time off because someone is tired prior to a deadline just does not make any sense.   Maybe the APA doesn’t think it is negotiating against a deadline.  I am also someone who knows a little bit about Board of Directors meetings and fiduciary duty, so if I was the APA, I would be taking Wednesday’s meeting seriously.

After all of the news, reviews and Wall Street’s muse over American’s financial blues I am guessing that AMR’s Board of Directors is feeling under pressure.  And Boards under investor pressure often feel the need to act.  As I wrote in American: Limited Options, Pain Likely, something at the Fort Worth, Texas carrier likely needs to give if no labor deals are reached – particularly a pilot deal that could serve as a template for other work group agreements.  The potential scenarios are, of course, bankruptcy, getting significantly smaller outside of bankruptcy or getting smaller inside of court-assisted restructuring.

Some of the messages I received on that piece suggested bankruptcy is an acceptable solution for American’s situation, particularly when dealing with the current management.  I think all of American’s union groups, and especially the pilots, should be very careful what they wish for.  Never forget the truism that it is probably best to deal with the devil you know.

The fact is employees at American still have their benefits, including pensions, because CEO Gerard Arpey chose not to use bankruptcy proceedings to cut costs the way everyone else in the industry did. Whether the unions like or dislike Arpey, though, is moot. If American files Chapter 11, creditors and the courts probably won’t let Arpey guide the airline during its time in bankruptcy.  They’ll want a restructuring guy, possibly in the mold of United’s Glenn Tilton, who turned his back on company history and acted in the best interests of financial capital, not employees to reposition the enterprise. That caused some serious labor/management relationship wounds.

American can survive labor discord as it has since Robert Crandall was in charge. I’m not as sure American comes out of bankruptcy unscathed – at least, not the American Airlines that we’ve known for the last 85 years. A much different airline would likely emerge, if at all, so emotionally-charged employees might rue their actions today.

Let’s review a few facts about bankruptcy and North American airlines.  Since 1991 there have been 14 airline bankruptcies and only one carrier remains a stand-alone airline today – financially troubled Air Canada.  Eight of the airlines have been liquidated or ceased operations:  Pan Am, TWA, Aloha, ATA, Skybus, EOS, Arrow and Mexicana (Eastern filed for bankruptcy in March of 1989 and ceased flying in January of 1991).  The remaining five airlines have been merged:  US Airways, United, Delta, Northwest and Frontier.

While the merged companies are stronger, they lost most – if not all - of their individual identity.  A merger partner with American in its current financial and labor condition is unlikely.  Private equity would only be interested in American after a deep cleansing of labor contracts in bankruptcy.  After all, even private equity wants clean fingernails when the entity emerges from court protection.

Union groups need to think long and hard about what that means for them. For American’s flight attendants and ground workers, a Chapter 11 filing would be the end of the world as they know it.

American’s flight attendants fly the least of any cabin crew in the U.S. airline industry. They currently pay less for medical coverage than their peers and still have pensions and retiree medical that are but faded memories for flight attendants at other carriers.

There are roughly 25,000 TWU members employed at American – mechanics, baggage handlers, cabin cleaners. A bankrupt American would dramatically slash that number, outsourcing a majority of jobs as much of the industry already does. Pensions, retiree medical – all gone. The reverberations would shake big cities like Miami and communities like Tulsa where the American maintenance base is the largest private corporate taxpayer.

Pilots like to think they’re different, more crucial to the operation, more prepared to handle anything that arises. That’s their job, and most are very, very good at what they do. The members at the Allied Pilots Association, though, should use the same reasoning and spend some time rethinking their position.

As MIT’s Airline Data Project shows, on average, American’s pilots are already making about two-percent more than their peers. The thing that should make pilots uneasy, though, is when you look at their benefits, which are worth about 40+ percent more than what pilots at other network carriers make. There is not a bankruptcy judge in the country who won’t immediately allow the company to toss all of that out the window.  It is not the wages per se; it is the benefit package and relatively poor productivity that makes the American pilot agreement uneconomic when compared to peer carriers. 

I’m not privy to what’s being talked about at the table between pilots and American, but the company is posting all of its proposals on its public web site, AANegotiations.com. From what I’ve seen, American’s current offers don’t dramatically change pilot benefits… they would still be significantly better than other carriers. What hasn’t been posted is any item on scope, and I’m sure the pilots would vehemently oppose any changes, no matter how necessary or warranted they might be.

If anyone on the APA Board foolishly thinks bankruptcy wouldn’t be so bad, they should review those facts I mentioned earlier. Besides the loss of pensions and work rules, a post-bankruptcy American would either be much smaller – meaning fewer pilots needed-- or prey to other airlines circling its carcass. If it’s plucked as a weak-sister acquisition, those APA pilots would most likely lose their seniority taking a backseat – or right seat – to their new colleagues.  And that assumes that acquiring airlines would even want former American employees – particularly in seniority order.

I could absolutely envision a U.S. airline industry without American.  Think of the value of the Heathrow slots, the LaGuardia slots, the JFK slots, the Washington National slots, the related real estate at each of the former, a ready-made Deep South America operation in Miami and an opportunity for network and low-cost carriers alike to finally get necessary real estate at Chicago O’Hare to mount a competitive operation.  American’s parts could be worth more than its whole to creditors and other airlines.

From a Board of Directors perspective, there are some basic facts to contend with. You cannot restructure the price of jet fuel.  Most, if not all, of American’s assets are pledged as collateral so little might be achieved in the airplane area other than rejecting certain leases on the oldest and most inefficient narrowbody fleet in the industry.  The company faces significant loan repayments and pension contributions.  In other words, AMR has every reason to file.

The pilots and the APA can belay that. They can be the leaders they think they are; not just for themselves, but for every other employee at American. Negotiating a deal now sends a signal to Wall Street, creditors and even consumers that things really can change. It also lessens the pressure on AMR’s Board of Directors to take a more active role in the company’s day-to-day dealings. Without it, the only pragmatic course for the Board would be to seriously examine its next steps. It can’t wait on the promise of a labor deal, especially if the APA mistakenly believes it has leverage and wants to try and use it.  Even if an agreement were reached today, it will be sometime in the first quarter of 2012 before the voting on a new agreement is concluded - that is why time is not on the side of the pilots and why AMR's Board is likely to grow restless if something does not happen soon.

Should a Chapter 11 restructuring end in Chapter 7 for some reason (a probability greater than 0 given that the company may be forced to cede control of its right to file a plan of reorganization), one can envision U.S. air transport system without American Airlines.  History suggests that the capacity void left will be filled in short order by the remaining players.  If a profitable hub opportunity exists for a remaining airline, it will be filled.  Will there need to be a hub at DFW?  No.  But there is plenty of local traffic to fill new service from existing airlines as well as Southwest at Love Field.  American’s aircraft order will likely be absorbed by the remaining carriers over the coming years to help fill the void left.

I just wrote “An Unpleasant Situation That Continually Repeats” last week that focused on unions thinking they know what is best for the company at both Qantas and Air Canada.  Maybe American was the sequel I was thinking about when I wrote that piece.  If that sequel includes bankruptcy, I know the story ends badly for the working men and women at American.  The rest of the industry will applaud the demise.

“An Unpleasant Situation That Continually Repeats”

Remember the movie “Groundhog Day?” Well, Qantas is starring in the current airline version with Air Canada in the supporting cast. The basic plotline has unions pretending to know how to run companies while portraying management teams as the dastardly villains whose only aim is to run carriers into the ground, milk their pay and destroy organized labor.

If you’re thinking you’ve seen this one before, that’s because you have. Outside of Hollywood, there is no better industry at recycling the same old material than U.S. airlines and their workers.  Like any movie fan, I love a good sequel, but the all-knowing unions versus incompetent management is the same story run more times than a 1950s B Western.

Still, the version from Down Under is quite possibly the most intriguing adaptation in recent years. At the crux of the Qantas story is CEO Alan Joyce.  During the past several months, Joyce has faced numerous intermittent strikes by employees; received alleged death threats as he seeks to change the course of Qantas; threw his hands up, shut down the airline and locked out employees for a weekend (the same weekend the Australian government was hosting a major conference); took a lashing for doing so from the Prime Minister and other Australian lawmakers; and, in a move reminiscent of U.S. airline stories, tried to explain the business to a dysfunctional government lacking a complete understanding of air transportation.

Joyce recognizes very clearly that Qantas must change, otherwise the Flying Kangaroo will land in a gravesite alongside Pan Am and TWA and not on a runway in Sydney.  Joyce wants/needs to establish a low-cost presence in Asia.  It already has a low-cost alternative called JetStar in Australia.

Qantas is a geographically disadvantaged airline – its home market is an end point on the global airline map.  Airlines in the Middle East have targeted Qantas’ traffic base using their geographic advantage to route traffic to points in Europe, North America, Africa and the Middle East.  Because of their lower costs, Emirates, Etihad and Qatar can offer much lower fares.  Singapore, Malaysia and Air Asia can do the same thing for the same reasons.  Imagine what will happen if (or when) the Chinese carriers become formidable competitors.

The union response? Rolling, intermittent strikes by the Transport Workers Union, the Australian Licensed Engineers Union and the Australian and International Pilots Union. This destructive industrial action forced Qantas to cancel more than 600 flights affecting 70,000 passengers, creating uncertainty for businesses and damaging the tourism industry.

I know some regular readers will say I’m once again bashing unions and sticking-up for management, but that isn’t the case. I think labor has some legitimate beefs with Qantas, but the reaction by the unions simply isn’t rational. When an airline is struggling, you don’t plunge it further into economic turmoil, especially when the heart of the dispute is job security. All the Australian unions have to do is look at past versions of this story to see how that works out.   It just makes no sense.

What makes this round of bargaining different than past rounds in the U.S. is there are major, structural claims that management cannot accept without putting the enterprise at risk.  It is one of the reasons I write so often about scope.

Joyce very eloquently outlined Qantas’ position: “No responsible company would let a small number of unions dictate how the business is run.  What the unions are actually trying to do is secure a veto on change. They demand the retention of outdated work practices that do not reflect the realities of modern aviation. They want Jetstar pilots to be paid at the same rates as Qantas pilots, a move that would drive up ticket prices for leisure travellers. These are major, structural claims that we cannot accept.”

I applaud Joyce for standing up and saying enough is enough.  Some very smart people have said Joyce’s major error was not informing the government of his intended actions, thus embarrassing the current administration. Truth is, whatever decision Joyce made to combat the union’s actions, he was damned.  If he did nothing, he was left in charge of an airline that had no idea if it could deliver service to customers because the unions could strike at any time.  He was damned if he shut the airline down, inconveniencing those same customers as well as humiliating the government. And if he gave the unions even half of what they wanted, he’d forever be known as the man who doomed Australia’s national airline.  

Like it or not, decisions made in management suites and board rooms are all about preserving the enterprise - - even if it means making unpopular choices.  That’s what makes the airline business different today than in the past.  The irony is both management and the unions really want the same thing; to keep the airline a viable enterprise into the future, thus securing jobs. It’s about building the best job protector that can be built – a healthy company.

That’s why so many U.S. aviation workers really should be tuning in to what’s happening at Qantas and, to a lesser extent, at Air Canada. Pilots and flight attendants at United/Continental, the pilots and all other groups in negotiations at American as well as the pilots and flight attendants at US Airways don’t have to produce their version of “Groundhog Day.” They can recognize reality and start a new script that guarantees good paying jobs for their members and helps keep their respective airlines competitive. Think of it as an adaptation of the UAW play.

To be stuck in the same place, with the same unproductive mindset and doing the same things over and over isn’t going to be any more effective in the Qantas story – or any other version – than we’ve seen in the past.  

Bill Murray’s character in “Groundhog Day” has a telling line I don’t want to see as airline unions’ epitaph. After trying to break the repetitive cycle he’s stuck in, Murray’s Phil Connors says, “I’ve killed myself so many times, I don’t even exist anymore.”  If management and unions don’t change the script soon, that’s exactly what will happen.

The Ultimate Unintended Consequence: Government Proposals Will Kill Small Community Air Service

Ten Reasons Why

I’ve been on the road for six weeks, traveling to communities large and small to discuss the grim future of small community air service in the face of economic pressures on regional airlines.

Those pressures only begin with jet fuel at a price equivalent of $120 per barrel, but the factors are many. They include the reality that: 

2) There are no aircraft of 50 seats or less in the production pipeline

3) All regional flying contracts will come up for bid between now and 2017 and likely will not be renewed by the mainline carriers

4) Low Cost Carriers in a regional market’s catchment area are drawing traffic to larger airports at the expense of smaller airports

5)  A growing pilot shortage will hurt the regional carriers first as regional pilots will find work on the mainline

6) Proposed FAA flight time/duty time regulations that put new limits on pilot flying hours will force regional carriers to hire more pilots to do the same amount of flying the sector is doing today

7) Congress, in a questionable response to the Colgan crash, passed a law requiring 1500 hours of training time for a commercial pilot

8) Most manufacturers won’t produce commercial airplanes smaller than 100-seats as most airlines can’t afford to sustain many routes with smaller planes

9) Negotiations between mainline pilots and management over new scope language is as emotional and contentious as it has ever been.

10) Proposed tax increases certain to punish the smallest of markets.

The Administration’s 2012 budget proposal already levies a $100 fee for every airplane departure in controlled airspace, costing passengers and the industry more than a billion dollars a year.  It also seeks to double the “security tax” paid by passengers to $5 per one-way trip, and triple the tax to $7.50 by 2017.  The total price tag for that proposal: $25 billion – $15 billion of which would be diverted for deficit reduction. The proposals together will cost passengers and the industry $36 billion over the next 10 years.

Air Transport Association of America CEO Nicholas Calio said it best when he said Washington is treating the airline industry like it treats  alcohol and cigarettes – taxing the hell out of it  as it does with “sin taxes” as if Congress actually wanted to discourage flying.  While I assume that’s not the government’s intent, it may well be the result.”

I do find it ironic that the government is seeking to tax an industry an incremental $36 billion over the next ten years after it lost $65 billion over the past ten years.  But I digress.

Let’s not forget that the airline industry ranks as the third greatest producer of economic activity in the US.  In my view, there is no way the industry can absorb these financial and regulatory pressures imposed by Congress without negatively impacting airlines and their role in driving economic activity. And the industry’s first response would be to remove marginal capacity from the system of production.  Where will they look to trim capacity even further – San Francisco to New York or Cincinnati to Des Moines?

Of course, airlines might try to pass new costs onto passengers, just as most industries do when faced with higher costs and limited opportunities for expansion. In this market, however, it is hard enough to simply add a few bucks to the price of a ticket to cover the rising cost of oil.  Imagine the impact of trying to pass on costs that will total billions at a time business and leisure travelers are counting pennies.

Typically, excise taxes like sin taxes work best in industries that have more control over the pricing. That is not the case in the airline industry.  Sin taxes are most successful on industries that produce products with price inelastic attributes.  The airline industry can hardly be termed an industry that produces a product with inelastic characteristics.

The ATA estimates the proposed taxes would lead to a 2.3 percent reduction in capacity at a possible cost of 9,700 airline and related jobs – and that’s just the impact from a tax increase.  Still unknown is the cost of the other factors outlined above, which alone would inevitably lead to fewer flights and fewer routes flown.

The mainline will hurt some. With fewer regional jets feeding the big carriers, how many larger aircraft do we need?  Some traffic will be captured at airports that continue to receive service within the catchment area of an airport losing service - but not all.  Some traffic may find its way onto competitor aircraft. And some demand may fall out of the system entirely.  In any instance, overall demand will suffer over the long term as marginal supply is removed from the system.

But the brunt of the damage will be felt in the small communities that rely heavily on regional carriers.

One of the things that bothers me most about Washington’s view of the airline industry is the clear bias in favor of the so called low cost carriers.  These airlines have been brilliant in cherry-picking profitable routes and creating networks designed for profitable flying. But it was the legacy carriers, not the LCCs, who invested in the assets to serve the nation’s smallest airport markets and sustained routes that, were subsidized by other flying.  It is the network carriers that keep small markets connected to the global air transportation grid. 

Unfortunately, the economics serving all these small cities are fast eroding because of factors the airlines don’t control, oil costs at the top of the list. But the lawmakers and regulators should step back and fast and realize how their well-meaning proposals could result in a loss of service to small markets across the nation.  The politicians will probably find a way to blame the airlines for cutting service while the real blame falls with those proposing “easy” fixes now that will do far-reaching economic damage  in the future.

Update on 10.25.2011 by swelbar

The good folks at ATR remind me that the ATR42 comes standard at 48 seats.  The company believes that it is a replacement for the 50 seat jets.