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© 2007-11, William Swelbar.

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Oct262007

« Just Put It On Ice: American’s Ability to Pay ≠ APA’s Expectations »

As I read this morning’s Wall Street Journal, the headline on page 2 is “Economy’s Weak Signals Persist” and the headline on page 3 is “Oil Tops $90 on Range of Worries.” What this means for the airline industry is well documented in Planebuzz click here.

We said the eyes would be on Texas airline labor negotiations, and we got a good glimpse of that this week. The Allied Pilots Association presented its Section 6 opener to American Airlines on Tuesday. This writer’s take on what American is seeking is a cost-neutral contract (which in effect preserves APA’s industry leading position) where productivity gains could cross subsidize increases in other sections of the agreement. By contrast, APA asked for pay increases in the 50% percent range.

This is one rich deal. Add the productivity gains and the multiplier effect of wage increases on pension and benefit costs (and well before any opportunity costs or opportunities lost are analyzed), my back of the envelope calculation suggests the price tag on this proposal is comfortably a three comma number. Yes, the number starts with a B and not an M. And this is before negotiations start with the other unions representing the vast majority of AA employees.

Let’s put this in perspective: Today, American has a pilot cost per block hour disadvantage versus every single one of its major competitors in the US market click here. If American had a pilot contract along the lines of the Continental agreement, that is at or above the industry in terms of compensation and productivity, American would need to reduce its annual total pilot costs by as much as $500 million click here. But American is not seeking concessions; it is seeking a competitive contract recognizing the “gives” by labor outside of bankruptcy.

I argue that the APA proposal fails to serve its members. Not just because of the costly demands, including the proposal that pilots receive holiday pay if they fly Super Bowl Sunday, but because the union’s demands insist upon a return to 1992 wages adjusted for inflation. That sets completely unrealistic expectations when put in context of the massive change in the landscape for network carriers, and the US airline industry for that matter, since the mid-1990s. American’s average “nominal” domestic fares were actually lower in 2006 than they were in 1995 click here.

In the media coverage, the APA suggested that its opening proposal would lead to a quick settlement. I beg to differ.

When two sides are so far apart on an agreement that there is no basis for movement, it is said that negotiations are “put on ice.” For many reasons, this round of labor negotiations is the most important since deregulation. For the major airlines to have any hope of succeeding for the long term, this upcoming round of contract talks must produce agreements that are durable and sustainable and make strides toward eliminating the cyclicality that has plagued discussions between labor and management for the deregulation generation.

There remains a real opportunity for these negotiations to be “industry interesting” in a good way and think about ways for employees to share in any upside while still realizing some protection in the downturns. That’s what the unions should be aiming for in getting their members a deal.

But if, in the APA’s view, the upside means in a 50+% increase in base rates then there really is no starting point. Openers are supposed to be starting points, not the point of no return.

Executive Compensation

We cannot discuss industry economics and labor without also discussing executive compensation. For as long as I have been in this industry, airlines have been run for pilots, by pilots and in fear of what pilots might or might not do. As a former flight attendant – that is how I put myself through school - I constantly questioned it and still do. For virtually any carrier, in a list of the top 100, 200 or 500 most highly-compensated employees, the majority would be pilots.

This industry has never had a deep bench of management talent . . . in part because airline executive contracts have historically not been as rich as executive contracts in other industries. The executive management team in the airline industry is usually there because they have jet fuel running through their veins, not because the financial upside is so great.

Many say that there is no justification for the executive payouts in recent years across industry – not just the airline industry, but throughout corporate America. But the simple fact is that markets are at work. Not all markets are rational, but given that markets by definition operate on perfect information, ultimately they return to the trend line.

For CEO’s, CFO’s and CIO’s the market rates are set in New York, Des Moines, Singapore, London and Los Angeles as companies in the US and around the globe are seeking the same talent to do the job for them just as American seeks to find the best people to fill these positions as well.

The reality is, however, that a new market rate has been set for pilots and it is not 1992 times inflation to the sixteenth. It is $120,000 and not $180,000 click here.

For awhile, “pattern bargaining” fueled an unrealistic – and unsustainable – growth in average pilot wages. It began with Delta’s lucrative pilot contract in 1999, followed by United’s topper in 2000 as it followed the "Delta Dot" along the road to bankruptcy.

Now there’s a new pattern, and a new market reality, and that is the contracts reached in bankruptcy and ratified at United and US Airways in 2002 and 2003. That’s how the market works, and airlines – like companies in any other competitive industry – generally compensate management and employees at the going market rate and as necessary to retain its best people – period.

Don’t assume that I support executive compensation packages that have benefited senior leaders while workers have seen their lives negatively impacted. I do not. But, I am a believer in markets. The convergence of what is paid to pilots, flight attendants, ramp workers has found an equilibrium and that is what markets with perfect information do. Will the market rethink executive compensation as well? I think so.

So......

We can spend a lot of time thinking about the APA proposal or just recognize that negotiations in this round will take some time. During restructuring, the market realities dictated quick negotiations and resolution. This time it is different. Neither labor nor management has significant leverage. Labor is trying to create leverage using the executive compensation issue because there is little else that resonates as well with a broad base of employees and the public. Meanwhile, management teams are doing their job and actually posting profits at a time when pricing power continues to decline - with no adjustments for inflation. The only structural change now permitting increases in revenue is in reduced capacity and in the lofty levels where oil is trading and, finally, an industry willing to pass on a portion of those increases to the consumer.

There are many who say the industry’s recent profitability comes on the backs of labor. That argument ignores the fact that the recovery is the result of tactical and strategic decisions, combined with other management actions, to achieve profits in an environment that has been structurally changed.

Keep in mind: $4-5 billion in profits in an industry earning $130 billion in revenue does not signal a healthy recovery.

I’ve titled this post “On Ice” for more than one reason.

The first page I read in the newspaper is the sports page. In an interview in the October 25 USA Today, Paul Kelly, the new Executive Director of the National Hockey League’s Players Association had some profound thoughts to share click here.

1. "Do we need to understand where we should cooperate and where we should draw the line? Absolutely," Kelly said. "But anyone who thinks I'm going to fire the first shot across the bow of the NHL, they've got it all wrong."
2. "My view of the world is that unless you have a personal relationship, a real human relationship with someone, it's difficult to transact real difficult business," Kelly said. "I want to get to know Gary, and I want him to get to know me. And I understand that there is a line there — that we represent different interests."

Perhaps hockey and airlines have little in common. But negotiations are negotiations, and they are not done on an island.

At American, as well as across the industry, pilot negotiations are going to result in "transacting difficult business". Captain Hill, reach out to Gerard Arpey and begin a real negotiating process. Mr. Arpey, reach for Captain Hill and reiterate the commitment you have made, and kept, to maintain pension benefits and retaining the components of the pilot’s agreement that ensure that AA employees will have dignity in retirement and in their day to day living to the best of your ability to pay – something that cannot be said of all carriers in this industry. Otherwise it could be a long, cold winter in Ft. Worth.

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Reader Comments (9)

Actually it was United's contract 2000 which came before any of the other follow-ons, which included Delta.

10.26.2007 | Unregistered Commentersea flyer

In response to sea flyer, I agree that the full Delta agreement was not negotiated until after the UAL 2000 agreement. What I was referring to was the negotiation between the parties to establish a 767-400 rate. Once this rate was established it changed the slope of the pay to aircraft size line. Captain Dubinsky referred to the Delta dot (767-400 rate) as altering the UAL ALPA approach.

Swelbar

10.26.2007 | Unregistered CommenterSwelbar

??? Airlines run by Pilots for Pilots etc... O.K. then who should an airline be organized around? FA's? Mechanics? MGMT? Gate Agents? FAA rules regarding Air Carrier Operations center around the Flight Deck, and thus Pilots. Pick an industry and you will find one employee group that dominates the issues. Hospitals its Doctors, Software companies its programmers, Insurance companies its adjustors etc...yea but flying is easy, and doesn't take much skill. Thats what they all say anyway.

10.27.2007 | Unregistered CommenterAnonymous

Some questions for the author:

1.Were there any numbers in your blog entry to substantiate your claim that the contract would cost AA "billions" of dollars?

2.Are there any numbers to substantiate that Continental's contract if applied to American would save AA 500 million per year? American pilot salaries are below CAL's and CAL enjoys superior work rules in the area of vacation, sequence protection, and sick time.

3.Does anyone other than the blogger in this industry use "block hour costs," to calculate pilot costs? How can one use such a strange metric, not used by any other reputable analyst?

4.Does any other reader believe that the strange justification of executive compensation in this blog is logical? AMR "named officer" executive compensation has exceeded gains in fortune 500 compensation nationally since 1992 by over 20%- 469% vs. 449%

5.The author of this blog is a principle of a major MIT study on airline crew costs- yet he is a board member of an airline. Does this call into question his objectivity?

6.Did the author forget all the disastrous corporate decisions that led to the strings of bankruptcies in 2002-2003?

Here are some numbers. AA's initial pay proposal would increase AA's CASM by .47 cents, less than 4% of total CASM as measured by the DOT form 41 statistics.

CEO pay has increased 723% since 1992- a 560% increase in purchasing pwoer.

AA pilot pay has decreased 1% since 1992 and AA pilots have lost 33% of their purchasing power.

The thing about markets is that they are cyclical. Maybe the rate for an airline pilot has been set- but rates don't necessarily stay set. The price of a pilot is about to change, the author- and the industry- had best prepare for that.

10.27.2007 | Unregistered CommenterJason

In response to Jason:

1. The numbers necessary to do a back of the envelope analysis of the cost of the contract can be found at a number of public data portals. BTS, MIT Airline Data Project and the ATA site are just a few of the examples.

2,3. Based on the reported data, if AA had CO pilot unit costs it would reduce costs by $500 million. Cost per block hour is a common industry measure for flight crews particularly. But if you dispute the denominator, the numerator does not change. The estimate of $500 million would remain the same.

4,5. I am an airline industry analyst and having a board position would not cause me to do calculations differently. In my opinion, my board position gives me insight into the difficulties of how to deal with executive comp that many do not get to see.

The source data is totally transparent. This blog only refers to the MIT Airline Data Project which is not a major study on crew costs - but rather a comprehensive tool to examine all factors impacting the industry. Crew costs are only one input. To evaluate the industry it takes more than an understanding of the cost of a pilot or the percent of revenue spent on distribution. The data project provides a place for people to go and put things in perspective.

6. I encourage you and other readers to view Terry Maxon's blog posting at the Dallas Morning News where he adjusts critical industry data points for inflation.

Thanks for taking the time to comment, Swelbar

10.27.2007 | Unregistered CommenterSwelbar

In response to Jason:

1. The numbers necessary to do a back of the envelope analysis of the cost of the contract can be found at a number of public data portals. BTS, MIT Airline Data Project and the ATA site are just a few of the examples.

2,3. Based on the reported data, if AA had CO pilot unit costs it would reduce costs by $500 million. Cost per block hour is a common industry measure for flight crews particularly. But if you dispute the denominator, the numerator does not change. The estimate of $500 million would remain the same.

4,5. I am an airline industry analyst and having a board position would not cause me to do calculations differently. In my opinion, my board position gives me insight into the difficulties of how to deal with executive comp that many do not get to see.

The source data is totally transparent. This blog only refers to the MIT Airline Data Project which is not a major study on crew costs - but rather a comprehensive tool to examine all factors impacting the industry. Crew costs are only one input. To evaluate the industry it takes more than an understanding of the cost of a pilot or the percent of revenue spent on distribution. The data project provides a place for people to go and put things in perspective.

6. I encourage you and other readers to view Terry Maxon's blog posting at the Dallas Morning News where he adjusts critical industry data points for inflation.

Thanks for taking the time to comment, Swelbar

10.27.2007 | Unregistered CommenterSwelbar

Hi Swelbar,

I think any logical person would think your position as a member of an airline board of director would create a conflict of interest, and would make it unlikely in the extreme that you are unbiased, particularly in the area of executive compensation.

I am very familiar with the work of many analysts, and know many of them and their work. They are all scratching their heads at the idea of "cockpit block hour costs" as a metric. It is not an accepted metric for measuring crew costs in the industry like labor CASM is for instance. Of course the carrier with the highest labor CASM in the industry isn't American, it's Southwest.

I am also familiar with the BTS and the Form 41 Data. There is no data there that I can see that allows to to assert that a Continental contract at AA would save 500 million dollars in annual pilot costs. Could you show me your math?

I've read Terry Maxon's blog and it presents a much more balanced view of the situation at AMR. It certainly doesn't gloss over the insane increases in management compensation, and it doesn't make rather transparent statements like "the market price for a pilot has been set."

With respect, sir, there are analysts and then there are consultants. Would you like to tell us if ATA, AIRCON, or any similar organization financed or contributed financial support to the supposedly "unbiased" MIT study?

I await your response with tremendous curiousity!

Jason

10.27.2007 | Unregistered CommenterJason

I think the issue here (and, more generally, with the MIT data) is that there is no one true or correct answer to the data interpretation.

I simply cannot find any evidence that the Form 41 and SEC data can be tricked up or massaged to suit either party's (organized labor or management's) point of view. It kind of is what it is. It doesn't lie. And, further, I simply don't see any evidence on the MIT site of bias or attempt at data manipulation.

I don't have a seat on the management side nor do I have a seat on the labor side. And, to be honest, I don't work for an airline. I am an observer of the airline economic and busines process. It won't be popular to say this, but I truly don't believe executive compensation (which is paid in at-risk stock) is comparable to labor costs. Further, I don't tend to buy labor's argument that labor costs can be offset with a simple fare increase. High school economics would teach you that labor is a fixed cost. Fuel is not. You can pass through fuel expenses to the consumer.

If you surveyed 50 people at Chicago O'Hare and asked them if they would be willing to pay more on top of the already-high government fees, PFCs, local fees, etc. to fund increases to pilot, flight attendant and mechanic salaries, I am pretty sure I know what the answer would be.

That being said, this is a healthy discussion, and I am glad there are sites like the Dallas Morning News, Fort Worth Star-Telegram, this one, etc. to have these issued raised.

10.27.2007 | Unregistered CommenterJetFueler

Hi Jetfeueler,

I took High School economics as well as college economics. I took it at that vaunted management friendly institution off Route 95 called "The Wharton School of Business." Even there I never heard it suggested that labor is a fixed cost. The cost of labor floats depending on the labor market and is never "fixed," and labor costs can be passed on to the customer just like any other costs.

Also, history has proven that passengers will fly. Fares have trended up significantly over the last three years and guess what? So have total industry RPMS. People will fly airplanes because that's how you get from A to B.

I'll bet if you asked your question differently- do you think pilots need to be well paid and compensated because they have hundreds of lives in their hands every day, and would you mind paying an extra 3.00 per ticket to insure you have safe, well paid, well rested pilots- you'd get a pretty unanimous answer.

I disagree that data cannot be manipulated to achieve a certain outcome. It happens in business all the time. You use the statistics that best support your position. Since Mr. Swelbar is working at the behest of airline management, possibly AMR management, he's just using the statistics that support his position. Here's an example- Mr. Swelbar uses a "cockpit cost" per block hour number in his comparison. How is that number derived? What is included in this number? For instance, do you think the fact that American does a great deal of long-haul international flying that uses augmented crews would influence this comparison? Of course it would. This is a silly statistic. The industry uses CASM to measure costs. Guess what? Southwest's labor CASM is higher than AMR's. Statistics can and will be manipulated.

Let's look at pilot salaries. American pilots sit behind Southwest by double digit margins. They sit behind Continental. They sit behind freight carriers, by double digit margins. Before you protest, AA is one of the largest freight carriers in the world and AMR management used freight carrier management compensation as a metric for their own compensation committee.

When it comes to the management compensation issue, you gents are just out of the mainstream. Very few people think it is reasonable that the AMR CEO shoud make over 40 times more per year than the highest compensated pilot at AA and more than 50 times more than the average pilot. Remember the part about "lives in hands?"

When American Airlines pilots received their most lucrative contract in recent history in 1991, the company launched onto a record period of profitability. A reasonable increase in costs will not bar continued profitability at AMR. Rest assured, that increased cost is going to happen, one way or another. This has reached critical mass and it's going to change.

Jason

10.28.2007 | Unregistered CommenterJason

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