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Dec092007

« Maybe the Allied Pilots Association Is Really Onto Something »

As I have written often and recently, the competitive position of the US legacy carriers in the global arena is a major concern to me. My thoughts on this topic are largely contained in a talk I gave at the ACI-NA International Aviation Issues Seminar in late November click here.

With the combined market capitalizations of the Big 3 EU legacy carriers (Air France/KLM, Lufthansa and British Airways) exceeding the market capitalizations of the Big 6 US legacy carriers (American, Continental, Delta, Northwest, United and US Airways) combined by nearly 33%, something clearly needs to change. And if Air France/KLM is successful in integrating troubled Alitalia into its fold, then the margin will become even more embarrassing for airlines carrying the US flag.

What a Cool Job

If there is a job I want in the airline space today, it would be the UPS whiteboard guy click here. Why? Because the UPS model, and the way they talk about it in their whiteboard campaign, demonstrates the futility of US carriers trying to operate successfully under collective bargaining provisions that are at least 35 years old. The UPS guy is not encumbered by existing lines or parameters as he connects UPS’s dots on the map. More importantly, the company actually connects the product to what customers want and demand –a novel concept! If there is a time to throw the past away (erase) and look to the future (redraw), it is now.

So maybe, just maybe, the Allied Pilots Association is on to something in its latest proposal to American Airlines. While I would never suggest that the APA “one liner” scope provision click here makes sense for the AA network as we know it today, anything that simplifies the ability of US airlines to implement commercial, tactical and strategic decisions to react to a changing domestic and global landscape makes very good sense to me. More importantly, anything that gets the mainline growing again is the best solution to some of the labor-related hostilities in the industry today.

Whiteboard Analysis – Regional and Codeshare Flying

What I like about the simplicity of the APA proposal is that it provides a starting point to begin serious negotiations – something the American Airlines negotiations are sorely lacking.

Given that scope defines who can do what flying necessary to operate the network, AA would get to go to the “whiteboard” and lay out for the APA the cost for feeder flying relative to the revenue generated by that flying, as well as the traffic and revenue contributions to its mainline domestic and international routes. As part of AA’s whiteboard exercise, they also get to demonstrate the value of revenue and traffic contribution the international codesharing partners now contribute.

If APA puts forward a scope proposal that reserves all flying for its member pilots and that makes economic sense, then there would be no need to scale back the current size of the network – all other things being equal. On the other hand, if APA is not willing to agree to terms – pay rates and work rules – that, when the interdependencies of all contractual issues are understood and at least match what AA pays today for this business, then the company would need to make some decisions about how much to shrink the current network.

Whiteboard Analysis – Mainline Flying

Let’s take it further.

The cost of the APA flying will ultimately determine the size of the network for regional and codeshare flying. The next calculation is the cost of operating the existing, or remaining, mainline network. If the network can sustain the 50+ percent increase in rates and all other items included in the union’s current proposal, then the APA will have realized its goal of restoring lost earning power to their members and establishing the pattern for the rest of the industry to follow.

Based on the cost of operating the mainline network under the APA proposal, there are two paths to explore on the decision tree: 1) if the remaining network cannot incorporate the cost of the entire APA proposal, then determine what portions can be operated profitably and the remaining network would need to be dismantled; or 2) determine how much increase in pilot cost the network could absorb and then ask the APA to adjust its proposal downward.

Whiteboard Analysis – What Is the Right Formula for US Legacy and LCCs?

This conversation is underway not only in union halls, but also on Wall Street and in corporate boardrooms. It is a topic on the Dallas Morning News’ airline blog click here. While Mr. Maxon sees the APA proposal is a bombshell, I see it as a starting point for negotiation that appears to be stuck. Historically, scope language is among the last issues negotiated in pilot contracts. Let’s switch it up this time and figure out exactly what unions want their respective companies to be - global leaders or niche players?

We talk a lot here about CEOs that are genuinely concerned about value creation versus value destruction – Glenn Tilton at UAL, Doug Parker at US Airways and Richard Anderson at Delta. But another CEO has been hard at work totally rethinking his business as well: Gary Kelly at Southwest. This past week, Kelly spoke directly to the “perils” facing the industry click here. Kelly and his pilots are also engaged in a discussion of scope language as their business is about to get more complicated with proposals for international flying and code shares as a way to boost revenue production.

With little to no clear investment thesis in the core business of airlines, UAL this week declared a special dividend to its shareholders click here, much to the chagrin of its employees and a very passionate Holly Hegeman who writes about the action in her blog, Planebuzz click here. If nothing else, Tilton and UAL are consistent in their focus on the shareholder – often the most ignored of stakeholders in the airline industry. While I can see the employee view, at-risk compensation is a way around this angst.

So unless the business of the business starts to have a clearer line of sight to the customer – meaning delivering a product that the customer is willing to pay more for – then the payment of special dividends, the selling of wholly owned subsidiaries, consolidation and/or a slow liquidation of US flag airlines will continue. You know, money talks and #$*&! walks.

Concluding Thoughts

I really think the APA is on to something with its scope proposal. Let’s talk about scope first among the tough questions that will determine the future shape of the US airlines. Once that question is answered we can move on to a meaningful discussion about how to better compensate a workforce because the current seniority-based, hourly rate system simply is not effective in the modern market.

Structured properly, this round of negotiations may just lead to finding the right network architecture to make the US carriers global leaders again. Or not. But doing business circa 1970 is not going to get it done. So let’s remove the clutter and the underbrush and start with a clean whiteboard. Maybe even do what the European carriers do and create business units that carry cost structures to match the sub markets they serve because they recognize that a one size fits all just does not work. And this approach could indeed be done with pilots on the APA list – just ask Northwest and US Airways.

Let’s stop saying it just cannot happen. It can.

Reader Comments (9)

Blogger said....
"If nothing else, Tilton and UAL are consistent in their focus on the shareholder – often the most ignored of stakeholders in the airline industry. While I can see the employee view, at-risk compensation is a way around this angst."

You do realize, sir, that ALL original UAL shareholders were "wiped-out" in the reorganization plan, which included many employee ESOP holders.

The primary beneficiaries of the dividend is the "current management" team, who owns a very sizable stake in UAUA.

Other shareholders have barely held their "newly" issued shares long enough to qualify for capital gain treatment.

The UAUA dividend demonstrates that UAUA is now throwing off so much cash that it literally doesn't know what to do with it. And so quickly after emergence from bankruptcy, exposes the bankruptcy gambit for what it was...an attack on employees.

What goes around......

12.10.2007 | Unregistered CommenterOccam's Razor

I do realize the wipe out of the equity when UAL filed for protection and quite honestly that is one event - and there are others - in recent history that is truly unfortunate.

I had a front row chair in the UAL ESOP. I was part of the advisory team to the flight attendants. Yes, the group that did not participate in the deal largely because we could not negotiate job protection provisions similar to those negotiated by ALPA and the IAM.

I am proud to have been part of that team that advised the client not to do that deal even though I firmly was/remain committed to seeing risk based compensation become a more important form of total compensation in this cyclical industry.

The United pilots paid their advisors in excess of $30 million to do that deal and advise them on the failed deal before it so I will just assume that the risks were fully vetted. The ESOP structure had more than its faults with governance being among the most troublesome.

You can look at my presentation mentioned in the post, and, yes I recognize that our carriers are generating cash. But this time, discipline is being employed by carriers that recognize that the best use for that cash is not investing in the core airline until either fundamentals change or structural change occurs. Otherwise, we just remain stuck in the historical virtuous circle of capital destruction.

12.10.2007 | Unregistered CommenterSwelbar

Swelbar said....
"I am proud to have been part of that team that advised the client not to do that deal even though I firmly was/remain committed to seeing risk based compensation
become a more important form of total compensation in this cyclical industry."

I realize that you and others are firmly committed to "risk based compensation". Which is why I'm here to explain to your readers that you will never get it.

Let's look at a "risk based" compensation plan already in place at AA. Take AA's profit sharing plan, you can see that the way it is structured creates many perverse incentives to move the capital structure of the company towards one composed mostly of debt.

In a way, the industry's common practice of "pre-tax profit-sharing" goals encourages management to engage in risky financing strategies, specifically "excessive leverage". Since "Interest Expense" can reduce pre-tax earnings....AMR has every incentive to employ excessive debt financing over equity financing.

Employees "unwittingly" underwrite the cost of debt financing and its associated risks by agreeing to such foolish profit-sharing schemes.

In addition, management has great flexibility in choosing which accounting principles to use and follow and how best to "time" their expenses so that they can minimize the "pay-out" due employee profit sharing...in the unlikely event that it pays out. These compensation schemes will NEVER work, for the simple reason that APA is viewed as a vendor/supplier of service to be "chiseled" down to the last dollar....not a business partner to "share" profits with. The "nature" of the management function is ALWAYS to reduce costs...these schemes are incongruent with reality and simply unworkable.

Already, we've seen AMR managemnt "accelerate" depreciation charges (which are generally used to defer taxes) even though AMR will not be paying taxes for many-many years to come. Why? Because accelerating those expenses is done simply to "minimize" profit-sharing with employees. This is what awaits the pilots who agree to your notions of "risk based compensation".

In AMR's management's case...THEIR compensation is hardly "risk based". If you look at that their payout scheme, you realize that it WILL always pay something. I believe the bottom payout is an annual 35% bonus even if they come in last place. Not very risky if you ask me.

I'm sure management's version of a "risk based compensation" scheme for the pilot's will payout approximately.....ZERO!

In addition.....I'm told that every time a pilot signs in for a trip, his compensation is already "risk based". In that, if his trip should cancel for a mechanical or weather, etc....he will not be paid. In fact, there is a very good chance that trip can't be made up due to FAA legalities (unlike FAs) or lack of open trips due to the way AMR operates their schedule.

I believe there is enough "risk" in pilot pay already. The odds of achieving your "committed" goals are ZERO!

12.10.2007 | Unregistered CommenterOccam's Razor

Razor

Thanks again for taking the time to comment. There is one area that we are in total agreement - and that has to do with a hurdle, whether it be pre-tax earnings or something else, whereby employees share in the performance of the company at the first dollar or something obtainable - except in an awful year.

Where we won't agree is on management's fervent charge to manage all costs of the business particularly in an environment where it has little to no ability to control pricing. When faced with that marketplace reality, management is charged by all stakeholders to pay no more than "market" for any input the company employs to deliver its product - labor or non-labor related.

Now back to the profit sharing hurdle. It is important to go back to 2003 and remember the environment where the current agreements were negotiated. The banks held all of the cards. Management and labor held none of any power - maybe a 5 high. It was the banks that dictated when and how much could be paid out in profit sharing because, in a risky environment, they were going to ensure that they got paid first. period.

With respect to leverage, let's remember that debt capital is the cheapest form of capital. Equity capital is expensive because there is an expected rate of return embedded in what someone is willing to pay today for that appreciation tomorrow.

And suffice it to say that right now, with no obvious investment thesis for equity, the cost of equity is very expensive. This industry has always been highly leveraged. Now AA is doing yeoman's work on de-leveraging itself without the aid of bankruptcy. United, Continental and others are doing the same. This is good.

Just look at the pressure outside shareholders are putting on companies to create value because the core business certainly is not.

But in the end, we need to make the success of the company available to all stakeholders at a reasonable hurdle with similar terms. I do think that can be a positive.

12.10.2007 | Unregistered CommenterSwelbar

If your readers are paying attention, they will see that this Contract is about Pay Restoration for the pilot profession and NOBODY else.

The AA pilot's disproportionate sacrefice relative to the other employee groups saved AMR from bankruptcy. The take-away from our collective 9-11 experience was that management and the other employees could care less about the pilots and their sacrefice. Turnabout is fair play.

The Pilots....in management's view....are just an ATM to run to when you need some CASH. That won't ever happen again. This is what has "seminally changed" in the industry.

If AA's passengers are unwilling to pay for the level of "convenience" provided them.....then don't expect the pilots to pay for it either. We are no longer in the business of "giving stuff away". As just another vendor to AA....understand that we ALSO are trying to run our own business as well.

You and your associates would have better luck trying to sell your vision of "at risk compensation" to the other employee groups.

For the pilots, "at risk compensation" is not something worth discussing until our pay is ABOVE cargo pilots. But do experiment with the other employee groups. Who knows...when our pay is restored to 1992 purchasing power levels, we may be in the mood to discuss such things...until then it would be wise to listen to the Focused Unified - Pilot Messages coming from APA.

AA pilots are drawn from the same "labor pool" as UPS and FEDEX pilots. Our skills and requirements "identical". We see how far we've fallen. We know the value of our services and have no intention of selling them short.

I understand what management objectives are with respect to cost and it's an understatement to say that "I don't care". Focus on what the passengers are willing to pay for. I can guarantee you....a competent and well-qualified pilot is tops the list, well ahead of "hot-towels".

AA can offer all the "convenience and on-board amenities" they want to passengers who are unwilling to pay for them.......without PILOTS their airplanes are just expensive cocktail lounges.

I think it's clear, at least to me, that this industry's pilots unions will soon be delivering a Focused Unified - Pilot Message to airline managements everywhere. We will try our best to make pilot services similar to a barrel of crude......NON-NEGOTIABLE.
Think of the coming cooperation between Pilot Unions as similar to OPEC.

12.10.2007 | Unregistered CommenterOccam's Razor

Razor

Your point is made. Me and my blog associate, my golden retriever, Lucy, will let you have the last word on this string. You and I will just have to agree to disagree on some points - not all. Your taking the time to read here and comment is appreciated.

12.10.2007 | Unregistered CommenterSwelbar

The point that comes through so very clearly, in these comments, in Holly's blog, and in some many of the same, is that there are too many people in and out of the industry who cannot accept the fact that the "good old days" are gone. The airline industry has changed, completely, and probably not for the better. I started in 1969, was working on the old H concourse at O'Hare when you were flying with the "Duck" and it was a different world back then.
Today, loyalty is gone, not just in this industry, but everywhere.
Capital has to be used where it returns the best results, and senior management will be rewarded, no matter what the unions want.

12.15.2007 | Unregistered Commenterdbrg909

I agree that it has changed and will change. My concern is that the outdated ways in which we used to do things are still present and therefore slow the transition into this new world. I am still not convinced that the industry cannot recreate itself into something desireable again - but it will require a changed mindset in union halls as well as in the halls of government. Well I guess we can dream and hope.

12.15.2007 | Unregistered CommenterSwelbar

It is going to take corporate genocide of the top floor at AMR before you will see any changes down in the trenches at AMR. After enduring the era of Crandall & Carty the employees were truly hopeful of Gerard Arpey. He said the right things and did the right things in the very beginning. We were all optimistic that we might have a Southwest type corporate culture awaiting us with the new leader. Greed set in and now you have all three unions waiting to extract their pound of flesh after being lied to on the “Pull together, win together’ malfeasant or as APA put it, “A cruel hoax.” To put it bluntly you can’t trust the guy anymore.

He should have said the PUP Bucks program was Don Carty’s idea and under my watch I’m not running AMR this way. He then should have met with all three unions and told them I have to pay my top twelve guys/ladies with MBAs the same as other major industries or we will have a mass exodus of our top talent and corporate knowledge. He then should have further said I will keep my pay the same but when the good times start to roll I expect a pay back too. The rest of the 970+/- bozos we are ten deep on and they could barely get a job sacking groceries at the local Piggly Wiggly let alone bailing out to find a better job then they currently have.

The contracts were rewritten in less than a month spring of 2003 and the third PUP Bucks payout is just around the corner with money from each employee’s wallet going to the few elite. You just can’t continue to treat people like this especially those who are tied to the company through union seniority numbers. They will react.

I liked the term “Murder/Suicide” that was coined when the Delta pilots threatened to go out on strike a few years ago when DA was on the financial brink. AMR is looking down the barrel of a strike by all three unions in the next eighteen to twenty-four months and I’ll be more then happy to pull the trigger.

Your nirvana will never exist with the current leadership at AMR. The damage has been done by the childish actions of the top leaders in their money grab. Even then you will have to purge a whole generation of employees before you can start to build Fantasy Air because you just can’t trust anyone in a suit these days.

Your dream is actually alive and well thank you very much it is called Southwest Airlines. All you have to do is look and see what Herb has done over the years. Oh sure they have had their disagreements but at the end of the day they shake hands, swill down a snort of Wild Turkey and then go ride motorcycles together.

Think of those who are flying high time this month so their kids can have a package under the tree. Have a Merry Christmas.

12.19.2007 | Unregistered CommenterChitragupta

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