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Apr282008

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Considering the Concept of "Rent Sharing"

Maybe the best answer to US airline industry woes is the same path followed in the early 1990’s when iconic names like Pan Am and Eastern liquidated.

I understand Continental’s thinking, I think. They have many attributes that are viewed in previous consolidation periods as positives: youngish fleet; decent, if not good, labor relations; hubs/gateways in markets with strong underlying local demand; hubs/gateways in markets that have interest not only to those in the US but around the globe; and a respected management team that has not only devised a plan but has acted on it. But they still have a fragile balance sheet just like the rest of the US industry.

Kevin Crissey at UBS writes this morning on Continental’s attitude toward consolidation: “We believe CAL mgmt view consolidation as beneficial over the long run but much less so in the short run as labor would take a big cut of the synergies. With fuel and demand draining life from the sector, mgmt appears to be focusing on CAL's survival and likely views a merger as increasing bankruptcy risk”. Continuing to beat that fuel issue to death, my only question is what is the short-term and what is the long-term for the US industry? Is the short-term six months or is it two years?

Mr. Crissey was right to raise the labor situation and the negative impact on any short-term synergies that might be gained from the overall deal. In last week’s congressional hearings on the Delta-Northwest hearings, I believe that Dr. Clifford Winston of the Brookings Institute referred to the topic as “rent sharing”. The negative synergies in "rent sharing" between labor and the deal in the case of Continental and United are somewhere in the $300 – 400 million range, or double those in the Northwest – Delta case.

But rates of pay are only half of the story. Continental’s pilots are more productive than United’s pilots per month based on publically available data in 2006. If that were to be the case, the Airline Data Project estimates that the increase in productivity to Continental levels would mean that 460 fewer United pilots would be needed. While final 2007 numbers will not be available for another six weeks, rate and productivity calculations underscore just one of many difficulties faced in estimating the offset of overall network synergies by the “rent sharing” calculation between management and labor.

On both the compensation and productivity calculations included in the Airline Data Project, please read the footnote that suggests problems with the US Airways and America West calculations for 2006. Further, and based on the calculations there should be no secret as to the difficulties American has in considering whether to play in this round of consolidation or not. The math for them is particularly difficult.

So maybe we just will not be able to get there. Bankruptcy is less an option unless it is a liquidating bankruptcy like we saw most recently with American and TWA where American purchased the assets of TWA. The few combinations left to consider do little to address the immediate need to minimize exposure to the US domestic market unless the opponents to change recognize that the current structure is simply not healthy. US Airways has too many eggs in the US domestic market basket. Hell, everyone has too many eggs in that basket.

Maybe we should start thinking about consolidation as the world thinks about our marketplace and engage in a consolidation of North America and bring Air Canada and Mexico fully into the conversation. This idea would address the US centric mindset that seems to dominate the conversations among the naysayers.

Talk about a bad time to be a CEO in the airline industry. Someone has to get their fingernails dirty. To be sure, private equity would not want to touch the issues left for the industry to work through. Last night, United said in a statement following the Continental Board’s decision: "Ensuring you have the right partner is everything,"

As the late Johnny Cochran might have said: If it doesn’t fit, you must attrit. And in the long run the survivors will benefit.

Reader Comments (5)

At last week’s House hearing, we heard testimony from the Brookings Institute which focused on the importance of free markets and their ability to absorb and react in the wake of an event such as a large scale consolidation. I’m a firm believer in free markets as the cornerstone of our economic system, however, these same free markets are essentially blocking the war of attrition that is so necessary to return the airline industry to health. The markets are plagued with barriers: barriers to exit that are too high and barriers to entry that are too low. It is a struggle to devise a solution for this problem besides the veiled threat of re-regulation.

Consolidation seems that it is only one of the possible answers in our current predicament. However, the current merger pairings seem likely only to build a giant, fragile house of cards which could easily crumble. It is clear in the Delta/Northwest combination that the rent sharing (which could also be interpreted as “bribing”) with the pilots would consume a costly chunk of the synergies between the two carriers. When this is paired with the declarations by the airline CEOs that there will be no hub closures (although who in the industry truly believes their assertions), the synergies seem even more minimal.

The war of attrition, rather than consolidation, is really the market-oriented solution to the problem, but the barriers stand in its way.

04.30.2008 | Unregistered Commenterblackbook

Blackbook

I agree with your points. Based on the way the partnering is going, I am in hopes that UAL sits on the sidelines. In fact, many of your thoughts lie at the heart of a piece I am planning on writing tomorrow or Friday. Thanks for checking back in.

Swelbar

04.30.2008 | Unregistered CommenterSwelbar

Bill,

Recently came across your blog. I am enjoying reading your perspective.

Couple of things before I post about your most recent ‘Atrit’ post.

I fundamentally believe that deregulation has been a tremendous success. More people are flying at lower fares than if we still had the CAB or some other government entity regulating the market. Even with the delays last summer in the east, even with the very real operational problems due to hub concentration, even with some of the stupid things some airline senior execs do ( DL and AA pay packages, Jet Blue senior execs taking a high risk operational path in the face of an ice storm), and even with the shut down of some venerable names (Eastern, TWA, Pan Am) I go back to the tremendous benefits going to the consumer each and every day. I am frustrated and irritated that the MSM continually bad mouths the industry and the inherent problems in flying people around in metal tubes. The MSM will not report ‘today, about 130,000 passengers flew Northwest airlines. Northwest did a great job -- completed 99% of its flights, 82% were on time. And most passengers were treated kindly and enjoyed their day. And they did this while charging the customer (1970 – yield of .29 per mile and today of .12 (?) per mile) 50% less than the average fare 40 years ago!’ OK – rant over. Basically yes there are problems, however the sky is not falling, and important positive things are occurring every day.

Re your ‘Atrit’ post. Thank you. In stating that the marketplace should work out the problems you hit the nail on the head. I agree 100%. It is my belief that the important players (senior management and union leadership) believe that they are insulated from the workings of the marketplace and therefore free to take positions that they would not take if they REALLY thought the worst could happen. If the pilot leadership at USair east and AWA each thought that their membership could end up with 0 (zero) seniority would the bickering go on? I think not. Same for the pilots at DL and NWA. If leaders thought market place solutions were allowed to occur, issues that are now immovable roadblocks to efficiencies could be solved. But that will occur only when parties actually believe the worst can happen.

You stated that UA would need 460 fewer pilots if CAL rules were applied to the UA pilot work force. I assume this number is generated, in large part, by the lack of trip/duty rigs at CAL - is that true? If it is true, then I have some thoughts to add regarding the issue, however I do not want to make my points without confirmation of the above. Do you have a breakdown of the work rules that contribute to the ‘460’ gap?

Bottom line is that in a free market, management and labor are free to do whatever they please and capital should be able to make its way to those companies that make arrangements with their work groups that make sense to the providers of capital. Letting the market place sort this all out difficult for a politician, particularly for a politician from an area that will lose jobs due to the workings of the market. However, our political leaders should be able to see that the pain experienced by some in the past has led to many benefits today. (I think some of the Jet Blue initial success at JFK was in part due to the demise of TWA as just one example). Attrition will be painful for some, however, it presents opportunities for others, and there certainly are other smart people with dreams and capital ready to move in where previous occupants could not get/keep their act together. As you succinctly said, ‘If it doesn’t fit, you must atrit’.

05.4.2008 | Unregistered Commentercp5000

I think CAL has a fairly strong balance sheet with almost $3 billion in cash on hand. Of course, I understand the opportunity for profit is restricted with the high price of oil, but I do think a merger with UAUA would have created MANY more problems than it solved...the largest being in my opinion having two groups of employees, one with a pension and one without, and adding a large aging fleet of planes from UAUA with no new aircraft on order.

05.4.2008 | Unregistered CommenterChuck

cp

Thanks much for taking the time to write a most thoughtful piece. And yes, for me, it is comforting to know that there is a kindred spirit out there.

As for the 460, it is number driven and represents my/our best effort to compare work groups and their productivity. I do not have the breakdown as to how the specific provisions of the respective collective bargaining agreements would weigh on our estimate.

But based on your insightful post, I know you know that such a number could not possibly be gleaned from public information which is why I state very clearly in the Airline Data Project that the details are left to those that are at the table.

In general terms, we know that vacation and sick leave explain nearly 80% of everything on the productivity side. Then it has to do with rigs, min days, guarantees etc.

And of course the relative seniority of the respective groups impacts all and we know that Continental has been growing and United has not therefore an ongoing averaging down of seniority.

I would really appreciate hearing your comments.

Second, let me apologize to the delay in responding to your post.

05.6.2008 | Unregistered CommenterSwelbar

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