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Monday
Jun132011

Autos, Airlines and the Question of Union Relevance

Last month I had the honor of being invited by Wolfe Trahan’s Hunter Keay to participate on a Labor and Policy Panel at the firm’s Global Transportation Conference.  I shared the dais with Dave Bates, President of the Allied Pilots Association; Lee Moak, President of the Air Line Pilots Association; and Sharon Pinkerton, Senior Vice President for Legislative and Regulatory Policy at the Air Transport Association. 

With Keay as our moderator, we had a lively discussion on a number of subjects including the always controversial topic of variable compensation for union workers.  Of course, I was the lucky panel member to be asked the first question, and as Swelblog readers know, I’ve been a longtime proponent of variable pay structures for airline industry workers.  Why? Because I believe that workers should benefit on the upside, just as companies should be able to hold costs stable on the downside.  History shows very clearly that each time labor concessions were made in this industry, management later overcompensated labor for those give backs in subsequent negotiations.  Ultimately the overpayment was not sustainable.

Swelblog readers also know that I like to write about the similarities between two legacy industries; autos and airlines.  The issue of variable compensation in the auto industry is coming to the fore as the United Auto Workers (UAW) made clear that it is open to exploring such pay in lieu of fixed wage increases as negotiations with Ford, General Motors and Chrysler begin in earnest in July.

But before we go there, an interesting editorial appeared in the Wall Street Journal on March 2, 2011.  In “Winds of Change in Unionland” (subtitle: “The end of the road for the UAW, except as an administrator of retiree health benefits”) the author talks about the UAW’s presence in union strongholds in the Midwest. But now, as public sector unions in the region are under attack and these states are less successful attracting new business, the UAW is shifting its strategy accordingly. The grand plan under new leader Bob King is to instead look outside the heartland states, instead focusing organizing efforts on Toyota and other auto factories in the largely right to work states in the South. The WSJ piece points to King’s success in organizing parts suppliers but attributed those victories to the union’s “politically-protected labor monopoly over the Big Three.”  In it, the author also points out that:

  1. The union had little to offer the suppliers’ employees but the false promise of job security, and the companies put up little resistance for fear of losing their Detroit contracts;
  2. The supplier campaign was a distraction from the fact that the Big Three's own workers were giving ground on jobs and job security; and
  3. Mr. King is blowing smoke about Toyota. The UAW has no card to play. The union's labor monopoly gives it no leverage over the transplant factories, and the union's current appeal to their nonunion workers is, realistically, less than zilch.

The article then points to the outsized labor concessions that have helped restructure Detroit’s auto industry and the UAW’s cooperation prior to bankruptcy as part of a deft political play in Washington to appease those politicians that protect the UAW’s monopoly hold on the U.S. auto industry.

The parallel with today’s airline industry negotiations, as the Wall Street Journal makes clear, is that every airline industry union complains that contract talks are taking too long and blames management. “Mr. King knows, in the current political atmosphere, he can't go back to playing his monopoly card to extract anticompetitive terms from the Big Three,” the author writes.

So, too, is the case with airline industry unions that seem to think that the world will revert to days past when companies continually “paid back” workers, plus, for prior concessions.  In each instance, anticompetitive terms contained in airline labor agreements remained or were augmented.

In a June 10, 2011 article the Wall Street Journal's Matthew Dolan and Sharon Terlep reported that the UAW had signaled that it is “open to discussing wider use of profit-sharing plans instead of fixed pay increases for its members, a key shift as the union nears contract talks with Detroit auto makers.”  Like airline unions in the past, “The UAW has historically resisted linking large portions of workers' pay to profits because its members would suffer in down years. Another fear: The auto makers were simply not making profits on a consistent basis.“

Why the UAW’s change of heart? The Journal report said King wants a “non-adversarial” relationship with management. Maybe that’s because the union doesn’t have much choice. As the newspaper asks: “What exactly has the UAW got to offer? Evidence is lacking that organized labor actually adds value, creating gains workers and stockholders can share. If it did, Toyota et al. would be clamoring to have the UAW in their factories. They're not.”

The Journal continues:  “Mr. King's dilemma is evident in his lukewarm response to the Big Three's opening gambit in this year's quadrennial contract talks, an offer of enlarged profit-sharing. Here's the problem: Incentive pay is earned pay; workers see profits as something businesses create, not something union bosses create. And the foreign transplants will only be too happy to compete on the basis of performance-related pay. If the industry is headed toward compensation based on success, what are workers getting for their UAW dues?”

Good question.

I certainly never looked at variable pay that way.  I see it clearly as a way to better align the interests of workers and management across an entire business cycle and as a way to avoid the crazy cycle of take/give/take and the resulting bad blood and mistrust between union leadership, employees and management. 

Think about this:  If variable compensation was in place following the concessionary period of 1993 – 1995, workers would have gained far more between 1996 – 2001, the most profitable period in airline history when U.S. airlines earned in excess of $40 billion.  Instead employees received nothing with few exceptions. 

Today, the goal of most airlines is to reach “responsible” contracts with union employees with costs sustainable over the term of the contract.  That’s a much better approach than the patterns of the past, when buying labor peace in one contract only forced airlines into asking for concessions before the amendable date because they could no longer afford the terms. And sustainability benefits employees, too, particularly if it avoids the need for concessionary bargaining in a downturn and provides protection on the upside to prevent companies from earning outsized profits on labor’s back. 

This is the area where unions have missed the boat in the past.  Too often, labor leaders spend too much time negotiating protections on the downside and ignore similar protections on the upside.  Think back to the more profitable periods in U.S. airline history during which, for many, employees were still in the middle of concessionary agreements. As industry fortunes improved, employees sat and watched because their unions did not negotiate protections on the upside that would have ensured their sharing in the profits – some of which were made possible from lower labor costs.

Of course, the industry has been anything but profitable over the past decade except for a brief blip of black ink in 2006-2007 and 2010.  So upside protections would have returned little if anything following restructuring, with some companies instead giving performance bonuses when they met stated operational goals.  But let’s suppose the U.S. industry now sits on the brink of a profit cycle.  If upside protections had been negotiated during the mid 1990s, employees would have shared in $40 billion of profits while new collective bargaining agreements were under negotiation. That would send a far stronger signal about the connection between productivity, competitive costs and profitability than has the long and painful cycle of give-some, take-some negotiations.

One thing is clear: carriers with relatively expensive labor rates today will need to adjust expectations at a time that industry economics, particularly domestic market economics, do not support above-market increases in rates.

Unions:  Irrelevant or Just In Need of a Total Overhaul?

Unlike some in the Wall Street Journal article that suggests unions are increasingly irrelevant because profits are earned by companies and not union bosses, I believe that unions are relevant but need to be totally restructured. 

Airline unions are just like the airline companies before restructuring; trying to be everything to everyone.   Unions have become too democratic.  Decision paralysis creeps in because an agreement must satisfy so many disparate interests – at least in the eyes of the leadership who may represent workers with a wide variety of skills, experience and education.  With few exceptions at the local levels, airline union leadership simply does not lead.  Rather they succumb to the pressures of the most vocal factions. 

Unions need to start relying on professionals at the negotiations table who have an ability to divorce themselves from the rhetoric and the politics and instead focus on reaching agreement. They need to lengthen the terms of their elected leaders so that leaders will be less likely to overpromise during their campaigns and be accountable to members for the hard work of negotiations. Anyone can make bold promises. Real leaders set realistic expectations and perform accordingly.

Longer terms for elected leaders might also help speed the course of contract talks. Unions would face less risk of elections distracting from their work at the bargaining table, and less time training members of the bargaining committees on the hugely complex set of issues, factors and finances that go into negotiations.

This type of internal chaos every two years can occur because the union, at least in collective bargaining, is a monopolist.  Monopolists have power.  But the days of union monopolies wielding power as in the past are quickly coming to an end as suggested by auto workers’ considering variable compensation as a significant component of this upcoming round of negotiations gets underway.  The automobile industry is a mature industry.  The U.S. airline industry is a mature industry.  Mature industries grow slower.  Mature industries tend to be more risk adverse than emerging or growth industries.  As a result, industries like autos and airlines need to look at alternative forms of compensating their people because mining new revenue takes time and often involves adding more risk than mature industries prefer. 

To remain relevant, U.S. airline unions need to begin a process of rethinking how they think.  Just as Ford, GM and Chrysler have unique needs in negotiations, so do individual airlines.  As author Susan Sontag once said:  “Existence is no more than the precarious attainment of relevance in an intensely mobile flux of past, present, and future.”  Unions exist because of the relevance attained in the past and the present.  What about the future? 

Tuesday
Jun072011

In The Airline Business We Just Do Not Talk About Balance Sheets Enough

In the Gulf States, we have Qatar CEO Akbar Al Baker saying to Gulf Business Nothing Can Stop Us Now.  In the article Al Baker talks about the high cost and inefficient airlines in the west.  In the U.K., a headline in The Independent reads:  More Carriers Could Fold Warns IAG’s Willie Walsh.  Bruce Smith, writing for the Indianapolis Star publishes a story on hometown Republic Holdings titled:  Republic Emphasizes Cost Cuts As It Fights To Compete.  Like a lot of airlines these days, Republic’s branded carriers – otherwise known as Frontier and Midwest  – are not only fighting to compete, they’re fighting to simply stay alive.

It’s easy to forget Republic now flies its own airline flag. Prior to purchasing Frontier and Midwest out of bankruptcy, Republic Holdings’ predominately did fee-for-departure flying for U.S. network carriers.  In October 2008, I asked:  Just Who Will Inherit the U.S. Domestic Market? Don’t Forget Today’s “Regional Carriers”.  Nearly two years ago, after Republic staved off Southwest from sponsoring Frontier’s exit from bankruptcy, I asked,  Is Republic Changing the Face of the US Domestic Market?   

In each of the Swelblog.com articles referenced above, I talked about how smart Bryan Bedford, CEO of Republic Holdings (RJET) is.   Bedford made the move to acquire Frontier and Midwest in an environment where it was increasingly clear the legacy carriers did not – and cannot over the long-term – operate under a cost structure that will not support the number of airlines trying to survive in the hypercompetitive U.S. domestic airline business.  Since then, consolidation among U.S. carriers has taken off – for network, low cost and regional airlines alike.

Smart or not, the price of jet fuel puts pressure on Bedford’s balance sheet more so than other carriers given Republic’s incipient fragility.  I have written time and again the most important financial statement for any airline today is its balance sheet.  As Republic Holdings trades near a 52 week low, many analysts are jumping off the RJET bandwagon.

Mike Linenberg, equity analyst at Deutsche Bank, wrote following Republic’s first quarter results, “Republic ended the March quarter with $467 million in total cash, $37 million higher than at the end of the December quarter. While the company’s restricted cash balance increased $87 million to $226 million, driven by the seasonality of its Frontier business, unrestricted cash declined $50 million to $241 million, impacted by the company’s relatively high credit card holdback provision of 95%. Regarding additional sources of cash, Republic indicated that it had some collateral-backed debt that could be refinanced to produce an additional $70- $80 million of net cash to the company.”

In the airline business, cash is king and fuel is the wildcard. With its fee-for-departure contracts, Republic left the fuel risk to its mainline partners.   (Of course the price of fuel affects the decision of the mainline carrier as to whether to buy regional capacity).  Now Bedford has to buy fuel for his Frontier and Midwest subsidiaries… that helps to explain why RJET’s unrestricted cash declined by some $50 million.

Why I was bullish on the Republic – Frontier combination in the early days was because the Indianapolis based holding company had bought a brand, one that came with a vibrant flying community – Denver.  With a community comes inherent demand.  With demand comes revenue.  But Last month, Ann Schrader of the Denver Post reported Southwest had jumped over Frontier in terms of market share at DIA.    

Republic announced the acquisition of Frontier on June 22, 2009.  On that date, the price of a barrel of West Texas Intermediate (WTI) crude oil was $64.58 and the price of a gallon of jet fuel was $1.78.  In 2011, WTI has traded in excess of $100 per barrel and one gallon of jet fuel tops $3.  It is one thing to be in the regional business when the cost of fuel doesn’t directly affect you. It’s another when you actually have to pay for the gas.

Southwest

On the flip side, I think that Southwest’s purchase of AirTran is brilliant.  In many catchment areas around the contiguous 48 states most populated and wealthy areas, the combined carrier has at least two beachheads.  While I still don’t believe Southwest, jetBlue, Frontier and Spirit will inherit the domestic U.S. marketplace; I am increasingly convinced the not-so-meek Southwest will inherit more earth than any of the others.  The U.S. domestic market has always been about the survival of the fittest. 

Might we be headed for another round where Southwest captures five points of domestic market share?  Possibly. What’s different this time versus the 2001 – 2006 period when Southwest and the other LCCs captured nearly 20 points of domestic market share is the airlines losing ground won’t be the network carriers.  More will come from weak competitors – like Frontier, Midwest and Spirit. .  There should be little surprise that Spirit sold a fraction of its intended shares at 25 percent less than desired price in its Initial Public Offering (IPO). 

Frontier is quickly losing pricing power in the very place it called home.  Presumably the value in the Frontier franchise was its cult following in the Denver local market. Without a meaningful, and growing, share of the local market, pricing power is compromised.  No pricing power in a high jet fuel cost environment does little to bolster a fragile balance sheet.  Southwest has the time and the financial wherewithal to whittle Frontier's following and, thus, its franchise value.

Southwest isn’t Frontier’s (and Bedford’s) only headache. United has a presence in Denver as well, one that’s not necessarily focused on local traffic. That makes Denver somewhat different than other cities where three carriers have tried to hub.  My guess is something is going to give in Denver because, at some point, the law of diminishing returns is sure to play out for any one of the three competitors.  And I’ll bet on Southwest’s balance sheet winning the war.

Southwest is an opportunistic competitor.  I expect Southwest to fill any voids left by either Frontier or United in Denver.  Where United or Frontier might be vulnerable, Southwest will likely exploit that weakness by adding capacity.  It can be patient because Southwest has a balance sheet that is far stronger than either of its two Denver competitors.  Frontier is, by far, the weakest. The high cost of fuel is its immediate enemy and Frontier has fewer options than either Southwest or United.

Labor - It Really Is About The Balance Sheet

The one thing that the pre-Frontier/Midwest Republic did not have to worry about was earnings as long as it delivered the product promised to the mainline carriers.  Today, the branded operation is suffering losses and is forecast to lose money going forward while most major players are going to make money.  As Linenberg’s analysis suggests, Frontier needs to generate cash internally because it has limited borrowing capability.

The strong get stronger.  The weak get weaker.  Survival of the fittest at its most emblematic. As Bryan Bedford told his shareholders – and the world - he needed to find $100 million in cost savings, his pilots protested outside.  No earnings and a weak balance sheet usually do not equal wage increases. It’s not about whether pilots deserve increases – that’s not what I’m talking about.  Balance sheet repair is not sexy.  Balance sheet repair does not add to earnings.  Balance sheet repair does not produce wage increases and work rule changes that resemble 2001.

What balance sheet repair does is keep airlines flying. If struggling carriers don’t find ways to fix their sheets, they won’t be around. I don’t mean they’ll file Chapter 11 and hope to reorganize or sell themselves off at the last minute. I mean they will cease to exist. Their one-time employees will be out of work, their assets will be auctioned off. No one is going to pump capital into an airline whose balance sheet is out of whack, whether that’s because of fuel, diminished market share or labor costs.  

It really is why pattern bargaining should be a thing of the past.  Every airline is different.  Every airline competes in different geographies, with different goals and has labor needs that other carriers don’t. 

The more I think about it, US Airways pilots – and whichever union/group is currently representing them - are really doing the company a favor by not coming to grips with reality.  US Airways is more exposed in the U.S. domestic market than any other network carrier.  The U.S. domestic market is a low-fare environment and requires lower labor costs than, say, a United or a Delta that have more capacity in international markets.  The same holds true for flight attendants and below-the-wing personnel. More to come on this one.

I see employees picketing and I scratch my head.  This industry lost nearly one in every four jobs during the past decade, yet still has more than 350,000 employees with wage and benefit packages in excess of $85,000.  This is an industry of good paying jobs despite the economic environment it operates in. Yet many labor groups refuse to recognize the need for balance sheet repair… and that labor costs have to be part of the fix. You can’t just tweak revenue or fuel costs or charge more for a ticket. Shoring the balance sheet requires a holistic approach.

Without that type of approach, as Willie Walsh recently said, more airlines will fold.  I’ll even venture more could merge. Frontier is a classic example of why this industry is not out of the woods.  And why even the network carriers are not done.  And why the regional carriers are not done.  Isn’t it interesting that Sean Menke, the former head of Frontier just joined Pinnacle Airlines – a truly regional carrier at this point in the industry lifecycle?  What does he know that the rest of us do not?  Me thinks that the domestic market will also be made up of today’s regional carriers; today’s low cost carriers and of course; today’s network carriers as Jeff Smisek, CEO at the new United said, "A domestic operation sized solely to feed our international traffic".  It will be different no matter what pilot scope clauses suggest.

Thursday
May192011

Regional Airline and Small Community Air Service: It’s Time to Regionalize, Not Marginalize, the System

There are dark clouds looming around the regional airline industry that threaten small community air service and the regional airline industry as we know it.  This could be one hell of a storm.

On Wednesday I had the honor of moderating a panel at the Regional Airline Association’s 36th Annual Convention in Nashville, TN.  The panel consisted of representatives of many diverse, yet critical, relationships to the industry’s regional sector.  Mike Ambrose of the European Regions Airline Association offered perspective and cited some of the differences/similarities between the US and European regional sectors; Greg Principato, long-time Washington aviation and political veteran and now head of the Airports Council International – North America provided the airport view of the importance of the regional carriers; and the current head of oneworld, Bruce Ashby, provided insight from the global alliance perspective as well as from his front row seat watching the US regional airline industry transform itself into what it is today.

The storm begins with fuel.  The equivalent price of a barrel of jet fuel is nearly $130 per barrel compared to $30 per barrel when the explosive growth of the US regional industry began in the late 1990s.  With regional economies around the US performing unevenly and demand down on top of soaring fuel prices and less capacity, it is no longer economically sound to fly to some markets.

As retirements of mechanics and pilots increase at the mainline carriers, talent is being plucked from the regional airlines to fill those vacancies.  Maintenance costs are escalating at rates that will test even the most optimistic and work to assure that current contracts between the mainline and the regional partners for 50-seat flying will likely not be renewed. 

All of these structural issues are compounded by the heavy hand of government regulation that will only increase costs to the regional sector.  This government intervention ensures that the regional sector will be smaller tomorrow than today, bringing economic carnage for affected communities.

Analysis of Large Hub Airports

The FAA defines an airport as a large hub if it accounts for at least one percent of all enplanements.  But an analysis by MIT graduate student Joe Jenkins that assesses individual airport’s domestic origin and destination (O&D) traffic reveals some interesting trends about air traffic, inflation-adjusted fares and the quality of individual airport access to the air transportation grid in the United States.

According to Jenkins’ analysis, between 2000 and 2010, the nation’s 29 large hub airports grew a paltry 1.1 percent. In terms of O&D, the fastest growing airports were New York – JFK, Charlotte, Denver, Ft. Lauderdale and Orlando.  Those losing the most domestic O&D traffic were Newark, Detroit, Los Angeles, Atlanta and Chicago.  In each case the trends are pretty clear:  Traffic declined at 15 of the 29 large hub airports over those ten years.

The main factors at play were capacity reductions by the network carriers, which depressed demand in hub markets, and a meaningful low cost carrier presence in the fastest growing markets.

In 1980 Orlando ranked 22nd among the large hub airports; in 2010 it ranked number 3.  Only Los Angeles and Las Vegas are larger in terms of local traffic.  On the opposite side of the scale, Miami ranked number 9 in 1980 and number 29 in 2010 (no doubt a function of the growth of Ft. Lauderdale, which ranked 24th in 1990 and 13th today.)

Jenkins also determines whether a market is experiencing improved access to the air transportation grid by looking at how much traffic is traveling nonstop versus connecting.  Only nine of 29 large hub airports saw decreases in access quality for each passenger.

Meanwhile, domestic fares fell on average 30 percent when adjusted for inflation between 2000 and 2010. Airports with the largest decreases in real fares during the period at Ft. Lauderdale, Denver, New York – JFK, Philadelphia, Boston and San Francisco.  Honolulu is the only one of the 29 large hub airports that realized an increase in real fares, which can be explained by the increase in longer distance flying between the US mainland and Hawaii and the liquidation of Aloha. 

Imagine that in the course of one decade, average real fares in the largest US domestic markets fell 30 percent.  And the regulators worry about too little competition? 

Analysis of Medium Hub Airports

At medium hub airports which handle between .25 percent and less than one percent of domestic enplanements, O&D traffic declined by an average of 6.2 percent over the 2000 - 2010 period.  Southwest is almost entirely responsible for the creation of medium hub airports.  During the carrier’s infancy (1980s - 1990’s), the “Southwest Effect” stimulated new demand by offering lower fares than were prevalent in the market before the LCC’s entry.  Today (2007 – present), the “Southwest Effect” diverts demand from surrounding airports more than creating new demand.  Maybe someday the regulators will understand this.  But I digress.

Of the 35 airports medium hub airports, 20 experienced a traffic decline. While Ft. Myers and Milwaukee grew over the decade, San Jose, Reno, Cleveland, Hartford, Providence, Ontario, Cincinnati, Pittsburgh and St. Louis all lost traffic.

The economic troubles confronting the industry have not been solely relegated to the network carrier sector. The drawdown of network carrier hubs at Pittsburgh and St. Louis have been the subject of much discussion within the industry, as has Cincinnati, a hub for Delta.  But many medium hub markets were hurt much more than Cincinnati.  Jenkins’ analysis makes clear to this analyst that Delta is doing nothing more than rightsizing Cincinnati to meet local demand - a prudent business decision. 

Clearly, the loss of air service is problematic to any community, and no two markets were more affected that Pittsburgh and St. Louis.  But Pittsburgh and St. Louis were also among the airports that realized the largest decline in average fares, along with Milwaukee, Orange County, CA, Cincinnati, and San Jose.  Those experiencing the greatest increase in average fares between 2000 and 2010 were Dallas Love Field, Burbank, Reno and Houston Hobby which, interestingly, all are markets that Southwest calls home.

Analysis of Small Hub Airports

Only the small hub airports – those that handle less than .25 percent of traffic and more than .05 percent -- realized a significant increase in traffic between 2000 and 2010.  The airports with the biggest gains were Orlando Sanford, Long Beach, Newport News, White Plains and Akron/Canton.  Of the 63 small hub airports, one-third of the airports enjoyed a double digit increase in traffic despite the most difficult decade for US airlines ever.   The worst performers in the group were Greensboro, Tallahassee, Colorado Springs, Corpus Christi and Stewart Airport in New York.  With the exception of Corpus Christi, there is no meaningful LCC presence in this group.

Among the 36 of 63 small hub airports with improved access to the national air transportation grid most were Springfield – Branson, Akron/Canton, Stewart (despite seeing below normal traffic growth), Flint and Long Beach. The airports realizing their quality of access declining the most were Gulfport-Biloxi, Tallahassee, Santa Barbara, Fresno and Syracuse.

Only the large hub airports realized a fare decrease between 2000 and 2010 more than the small hub airports.  This will certainly come as a surprise to those that claim smaller airport markets have not shared in consumer benefits brought on by competition.  Average fares declined the most in White Plains, Allentown, Long Beach, Richmond, Atlantic City and Wichita, in part because of the influence of AirTran. The merger Southwest and AirTran makes even more sense to me now as Southwest’s 72-point network is significantly augmented by a network of small hub markets.  But what happens in catchment areas like Akron/Canton and Cleveland? There are many of these shared catchment areas when the merged route maps of Southwest and AirTran are examined. Only time will tell.

Analysis of Non-Hub Airports

Where the rubber hits the road in the next few years is at the very small, non-hub airports.  

Here, those most successful in generating traffic were Ft. Collins and Laughlin, AZ.  Among the worst performing were Pocatello, Sioux City, Toledo, Muskegon and Lansing.

Among these mostly small communities, some did gain better access to the US air transportation grid, including Hot Springs, Rockford, Western Nebraska, Laramie, Peoria and Toledo. But others are losing service, with Pocatello, Klamath Falls, Elko and Columbia, SC atop that list.

All the discussion of Essential Air Service in Washington underscores the importance of revenue economics in this sector.  When I looked at the traffic performance relative to the trajectory of the inflation adjusted fare line, only one non-hub really shined: Aspen Eagle.  This explains the relative levels of new service being started there.  Of the low performing airports not yet closed, Toledo and Muskegon, MI are the worst.

As a significant number of regional contracts expire through 2016, the real question will be whether it is economical for airlines to continue to serve some of these markets. The prospects are not good. In addition to punishing regulation and fuel prices, the regional sector already suffers from a pilot and mechanic shortage sure to be compounded by a coming wave of retirements at the network carriers. Further compounding manpower issues for the nation’s regional airlines is the dubious impact of new legislation that mandates 1,500 hours of qualifying flying time for regional pilots.

In keeping with Tennessee vernacular:  In coming years it will be difficult to “perfume the pig”. 

The Southwest Catchment Area and the Impact on Small Airport Markets

Let’s face it: the enemy of the small airport is the high cost of oil, a poor local economy and, yes, the presence of Southwest Airlines within a two hour drive.  Consider the facts.

With service to Pittsburgh do we really need service to Latrobe, Youngstown, Morgantown, Franklin, Akron, Johnstown, Clarksburg, DuBois, Altoona, Parkersburg, Cleveland and Erie?  For some of these markets the highway is already the first mode of access to the air transportation system.

With ample service to Raleigh/Durham, do Pinehurst, Fayetteville, Greensboro (remember their bad traffic performance), Kinston, Greenville, NC, Winston-Salem, and Jacksonville, NC need their own airports? Raleigh/Durham has been shown to be outperforming most in their peer group of airports.  The catalyst for that outperformance is because the best service in the “air service region” is offered at RDU.  Jacksonville and Greenville will never be able to offer passengers the air service menu that is available in Raleigh/Durham no matter the number of frequencies or the number of hubs served.

Some of these airports are, simply put, ripe for closure.  But some should also be candidates as tomorrow’s “essential.”  Bills doing away with the Essential Air Service Program as defined in 1978 are unfortunate.  What’s needed instead is legislation that better defines “essential” in today’s airline revenue system.  Secretary LaHood visited the Regional Airline Association Convention on Tuesday.  He said that no Reauthorization bill will exclude Essential Air Service as we know it.   And that’s a mistake.

It is high time that we begin talking about the regionalization of air service.  The market is already causing that to happen in places like Bloomington, IL.  With no replacement airframes in the pipeline to replace the flying done with 50-seat and smaller aircraft, we need to talk about air service regions.  But no one in Washington will have the guts to say that the local airport should close even if its customers would fare better (pun intended) by driving to a better performing airport in the region to access the system.  We should be investing in infrastructure at the best performing airports within regions rather than building monuments to Congressmen and local politicians that will not add value to the overall system.

There is much more to write, and I will.

 

[Note:  Thanks to MIT graduate student Joe Jenkins for his excellent analysis of domestic air service contained in this blog.  Mr. Jenkins plans to complete his analysis and thesis of airport network access in August 2011.]

Wednesday
May042011

Air Canada: Hypocrisy and Competition at the Same Time

In Tuesday’s Wall Street Journal there was a story titled:  Air Canada Tries New Path.  [Note to self: I will be interested]  But it was the subtitle that truly piqued my interest:  Carrier Is Pushing Toronto, Other Hubs as Transfer Points for U.S. Travelers.  Then I broke into laughter.

Not long ago I was writing about how the Canadian government was in a trade dispute of sorts with the United Arab Emirates and the efforts of Emirates, Ethiad and Qatar to expand services into Canada.  The rhetoric grew louder, with large doses of protectionism for Canada’s flag carrier.

"What Emirates wants to do is flood the Canadian market with capacity,” said Air Canada’s CEO Calin Rovinescu. “Its strategy is to scoop up travelers going elsewhere in the world and funnel them through Dubai, further strengthening Dubai as a global flow hub." 

Rovinescu also said Emirates' strategy will “constrain the growth of Canadian airports by turning them from hubs into stubs at the end of a spoke that leads only to Emirates' hub in Dubai." Just in case he didn’t make his point, Rovinescu added, "Sure, you will still be able to get to anywhere from Vancouver. But you will have to get there through Dubai."

In Tuesday’s WSJ, Caroline Van Hasslet writes:  “Air Canada is relying on the proximity of its domestic hubs to the giant American market, what Mr. Rovinescu calls his ‘international powerhouse’ strategy.  He [Rovinescu] identified Toronto as the carrier’s key hub in the push but also uses Montreal and Vancouver to attract American flyers traveling to Europe or Asia.  He hopes to double Air Canada’s transshipment traffic this year . . .”.

According to Van Hasslet, “Air Canada hopes to capitalize on its recent capacity increases, especially to Asia,” noting that the carrier is also betting that its relatively young planes will be a primary attraction for American business travelers.”

That sounds very much like the strategy playing out in the Middle East, where new planes, a young workforce and geography are the primary structural advantages for carriers calling the region home.

Simply, as networks increase in scope, carriers can justify more and more service into secondary and tertiary markets as the connecting possibilities increase exponentially.  Rovinescu says he wants to move passengers from one country, through a so-called gateway nation, to a third country.  With the exception of Toronto, other Canadian cities would be secondary to Emirates just as Air Canada calls Boston, Pittsburgh and Cleveland secondary.

But those secondary markets are critical in filling airplanes destined for Europe and Asia. The U.S. cities mentioned by the Air Canada CEO are just as important to American Airlines, Delta Air Lines as well as their STAR alliance partners, United-Continental and US Airways.  What to make of this strategy that will certainly transform Air Canada overnight into a global juggernaut?  Don’t buy the line.

As I touched on in the previous blog, Air Canada was trying to negotiate compensation and work rules with it pilots doing domestic flying versus international flying.  This points to the simple fact that network carrier legacy rules will not work long-term in either the Canadian or the U.S. market.  But, unlike the U.S., Canada faces a true structural conundrum.   Nearly two-thirds of the country’s traffic can be found in just eight metropolitan markets.   So Air Canada sees the need to raid U.S. markets to fill those big, new airplanes destined for Asia, all along potentially turning U.S. hubs into stubs on the global map.

But Wait – Let’s Talk Competition Too

Yes I am calling out Air Canada for the duplicity of its words and intended actions.  The question is what it means to all the naysayers who claim that it is global alliances that are driving up cross-Atlantic airfares.

Rarely do they mention the role of rising fuel prices and airlines passing on the cost to the consumer which makes percent changes from recent history even more dramatic.

Rarely do they mention that the architecture of the Middle East carrier’s networks is being designed to mount the ultimate challenge to the Big 3 global alliances. 

To suggest that there is no inter-alliance competition; one has to look no further than Air Canada’s “international powerhouse” strategy.  What I think is going to be interesting is what to make of the intra-alliance competition for the same traffic and revenue.  Yes joint ventures work to address some of the concern.  But …..

Now is the time to think about cross border ownership.  Maybe it is also time for U.S. carriers to act and make the rest of the world react.  Air Canada is the poster child for cross border ownership because the Canadian market cannot support two carriers.  And borrowing traffic and revenue from the U.S. is yet another Band Aid solution to problems that underlie the carrier’s long-term sustainability. 

Air Canada certainly knows this to be the truth as well.

Sunday
Apr242011

Pithy Ramblings On The Past 24 Days

In the 24 days since I last wrote, I have given multiple lectures, participated on a panel at the EU Forum on Transatlantic Competitiveness, prepared to present at Atlantic Southeast Airlines' Spring Leadership Conference and am working with two MIT students, Kari Hernandez and Joe Jenkins, on what I believe will be an insightful and important study on airline industry efficiencies and community access to the nation’s air transportation grid.

The worst NCAA national championship game in history ended three painful weeks made more so by my abysmal picks for the tournament.  And the Master’s golf tournament began and ended with no American at the top of the world ranking, just as no US airline can be said to be atop of the global airline industry.

With earnings and proxy season in full swing, it’s clear that most airlines are scrapping their way to respectable results even as high fuel costs depress their performance and executives continue to get paid executive salaries even at the sharp objections of unions.

And with so many union contracts still under negotiation, labor disputes continue to dog the industry, here and at airlines around the world.  I looked with hope to the pilot negotiations at Air Canada, where it appeared that the union was willing to consider less onerous restrictions on domestic flying in recognition of economic difficulties in the domestic Canadian market.  But rather than put an agreement out to vote, the union instead recalled its Chairman, doing little to strengthen the airline for the future. In response, the Centre for Pacific Aviation said it best: “That Air Canada needs something dramatic to make it sustainable is as obvious as the maple leaf on the national flag.”

I made the same suggestion in my presentation to the FAA's 35th Annual Aviation Forecast Conference.  But in doing so I often feel much like the Chairman of the Air Canada pilots union with plenty of readers who want to recall me when I look economic reality in the eye and recommend dramatic change.  One reader warns of a looming pilot shortage citing the law of supply and demand.  But that law will apply only by depressing the demand for pilots as the industry in the US will get smaller yet before it gets bigger.

At most of the US network carriers, cost structures are still too high to continue domestic flying at current levels.  And those high cost structures make it hard to justify investment in the hundreds of new narrowbodies necessary to replace fleets performing domestic flying today, particularly if today’s managers are truly serious about achieving a return on capital that actually exceeds the cost of capital.

Speaking at a CERA Conference in March, United-Continental Holdings CEO Jeff Smisek acknowledged that United-Continental, the product of the merger of United and Continental, will shrink in the U.S.  “We'll have the domestic [operations] sized solely to feed the international traffic," Smisek said.

Warring words between pilots and management have been increasing in volume in Australia too. Qantas had it relatively easy domestically once Ansett, the largely domestic carrier, was liquidated in 2002. When Virgin Blue grew to replace Ansett, Qantas responded by forming Jetstar, an airline within an airline.  But then came Tiger Airways Australia which now leads pricing in the Australian domestic market.  So legacy Qantas, with a cost structure once supported by a near monopoly in its domestic market, has now lost its competitive way.  Add to that pressure from the Middle East carriers internationally, a route system that is nothing more than a spoke to the world’s hubs is under challenge from all directions.

We can expect to hear similar noise from union halls in Germany, France, the Netherlands and the United Kingdom.  This is a region with social cost structures that look more like that of the state bureaucracy in Wisconsin than what will be needed to compete for tomorrow's global traffic.  I increasingly believe that what is being built in the Middle East will challenge the competitive integrity of each of the three global alliances.  Given that these alliances are nothing more than Band-Aid solutions to maneuver around archaic rules and regulations governing air transport, the bandages will begin to lose their adhesion one by one.  Global airlines built organically, particularly through cross-border mergers that build a brand, will begin to win the day. 

Not surprisingly, the response to the Middle East carriers from Canada, Germany, France and elsewhere has been protectionist at best. First the world wanted to open the skies.  Now that the skies are largely open for some, the talk has turned to restricting access to markets from new, innovative and vibrant competition.  I agree that the new competition should not be allowed to access cheap capital that is not available to all.  But to limit 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. Until a forensic accounting of Middle East carrier finances is available, it is all heresay to me.  Even Willie Walsh speaking at the EU Forum said he sees nothing abnormal in the numbers being reported today.  

In my mind, the US network carriers already have faced this type of competitive challenge to their domestic operations from upstart airlines with a labor cost advantage, new, more efficient aircraft and a cost structure that reflects the realities of today’s market in part by doing things like outsourcing ground services.  Why was it OK for the low cost carriers in the US to take 20 points of domestic market share away from incumbents and it is not OK for more efficient operations in other parts of the world to challenge incumbents in Europe and Canada?  Let’s not forget that one of the benefits of LCCs in the US was stimulating new demand that filled airplanes painted with new and old liveries. 

Finally, a few words on the battle between American Airlines and the global distribution systems/online travel agencies. We cannot talk about the airline ticket distribution system without mentioning the Business Travel Coalition – the advocacy group that tells the world it is all about protecting consumers when it is doing nothing more than to ensure the sustainability of its business with cash flows from the distribution duopoly.  In the past month alone, the BTC News Wire put out communications that, among other things, suggested that airlines are lying to Congress, railing against airline fees and urging consumers to write Congress in protest.

As I wrote 24 days ago,  despite the rhetoric from BTC and the constituents it represents, the coalition is doing more to protect an outdated mode of operation and stifle innovation than support a strong airline industry.  The GDS duopoly cannot move fast enough for an industry that sells “time saved” no matter how painful it is for the BTC and the online travel agencies to have the revenue tap turned off.  It’s time for the GDS to recognize they can’t support interests other than their ultimate customer – the airlines that actually do serve the air travel customer.

Much more to come.

Tuesday
Mar292011

To The GDS's: Either Evolve Or Dissolve -- It's That Simple

In the March 12 Economics column of The New York Times, University of Chicago economist Richard Thaler correctly titles his piece as it pertains to the airline industry:  “This Data Isn’t Dull. It Improves Lives.” The column then goes on to distort the intentions of the airline industry. 

At the heart of the matter is the relationship of the airline industry to the Global Distribution Systems (GDS).  Every time an air travel consumer works with a travel agency, the information being supplied by the agent is likely provided by a GDS.  The data necessary to enable the agent is supplied by the airlines to the GDS.   

In the early years following deregulation of the airline industry, GDS were largely owned by airlines and used to provide information to intermediaries to sell tickets on particular carriers.  The systems were biased toward the airline(s) providing the technology to the travel industry community.  These massive networks were built using the technology prevalent at the time – prior to the advent of the internet – and GDS were compensated for providing and maintaining vast private networks and for acting as gatekeepers between agents and airlines.

In fairly short order, the government stepped in to regulate the bias.  As a result, the GDS were no longer a distribution tool aiding the airline(s) that invested in the technology directly; rather they became a tool of the travel industry to sell a service.  Today, the airlines pay an intermediary to distribute their product – and they are paying a price much higher than the prevalent transaction costs. The airlines’ costs reflect an outdated model replete with older and more expensive technology as the GDS fight to sustain their large networks and maintain their role as gatekeeper.

But the intermediaries don’t pay the airlines for the airline-created content they use to lure customers to their respective websites so they can sell hotel stays and rental cars.  It makes no sense.

Name a financially successful industry that turns over control of its inventory to an intermediary. I can’t think of one either.

Airline travel is now available for purchase on multiple channels via the internet, including through the airlines’ own websites. Those sites typically provide carriers with the most control over the shopping experience while also being the lowest cost channel for the transaction. It is simply much cheaper and more efficient to use newer, internet –based technology to distribute tickets without the need for a “gatekeeper” between airlines and agents.   

Now the airlines also want to be able to go directly to their customers via their own channel.  Not that the airlines do not value the higher yield business that comes from agencies.  The motive is not, as some detractors have said, because airlines want you only to shop at their sites or not reveal what the cost of a trip is if you check two bags.  Rather, airlines are looking for ways to differentiate themselves by offering additional products and services to their customers that enhance the travel experience. This information is something the GDS cannot provide today without a significant investment in their systems.

Duopolists are typically reluctant to invest new capital unless it is absolutely essential to protect its cash cow

The airlines don’t necessarily want - or need – to drive all transactions to their sites and there is still a role GDS can play in this process. GDS could be content aggregators, allowing customers to easily compare fares. Right now, though, that’s a role GDS seems unwilling to take on perhaps worried about risking their fees.  

There are other factors at play here as well. First, airlines know their particular customers better than the government or the GDS. Plus; the GDS haven’t evolved as the industry has dramatically changed.  

Today’s GDS force the airlines to compete only on two factors; service and price. By limiting areas how airlines compete, the product offered is the definition of pure commodity. This was true in 1983 just as it is today. 

Despite the airline industry’s efforts to remove more than $20 billion in expenses over the past decade, the price of another commodity essential to its business increased more than fourfold – oil.  The airline industry is left with little choice, if it is to ever be a sustainable business, but to begin the process of de-commoditizing its product and finding new revenue sources.  To do so, means fundamentally altering its legacy relationship with the GDS and recapturing control over its inventory.

The airline industry has found new ways to generate revenue by offering customers products they value and are willing to pay for, including seat upgrades, passing through security faster or day passes to airport clubs. Bag fees, now charged by the majority of U.S. carriers, reflect a more accurate way to pay for what you use. In other words, customers that don’t check bags no longer subsidize the cost of those who do.  

Yet the GDS and supporters claim airlines aren’t being “transparent” in their pricing that they do not want to reveal the total cost of trip to a passenger.  Few industries have price transparency like the airline industry – compare it to cell phone contracts – and the majority of customers know exactly what they’re paying for when they travel.

Thaler is right; the data supplied to the GDS is anything but dull and service and price competition have benefited many by making air travel affordable to the masses. This will certainly continue as the competition is as hungry today as ever.

This is not a fight about defending the purity of data or somehow withholding it from those whose only aim is to presumably help customers. No one, including the GDS, can really dispute that this information comes from the airlines.

Despite the rhetoric, it’s also not about protecting customers from an industry desperate to reach more. This is about protecting an outdated mode of operation and stifling innovation.  The GDS duopoly cannot move fast enough for an industry that sells “time saved”.  The GDS doesn’t want its revenue tap turned off. It’s time the GDS recognizes it can’t support interests other than their ultimate customer – the airlines.  The airlines are simply looking to adapt to new economic realities and help their ultimate customer – the person who actually buys a ticket.

Duopolist.  Monopolist.  Neither is accepted in the airline business.  Now the airline business says it is time that vendors servicing the airline industry cannot be duopolists or monopolists either.  It is all part of the evolution of the business that began in 2002. 

Tuesday
Mar082011

Jet Fuel and Labor Part II: Commenting on the Comments

The message of this blog as it pertains to the current round of industry-wide negotiations can be boiled down into six words:  Doing More With Less For More.  Honestly, I have not heard management teams say they are seeking concessionary contracts.  I have not heard anything suggesting W2 wage reductions are being sought.  What I have heard is productivity is needed in return for an increase in W2 compensation.  So Doing More (flying/working more productive/smarter time) With Less (fewer headcount needed to staff some level of flying) For More (increase in wage and salary compensation).

When I posted my last blog item, Oil and Water; Jet Fuel and Labor, I expected colorful comments from readers.  And I wasn’t disappointed.  You can’t have had my career and not ruffle some feathers.  And I did.  The comments were also instructive, showing sections of my blog that needed additional explanation and clarification.

Yesterday, I had a private exchange with a thoughtful pilot leader.  After some initial back and forth over the merits [or lack thereof] of my blog piece, he wrote, “My pilots and I have been living under a concessionary contract for X years now.  Our work rules were gutted down to the FAA Minimum....the CEO and the officers seem to be doing quite well though, aren't they?  Nobody is looking to break the bank.  I don't begrudge what anyone else makes. I just get tired of the excuses that there is no more left for the working guys after everyone at the top has already skimmed off all the cream!”

I lead with this exchange because it captures the essence of many of the comments made.  It’s pertinent for its truths and its misconceptions, just as many of the other comments were. For instance:

  1. $100+ oil may be the new reality, but you cannot expect any workforce to accept wages from 2001.  SWELBAR:  The industry has drastically changed since the heyday of 2000 and oil prices in 2008 and now in 2011 are but part of the catalyst.  For instance, according to MIT's Airline Data Project in 2001, U.S. airlines employed 89,349 flight attendants.  In the nine years since, nearly a quarter of those jobs - more than 25,000 - have disappeared.  No one likes to be told that they're not as in demand or cannot command the wages they once did.  Millions of U.S. workers - union, non-union, auto workers in Detroit to tech nerds in Seattle - face the same dilemma airline workers must come to grips with.
  2. Unions need to wake up to the new reality and give up the long lost dream from the regulated era and the flying public needs to acknowledge that good service from a safe airline might actually cost something more than the bus fare they want to pay.  SWELBAR: I agree up to a point, but what about the price elasticity of demand?  At some point consumers (and I mean the all important business and premium passengers) will simply decide it's not worth the expense and simply stop flying.  The acknowledgment needs to come from management and employees that they're providing a consumer-driven commodity.  That's all.  You price consumers out of the market and you price yourself out of a job.
  3. Continually beating the "it's the union's fault" drum is old, hollow, and doesn't reflect the reality of the situation.  SWELBAR: When it comes to oil prices, I'm certainly not blaming the unions.  The unions have the same control over oil prices as management - NONE.  What I said, and have said, was the history of pattern bargaining in the airline industry was created when oil prices were not a factor.  They are now.  To make the U.S. aviation model work, everyone needs to realize, and accept, that things are not the same and there is no going back.  If you want a relevant example, look no further than the auto industry.  Fuel is a factor for automakers too and they have been been forced to shrink the workforce all the while ensuring that the smaller workforce is efficient - ways to escape the burden of unsustainable contracts yet still turn out a safe, reliable product consumers want while facing increased competition from domestic and global competitors.
  4. Regardless, to try to base employee costs on the cost of oil is absurd.  They are unrelated, just as is the cost of airframes, engines or catering is to oil.  SWELBAR:  In a word, wrong.  Every cost affects the bottom line through its consumption of the revenue pool; it's just a matter of by what factor?  When jet fuel remained at the equivalent of $29 per barrel for 25 years, it had little impact on the bottom line for most airlines and, thus, employees.  That's obviously changed, as it would with any cost where a penny increase can mean tens of millions of dollars in increased expense.  If engine prices suddenly rose 100 percent, don't you think airlines would have to drastically rethink their consumption of engines?  This is about controllable costs, which oil isn't.  Something has to give.
  5. Keep this up and Air India will have continuing service to OMA because the only ones who will have labor cost that is acceptable to your masters will be third world countries who will be laying over in East LA at the Days Inn with the entire crew sharing two rooms and thinking this is a great layover.  SWELBAR:  This actually raises a good point.  Increased competition is a factor for the U.S. aviation industry no matter the cost of Jet A.  The shape and makeup of the industry will continue to evolve and will further embrace multi-national carriers.  Oil could accelerate that process by culling some carriers or impede it by slowing international growth.  If U.S. airlines - management and unions - don't rethink the business model, accounting for oil - then it really does not matter what "acceptable labor costs" might be.  Does it?  A major message in this blog is instead of fighting tooth and nail for what once was, maybe it is time to think of what has to be. 

Going back to my exchange with the learned pilot leader, this is how I responded, “I have been around a long time like you, and if someone can say the past volatility in labor’s earnings worked nicely for them then ….. there is just not much to say.  Many of the business practices in this industry are built on a model of growth.  When there is no growth, then something has to be done to those costs that are controllable.  There is no more need to file for bankruptcy because oil is not controllable.  [Inserted today:  The price of oil cannot be restructured].  Not a damn thing that can done.”

I went on to say if people would take the time to move beyond their visceral reactions and think about my arguments, they’d see I believe  flight crews are less an issue than “below the wing employees” where differentials have grown significantly at some carriers. “I want you to have yours too.  But the zealots saying ”I am going to get it all back and more” when the environment is diametrically different – as it is –  then someone in a (labor)  leadership role is not doing their job.” 

“There is enough to go around, as I will write later in the week.  But [pilots] and flight attendants working 40 hard hours per month are not an answer.  Too much headcount for the amount of flying to be done.  Ground workers at an all in rate of $25 when it can be outsourced for a fraction, which is what many of the LCCs do, is simply not good business.  The restructuring is not done.  Doing More With Less For More needs to be a mantra.  If oil keeps going, and my dart board is as good as anyone’s, then capacity will again get cut in the fall.  2008 all over again – just not as deep.”

“As for management doing nothing, this is the first time in 30+ years where capacity actually reflects a business environment where costs can be passed through.  Even Southwest is a participant.  That is but one change that had to happen.“

Final Thoughts

There is no question the key to success for this industry going forward is raising fares.  And that’s happening, thanks to Southwest now taking a lead versus being the carrier always fighting the industry on pushing through an increase.  Since December 2010, Southwest has been part of five – read five – fare increases.  No longer does the lower cost carrier enjoy a unit fuel cost advantage either - Southwest isn’t hedged like it was between 2004 – 2008.

As one commenter said, “This notion that airlines cannot control domestic pricing is absurd.”  Then the same person actually outlines how airlines are finding new revenue streams from unbundling attempts.  Here’s the catch: The unbundling was done in response to high oil prices in 2008 because there was no industry consensus on increasing base fares. If one carrier doesn’t raise fares like everyone else, the attempt to increase ticket prices typically fails.  To say that management has done nothing to address a poor revenue environment is simply wrong.

Any discussion of management compensation on this blog is a non-starter - as I have learned.  The comment section is not big enough to house the emotions that spew forth over the subject.  Few things at the Board of Directors level are more difficult than management compensation plans; especially with the level of scrutiny those plans now receive.  Because of the outcry, the chairperson of the Compensation Committee might be even more important than the chairperson of the Audit Committee. That’s just not right.  Management has their contracts.  Organized labor has theirs.  Given the volatility in costs and the push to see pay-for-performance as the rule and not the exception, labor should be making it a part of their overall compensation as well.

That I’m somehow tying labor costs to oil costs is absurd.  I suggested volatile - and increasing - fuel prices consume more of a finite revenue pie.  I should have explained that better.  The pie is finite when base fares are considered because the industry has to agree.  The unbundling strategy being employed is designed to increase the size of that pie.  It is working.  But when an industry is profitable primarily because of fees collected, one can easily read that as a negative simply because it’s not sustainable.

A long-time critic of the message of this blog stated, “Even Wall Street says there is no blood left to squeeze out of the employees yet you still beat that drum over and over and over........ Get some new material.  You being a shill for the ATA I assume the always lower labor cost mantra will continue until everyone is working for free.”

I challenge anyone to read this blog and find where I said airline workers should work for free.  Further, I dare anyone to find where I suggest contracts in this round need to be concessionary (less total cost than the previous contract).  I have said time and again expectations that the industry can afford to repeat its past patterns of repaying concessions, plus more, have to stop.  I have also said productivity improvements are paramount in the industry as it is still operating with too much headcount.  This is where the business of unions needs to look in the mirror and ask, “Is it better to negotiate a great agreement for fewer people or an OK agreement for many people”?

This is about Doing More With Less For More – that’s the reality. While I understand the emotions that can be triggered when talking about people’s livelihoods, it doesn’t change the reality. My hope is the sooner a truculent industry embraces what it is, the better off every ground worker, pilot, flight attendant, shareholder and, yes, even management will be.

Thursday
Mar032011

Oil and Water; Jet Fuel and Labor

On June 25, 2008 I blogged asking the question:  Is Oil A Cancer Or A Cure?  At that time, the price of a barrel of oil had not yet reached its apex of $147 per barrel, but was well on its way.  Based on findings by the Air Transport Association’s superb economic analysis team led by chief economist John Heimlich, the U.S. airline industry paid the equivalent of $174.64 per barrel [price of a barrel of oil plus the equivalent cost to refine crude into jet fuel (the crack spread)] on July 11, 2008.  By December 23, 2008 the price of a barrel of West Texas Intermediate had fallen to $30.28 per barrel.  So far in 2011, we’ve seen a similar surge in oil prices, but based on current geopolitical events, I am not expecting another $117 drop in the price of a barrel of oil like we witnessed in 2008.

I’m actually wondering what happens if the wave of Mideast political upheaval washes over Algeria? Or Saudi Arabia? Some economic experts say the price of oil could rocket past the $200 threshold.

In 2011, the industry has paid an average of $89.15 per barrel of crude and another $25.80 in the crack spread for a total cost of “in the wing” jet fuel of nearly $115 per barrel.  Since February 22, 2011 the industry has paid more than the equivalent of $120 per barrel for jet fuel.  On March 1, 2011 the industry paid the equivalent of $132.17 per barrel for jet fuel including the crack spread of $32.54.  For all of 2008, the industry paid the equivalent of $25 per barrel to refine crude into jet fuel.  In the last five days of trading the crack spread paid by the industry is nearly $30 per barrel. 

That’s a lot of numbers, so let me put this in a way that might shock even the most ardent follower of the airline industry: Today’s cost of just refining oil into jet fuel is roughly equal to the total jet fuel price per barrel paid by the industry every year between 1978 and 2001.

1978 – 2001

The mindset of many airline stakeholders - and particularly labor - is based on the period between 1978 and 2001.  Deregulation began in 1978 and 2001 marks the beginning of wholesale industry restructuring. .. which actually should have started 24 years earlier.  To put this period into an oil perspective, over the first 25 years of a deregulated industry, the equivalent per barrel price of jet fuel was $28.93.  Oil was cheap (more than four times cheaper than in 2011) and it was the basis for the industry to grow too big, too fast.   After all, the biggest “uncontrollable cost” was a blip.  There was little change in either the price of a barrel of crude or the crack spread.

Based on analysis at MIT's Airline Data Project, between 1978 and 2001, the industry grew nearly 2.5 times in terms of available seat miles.  Traffic grew faster than capacity.  The great enabler in the growth in addition to the cost of jet fuel was the fact industry yields, or the amount the customer pays per mile, declined by 39% when adjusted for inflation.  Domestic yields fell by an inflation-adjusted 41 percent over the same period.  In other words, cheap seats. The price of an airline ticket was one of the great consumer bargains.  This fact ultimately led the network carriers to refocus their operations on international flying because their high cost structures struggled to conform to the realities of the domestic market economics.

As the industry added capacity, employment grew by nearly 220,000 full-time equivalents.  During the same period, the total cost of an employee to the industry declined by eight percent in real terms.  I can hear it now, ”no way – my salary is significantly less.”  Yes, it is true salary costs when adjusted for inflation have decreased. On the other hand, the cost of pension and benefits paid to airline workers has grown at a rate faster than inflation.  The cost of an employee to a company is not based on salary alone.

Over the 24 year period being discussed here, it is true that employee productivity in terms of available seat miles per employee and enplanements per employee increased 44 percent and 30 percent respectively.  Much of that is again driven by cutthroat competition driving prices downward in order to stimulate demand.  Here is the kicker.  The number of available seat miles produced per dollar spent on labor fell by 42 percent.  Or, labor is producing more output but the cost of that output is increasingly expensive.  This fact alone was unsustainable and the restructuring process was used to address the underlying economics.

Many areas of the income statement were addressed by managements over the period with the most noteworthy being the decision to stop paying legacy commission rates to travel agents.  This action alone saves the industry nearly $6 billion dollars per year although we can also say that the savings are largely competed away in the form of lower fares.  Food and advertising expenses were also reduced.  Each of these cost areas, like labor, is considered controllable costs.  Oil is not.  What the industry did realize over the period was a 30 percent efficiency improvement in the consumption of fuel.

2002 – Today

As 2001 came to a close, unit costs at the network carriers in the face of free falling unit revenue became the story.  US Airways was the first carrier to file for bankruptcy.  United was second.  And American followed with an out of court restructuring.  Each carrier had extremely high overall unit costs relative to the industry as shown by the MIT Airline Data Project.  The ADP also shows the three carriers were out-of-market with respect to unit labor costs relative to the industry.  The network carriers mentioned simply had costs so high, there was no choice but to seek some sort of a consensual restructuring either through bankruptcy or out of court if they were to live and fight another day.  The scary part is, oil was still reasonable during this time. The industry jet fuel price per barrel equivalent as restructuring commenced was $30.07.

While jet fuel prices are uncontrollable, so too is airline pricing, particularly in the U.S. domestic market.  Since 2001, the industry has only increased capacity by 2.5 percent as capacity discipline became the mantra.  Again traffic grew faster than capacity as inflation adjusted yields fell another 12.5 percent.  The nominal level of capacity growth can be attributed to the growth in regional carrier and low cost carrier flying.  Since 2001, mainline carriers have shed nearly 24 percent of their previous domestic capacity with nearly one-third of that capacity removed since the 2008 fuel spike.

Capacity cutting was all that was left in the face of high oil prices.  When carriers delete capacity, they also eliminate jobs.  Since 2001 the industry has shed nearly 155,000 jobs – a period when the jet fuel equivalent price per barrel averaged $73.08.  Labor productivity has improved significantly as the network carriers restructured.  But as I’ve talked about before, the problem with a seniority-based system is that average costs increase as the less expensive employees are the first to be let go.  In 2002, when the restructuring began, the average cost of a full time equivalent airline employee was $74,910.  Today, the average cost of a full-time equivalent employee is $83,869.  More troubling is the benefit and pension package for full- time employees in 2001 cost $11,560.  Today, the cost of that package is $18,195 reflecting seniority as well the country’s inability to reign in medical costs. 

So Here We Sit

The history of pattern bargaining - and resultant expectations - between labor and management was created on a basis of $30 per barrel for jet fuel.  Today, the cost of jet fuel is the equivalent of $132+ per barrel.  Yet labor doesn’t seem to acknowledge the fact that times – and oil prices – have changed.  There are 52 airline cases under the auspices of the National Mediation Board and I will wager few, if any, of the labor negotiating teams consider oil a major factor in a future contract. It’s “management’s problem.”

Well, it’s also labor’s. While the industry has been creative in finding new revenue to address the reality of fuel costs, consumer pass-throughs generally lag behind the rise in the price of fuel. The bigger issue, the one labor has trouble admitting, is the size of the revenue pie is finite.

Oil is uncontrollable and therefore difficult to predict how much of the revenue pie it will consume.  Cost reductions in many areas of the operation have already been largely realized.  And that’s where oil prices become labor’s problem.  Employees – rightfully - want their share of the pie, and they’d like to make-up the concessions of the past.  The problem is the pre-restructuring high water mark, when oil was around $30, is what labor wants to return to. That’s not possible and it’s certainly not sustainable.   

I have heard it said many times, "labor is not going to subsidize the price of oil again".  Well, truthfully, labor didn’t the first time. When restructuring began and adjustments to labor costs were realized the price of jet fuel was not the issue.  It was declining revenue.  After much pain inflicted on virtually every stakeholder group over the past decade, $100 per barrel jet fuel is the new reality.  Expectations of returning to the past should be forgotten.  I like to use history, but history is useless in evaluating this industry because the fundamentals that now govern the industry’s structure like oil and the economies of China and Germany and Brazil are new and rapidly evolving.

I had someone say to me the other day that shouldn’t we throw away the past and just start again making this apex the new reality?  The simple answer is yes.

Wednesday
Feb232011

Wisconsin, Herbert Stein and US Airlines

At the end of my last post, I encouraged readers to Google Herbert Stein, who served as Chairman of the Council of Economic Advisors under Presidents Nixon and Ford.  If you did, you may have seen one of my favorite Stein quotes: “If something cannot go on forever, it will stop”.  

Last week, Chairman Stein was the subject of my remarks to the 36th Annual FAA Aviation Forecast Conference -- Herbert Stein's Law and the US Airline Industry.

In this industry, Stein’s law stands. Those things that could not go on forever stopped.  Like airlines that paid an increasing share of a ticket price to a middleman just as those fares, adjusted for inflation, continued their 30-year downward trend.   Or adding capacity at rates that exceeded the growth in real GDP in order to feed the hunger of management teams that wanted market share above all else.  Or competing away the cost savings of every new technology, efficiency, product or service in the form of lower ticket prices so that savings never found their way to the bottom line.  Or watching unit labor costs increase in nominal terms at the same time output per employee wallowed for the 15-year period between 1986 and 2001. 

You get the picture.

Since 1986, the industry’s output (measured as Available Seat Miles) per labor dollar has decreased nearly 25 percent – a trend as applicable to United and American as it is to Southwest.  Even as output increased, the cost of that output increased more.  According to the MIT Airline Data Project, in 2009 American paid more per ASM for labor than any other network carrier, while Southwest was by a large margin the most expensive among the nation’s low cost carriers.  This trend is not sustainable over the long term – either for those airlines in particular or any other airline that ramps up its labor costs to buy union peace only to price themselves above the competition.  This is but one reason I believe that the job of restructuring how employees work is far from complete.

Wisconsin

Egypt, Libya and Wisconsin.  Each is undergoing a revolution.  But the labor pains in Wisconsin are probably only a precursor to what will play out in other states dealing with bloated public sector union contracts as governments seek ways to close wide budget gaps.  Unfortunately, these gaps are so large that many states have few places left to turn than the employees who in one way or another work for the state.

This story has many parallels to highly unionized private industries, like steel, autos and airlines.  The damage to the US steel industry has largely played itself out as manufacturers found lower cost places of production.  But in the end the US steel industry is but a shadow of itself; having shed nearly 75 percent of jobs from its peak.

The same is true of the US auto industry – once a global giant – but today employing a fraction of the American it once did.  As demand for US-made cars slumped further year after year, the government forced a bankruptcy-style reorganization of General Motors and Chrysler that seems to be producing positive results, while Ford has managed to survive without government intervention.  But no US carmaker can long ignore the elephant in the room – a massive liability in employee and retiree benefits and pensions.

Defined Benefit pension plans and employer-paid health care have their roots in Roosevelt’s New Deal.  Now, nearly 80 years since the tenets of FDR’s plan passed Congress, private-sector employers have decades of experience dealing with the legacy costs of Roosevelt’s deal. Public sector unions are newer to the battle, with recent flare-ups in Canada, Detroit, Philadelphia and Tulsa to name a few, while many states like Indiana, New Mexico, New York and California, are just beginning to face the budget music and the political toll of taking on the public sector union machine.

In the February 20, 2011 New York Times, Nobel Prize winning economist Paul Krugman referred to Scott Walker as “Wisconsin’s new union busting governor.”  I will grant you that some of the things Walker is seeking are overly ambitious if fixing the budget deficit is the objective - like prohibiting the state from collect union dues through payroll deductions as is standard practice and has been for decades.  Nonetheless, the fight started by Walker with Wisconsin’s unionized employees underscores the fact that neither private nor public concerns can provide the outsized, politically-protected level of benefits that were won in past negotiations and now considered downright entitlements. 

Today, most employees in private-sector companies pay roughly 25 percent of their health benefits and likely contribute some percent of their pay to a defined contribution retirement plan like a 401(k).  Walker isn’t asking for more.  In fact, he’s asking state employees to pay just 12.5 percent of their health care costs and 5.8 percent toward their pension.   According to the Bureau of Economic Analysis, public sector benefit packages cost an average of $17,000 per employee. This, according to USA Today, is about 60 percent more than benefits packages offered in the private sector (with the important exception, for Swelblog readers, of the airline industry, which even after restructuring still offers a richer pension and benefits package at an average of $18,195 than most private industries.)

Is Walker a union buster as Krugman suggests?  Or is he simply doing the right thing for Wisconsin taxpayers and future generations that can’t afford to subsidize the outsized expectations of a protected class? Krugman suggests the fight is all about political power, but then he overstates Walker’s intentions.  Power and control are at the heart of most disputes and many competitions, including the recent mid-term elections.  And those elections sent a message that the public is calling for deficit reduction whether in federal or state government.  The largest controllable cost is labor.  So is it busting unions or making necessary corrections to something that cannot go on forever – therefore confirming Stein’s law that it must stop? Walker, after all, is a Republican and can count on support from his party colleagues in the legislature.  Imagine, then, the job liberal Democrat Jerry Brown has in California as one of his only hopes for fixing the budget mess there is to call for deep, deep cuts in the public sector payroll. 

Airlines and Wisconsin

In the airline industry, power and control defined collective bargaining until bankruptcy forced a correction.  Many public sector unions believe they don’t face that risk because states, unlike private companies, hold the power to raise taxes and produce revenues on demand. But that gets more difficult in the wake of a stubborn economic recession, when raising taxes would only lead to less money in people’s pockets to spend on goods and services and fuel the local economies dependent on consumer spending for a recovery to take hold.  Increasing taxes on business only makes the state a less attractive as a place to do business, which has its own price in discouraging job creation and driving away investment.  So raising taxes is no panacea, and may not even be a practical solution.

Ironically, some airline unions believe their pay and benefits can be restored if only the industry would increase ticket prices.  The problem there is no single airline has that kind of pricing power vis-à-vis the competition. 

In my presentation to the FAA Forecast Conference, I posed the following hypothetical question: What happens if you calculate the profit/loss per enplanement using passenger revenue only?  After covering interest costs the industry lost $12.80 per enplanement during the 1980’s; $11.49 during the 1990’s; $21.28 during the 2000’s; and $19.47 in 2010.  But the industry made money in 2010, right?  Yes, but because offsetting the loss of $19.47 per enplanement was the equivalent of $8.70 in ancillary fees, thus reducing the loss to $10.76.  Other sources of revenue made the loss a profit.  Unfortunately, raising the base fare is not the answer.  Finding other revenue sources or diligently reducing costs is.

Just as the public sector has been forced to reduce services and consolidate schools to address budget shortfalls, airlines cut capacity in the face of rising oil prices.  Headcount – a fixed cost -- was cut even further. With the continued high cost of labor in the industry, the decision to hire today is a difficult one for any airline.

It is true, as the unions contend, that total employee compensation has not kept pace with the rate of inflation since 1978.  Total compensation is made up salary, benefits and pensions and payroll taxes.  The other factor to consider, however, are the work rules that, while not compensation, dictate the headcount an airline needs to keep on the payroll to do X amount of hours of flying.  What airline unions are saying is pay workers more, but don’t touch benefits or work rules.  That cannot be done, not when the cost of benefits has risen at the cost of inflation plus 46 percent.  Like so many states are discovering upon taking a hard look at state employee contracts, it is the cost of benefits that is the biggest financial drain, an expense crowding out how much can be paid in wages.  This fact seems to be lost to the governor’s detractors in Wisconsin.

Oh, I Can Hear It Now

So let me beat you to the punch.  “Swelbar,” you might say, “You are nothing more than a union buster like the Governor of Wisconsin!  You are against the workers.  Companies get only the union they deserve.”

No I am not and no they do not.  But unions, and management, need to recognize the realities of the economic and competitive environment and let go of the power struggles of the past if they’re going to be able to survive in the future. In the midst of an incredibly difficult round of negotiations, this is a tough message.  But it’s not anti-union to make the point. It is “anti” those who believe that nothing has to change.  And that goes particularly for some union leaders who need to radically overhaul what a union is and does in 2011. 

Maybe James Sherk at The Wichita Eagle said it best:  “The labor movement is losing its customers. Private-sector union membership has fallen below 7 percent. Only 1 out of every 10 nonunion workers tells pollsters he or she wants to unionize.  The unions have only themselves to blame. They haven't adapted to the modern work force. Today's workers want — and expect — employers to recognize their individual contributions. Few want a one-size-fits-all contract that treats everyone alike. Yet that is exactly what collective bargaining offers.”

The airline unions have used, and are using, promises and unrealistic expectations to persuade members that they deserve more than most airlines are able to pay.  And that is a belief that cannot go on forever and therefore must stop.

Saturday
Feb122011

Nature Abhors A Vacuum - Proving True At The Allied Pilots Association

Having been critical of some union leadership in the past, I now must acknowledge when some get it right.  And that someone is Captain David Bates, the president of the Allied Pilots Association at American Airlines.

I may not be doing Captain Bates any favors here. In the sometimes irrational world of union politics, leaders too often are applauded for destructive rather than constructive behavior, which is one reason labor relations are such a mess in the airline industry.  But here goes:

There have been few topics covered as extensively at www.swelblog.com as negotiations between American Airlines and its pilots represented by the APA.  My take is that for too long the APA’s behavior and actions were not becoming of a professional pilots union.  I wrote many times about Captain Lloyd Hill (Bate’s predecessor) and his term of empty promises:  All Eyes on Texas; Just Put It On Ice: American’s Ability to Pay ? APA’s Expectations; Maybe the Allied Pilots Association Is Really Onto Something; American Airlines and the Allied Pilots Association: A $3 Billion Question and AA’s Labor Negotiation Scenarios Get Even More Interesting to name a few.  His delusional approach to union leadership often landed Hill a starring role in the ongoing saga of Captain Lloyd and the Lost Planet Airmen.

My last post on the flight attendants union at American, A Flight Attendant Representation Inflection Point? received a lot of attention.  And it is most relevant to what transpired this week when Bates delivered his speech to the APA Board of Directors.  I have wondered many times how APA’s new leader would begin the process of ending the tough and reckless  leadership style of his predecessor and transition to a style he has shown to be tough yet pragmatic.  His words to his Board very clearly follow his actions in his first seven months in office.

As I’ve said before, there is a financial concept lost on union leaders today:  Net Present Value (NPV.)   It means simply that cash flows realized in the short term have more value to the firm (or individual) than cash flows generated years down the road. 

Bates recognizes this in his speech when he states early on: “We're now coming up on the five-year anniversary of when management opened up contract negotiations. Your National Officers know what the pilots want in this contract. We know that our earning power is diminishing each and every day.”  [the concept of NPV loud and clear].

The next five paragraphs of Bates’ speech speak plainly and loudly with a message that should be heeded by labor leaders throughout the industry.  And that is this:  The historic pattern of bargaining, in which a union gives in one round with full expectations that they’ll get it back plus more the next time, is history.  In the past, airline labor agreements addressed only the competitive realities confined within the 48 contiguous U.S. states to the extent they addressed competitive realities at all.  Today, union leaders need to accept that this is no longer the case. Airlines cannot cave to the urge to repeat the patterned sins of the past and give away pay without demanding changes necessary to compete with new and different competition.  At the same time management must listen carefully and think creatively about addressing labor’s concerns about jobs in a different but an increasingly global competitive industry.

Bates’ Five Paragraphs of Truth

I'm going to tell it straight. For the past several years, APA has played the blame game. We've blamed management, we've blamed the National Mediation Board and we've blamed the recession. We've portrayed ourselves as victims of an unfair world.

It's time we look in the mirror and get honest with ourselves. In APA's extensive contract proposal crafted several years ago, we opened on a large number of items in nearly every section of our contract. Instead of concentrating on the most immediate and important items, we created a wish list for a "dream contract," asking for dramatic increases throughout the contract. We loaded up the openers with "throwaways" and put hundreds of items on the table--of which approximately 320 still remain.

We told the whole world that we didn't know or care how much our demands cost. We said we didn't care what was going on with the economy or with the corporation's economics. We didn't consult with professional negotiators. We abandoned working within established industry protocols and severed ties with management.

These are some of the reasons the NMB and the United States government put APA in recess. The NMB told us to clean up our act. They told us that it does matter how much our "demands" cost, to quit bickering over internal governance and that we needed a leader who was empowered to make decisions. They were clear that APA's radical rhetoric had isolated us and that APA did not have many friends in Washington. They were concerned that the APA Negotiating Committee had no authority to bargain and that much of what they brought back was rejected. Lastly, when I was first elected APA President, the NMB was very direct in stating that there appeared to be no one in charge at the union. The NMB considered APA a basket case and no longer wished to waste resources. Fortunately for us, much of this has now been reversed.

Since our openers, we have refused to remove any items from the table and come off any of our more "interesting" demands. To do so--according to some--would be "negotiating against ourselves," or so the mantra goes. But what we've really done is to paint ourselves into a corner, thereby playing right into management's hands. We've given them the tools to slow negotiations down as much as they want. After five years, we still haven't had any serious negotiations on some of the most important items such as scope, pay, retro, stagnation and others. At the rate we are going, we could literally spend the next decade in negotiations.

Bates concludes, “It's time we get serious about clearing out the underbrush. Our pilots want an industry-leading contract now--not years from now.”

The full text of Captain Bates’ speech can be found on Terry Maxon’s Airline Biz Blog at the Dallas Morning News. 

The hard work of fixing labor relations and contracts in the airline industry must begin with clearing the underbrush  -- a  task that must be done before an efficient use of the National Mediation Board (NMB) can commence.  Using the services of the NMB to “work through” issues with the uniform section is grossly inefficient.  Nonetheless, that is how it seems many negotiating teams are using the Board. Reaching impasse on the uniform section [cynical emphasis added] does not constitute having reached the conditions for a release.

As the Dunlop II Commission recommended, both parties had best be working hard toward a resolution of the issues before a release is considered/granted.  Bates understands this clearly.

As I write this, I can hear the hue and cry from his union brethren that, with his speech, Bates is acting like a management lackey.  But that is simply naïve.  Negotiations require a back and forth on issues important to each party.  That’s the way it’s supposed to work. Changing course from the discredited reliance on “pattern bargaining” does not signal defeat.  It merely recognizes that the old way is not working toward reaching a agreement.

Every union has its minority factions that want to “burn the furniture” before they’re ready to sign a deal on the house.  That is a strategy that has proven in this round to not work.  Captain Bates is from a domicile at American, Miami, known to be a home to the union’s Taliban.  That faction will certainly scream.  But the professional airmen at American deserve better than the prior administration and maybe, just maybe, they will accomplish their ultimate goal of getting a leading contract.

This Wednesday, February 16 I will be speaking at the FAA Aviation Forecast Conference in remarks I’m calling: The US Airline Industry and Herbert Stein’s Law.  If you are not familiar with Herbert Stein’s Law, then give it a google.  More to come . . .

Tuesday
Jan252011

A Flight Attendant Representation Inflection Point?

There is no questioning the importance of a flight attendant to commercial carriers, whether as the onboard safety professional or as an extension of an airline’s marketing department.  As they themselves are quick to point out, of all airline employees it is flight attendants who spend the most time with customers, a role they say should have more value in their compensation. 

This blog has often been critical of pilots and the leadership at the major pilot unions for being unrealistic in their contract demands, particularly in an industry struggling economically. Today I look at the flight service unions and wonder if there is a fundamental change in direction afoot.

One has to look no further than the combined work forces at Delta, where the non-union Delta flight attendants and their unionized counterparts at Northwest recently voted against union representation.  Delta, where only the pilots are unionized, has flexibility and productivity built into its operation so that the airline can quickly adjust to market conditions rather than be hamstrung by contractual restraints. In return, Delta has long offered relatively high industry pay and a culture employees value.  That’s one reason that when Delta announced plans last year to hire 1,000 new flight attendants, more than 100,000 hopefuls applied. By all outward signs, Delta flight attendants are largely satisfied with their jobs, and tens of thousands of applicants would evidently love to join them. So perhaps it is no surprise that flight attendants at the “new Delta” rejected old-style union representation.

My question is whether contract negotiations elsewhere in the U.S. airline industry will challenge the status quo as defined by old-line labor agreements negotiated by the Association of Flight Attendants – CWA (AFA) and the Association of Professional Flight Attendants (APFA) to promote the level of productivity and flexibility today’s airline industry demands.

At American, for example, the mantra coming from management in its negotiations with flight attendants has been increased productivity in return for increased pay.  That formula works at Southwest and Continental and Delta – where high productivity has lead to higher pay.  The conundrum for the APFA at American is that their current contract pays flight attendants at or near the top of the industry but puts productivity near the bottom as compared to other carriers.

To be clear, “productivity” in this context does not measure how hard an employee works but, rather, is dictated by the work rules outlined in a collective bargaining agreement. Too often, these work rules limit the number of hours an employee can work as one way of forcing a company to hire more employees.

 In many old-line agreements, aircraft technology (flying longer and faster) is the driver behind the work rules.  This technology – more advanced aircraft that could fly more passengers faster and farther --created a false perception that employee productivity was increasing. Today there is little to no technology effect on flight crew productivity. And it’s high time that contract agreements reflect that reality.

From my perspective, the APFA is neither willing to acknowledge nor accept that fact. Rather than agree to increased productivity – even to a point that is at par with flight attendants at other carriers --  the union is insisting on pay increases without offering anything in return. Absent that, the union has threatened the sides have reached “impasse” and the union should be allowed to call a strike.

At this point, there’s no predicting the end game. Last week, the union reported that the National Mediation Board will not now act on its request for a “release” to strike and has scheduled no additional meetings, a story reported by Terry Maxon of the Dallas Morning News in a thoughtful recap of the difficult negotiations at American. The union, not surprisingly, blamed the company: “APFA Negotiators did everything they possibly could to achieve a deal,” the union said in a hotline message to members, “But the company is still unwilling to recognize the value Flight Attendants bring to this company."

Maxon then updated his blog post to include this statement from the company:  "We [American] are disappointed not to have additional dates. After more than seven months since our last negotiating session, the company team looked forward to meeting with APFA in early January in Nashville. During the week, we presented APFA with several proposals to move the process forward on items we know would affect all our flight attendants. Unfortunately, APFA did not respond to the company's most recent proposals or offer any proposals of their own. We believe this lack of movement contributed to the NMB's decision not to schedule additional dates.”

Clamoring for a strike in this environment is old school, chest thumping, red meat stuff that will probably ensure only that member flight attendants will wait longer than necessary to get a new contract. And it’s my guess that the NMB realized this in calling a time out, recognizing that the union’s failure to negotiate is not the same as negotiating in good faith and failing to come to an agreement.  That’s the definition of real impasse. What the APFA is doing is posturing rather than putting in the hard work of good faith negotiations as envisioned by the Dunlop Commission in its recommendations to improve airline labor-management relations.

Like it or Not, It’s Still About the Economics

Unless I have missed something, American was the only network legacy carrier to lose money in 2010 and is forecast to be break even at best in 2011.  And one trend that no one is missing is the price of oil that has settled for the moment around $90 per barrel.  Add to that the trend line in the crack spread, which has jumped from $10-15 per barrel in the last six months of 2010 to about $25 per barrel now.  So for airlines, the true cost of “in the wing” oil can top $100 per barrel depending on where they buy their fuel.

In most cases, the airlines are doing what they can on the costs they can control. They are keeping capacity increases in check. They have successfully implemented fees to bring in much-needed revenue.  And perhaps the profits we saw in 2010 are the return on this discipline and new pricing strategies. But one year of profits does not define a trend. And in the long term, it is not enough to compensate for labor’s outsized asks at the negotiating table or the expectation labor leaders create when they tell union members that they should “get back” the concessions negotiated during the industry’s restructuring period. 

Back to Flight Attendants

Which brings us back to flight attendants and the labor struggles at play throughout the industry. Consider the case at US Airways where five years after the merger with America West, the AFA represented flight attendants from each airline are still working under the agreements negotiated prior to the merger.

And that case merely sets the stage for what’s to come at United–Continental Holdings, where the old line AFA has petitioned the NMB to declare the merged company a single carrier in order call an election that would bring the Continental flight attendants, now represented by the International Association of Machinists and Aerospace Workers (IAMAW), under the AFA wing.  That would be a different direction for Continental’s inflight service, whose contract with the IAMAW emphasizes productivity and flexibility that has served the airline and its employees well in recent years.  So as with the decision at Delta, that election will go a long way in determining the direction of labor in the airline industry.

This industry has only begun a long overdue and ultimately necessary transformation that could bring sustained profitability, but only if that transformation is allowed to go forward. That will require the constructive participation of organized labor which, like the airlines themselves, must transform the way it conducts business.

United has that opportunity in negotiating a joint collective bargaining agreement for employees of the merged carriers. There, it is up to leadership to demonstrate the stark difference between one contract that produces high productivity and high compensation, and the other that produces low productivity and lower compensation, and work to convince flight attendants what is in their long-term best interest

And I believe that, ultimately, the AirTran flight attendants represented by AFA will come to embrace the highly productive, highly compensated terms of the Southwest flight attendant agreement negotiated by the TWU

American, for its part, does not have battling unions contend with – only a battle between expectations and reality.  The unions have so far been unwilling to reconsider contract language and provisions not even relevant to today’s industry. There are no more magic bullets like the jet airplane coming along to artificially inflate employee productivity.  The only way to get there is to rethink dated notions of productivity and job protections.  And that’s a real opportunity, for labor and for management.

Monday
Jan102011

Unbundling, Rebundling and Now De-Commoditization

As the new year begins, I’m encouraged that airline industry is truly making changes necessary for long-term survival.  Over the past decade, airlines have engaged in a restructuring period like no other since deregulation – in fact making the kind of meaningful structural changes some thought deregulation itself would bring .

American Airlines’ aggressive posture in restructuring the way airline tickets are distributed is an obvious next step in this process.  In most businesses, low-hanging fruit is found where a middleman is involved, as is the case with the aggregators like Orbitz and Expedia.  For the airlines, this effort has some risks and involves more than just cutting costs.  It is about addressing some of the core issues that plague airline pricing and can be termed the de-commoditization of the very product airlines sell – a seat from A to B.

On November 25, 2009, Swelblog wrote about a presentation that former Air Canada President and CEO Montie Brewer gave at MIT titled:  Five Reasons Why the Airline Industry Will Never Be Profitable.  According to Brewer, one significant reason the industry will fail to earn a profit over a sustainable period is the presence of the Global Distribution Systems (GDS).   Now before our very eyes, American Airlines has taken the leadership to challenge the roles played by the Online Travel Agencies (OTA) and the GDS.

Reason #1 cited by Brewer as to why the industry will never be profitable is that the capacity-lead business model causes “constant overcapacity”.

Since deregulation the airline product has been commoditized.  In the commodity framework, the only way the industry, or an airline, can grow revenue is to grow capacity.   But that model didn’t work for airlines, where Computer Reservations Systems and the GDS’s institutionalized the notion that in order for an airline to grow revenue, it needed to offer more and more capacity even before demand warranted.

The addition of capacity led to low and lower operating costs.  On the margin, revenue exceeded cost.  Uneconomic capacity was being deployed each and every day.  Ultimately, it created an industry too big to be sustainable.  If not for the price of oil, the airline industry would never have shed the level of capacity it did between 2008 - 2010.   

The GDS were a major contributor to the commoditization of the airline product.  Therefore, airlines that distribute directly to the consumer have the best likelihood of differentiating, and more importantly, not commoditizing, their product.  This fact contributed to the trend in which certain airlines did well even as much of the industry suffers. Note the one airline in the US that does distribute directly to the consumer:  Southwest.  And Southwest has differentiated, not commoditized, its product. 

What is a commodity?  According to Miriam Webster, a commodity is a good or service whose wide availability typically leads to smaller profit margins and diminishes the importance of factors (as brand name) other than price.  Commoditization can be defined as the process of prices moving substantially lower because of strong competition. Commoditization happens because too many competitors enter a market when they see the large returns that can be earned on certain products. However, those returns soon disappear as competition drives prices lower.

Each defines the airline industry.  Each defines patterns that today’s industry executives are trying to break.  Just because it was done one way or another yesterday does not mean it is the best way of doing business tomorrow.  Enter the Business Travel Coalition (BTC).  Under the veil of protecting consumers, the BTC is doing nothing more than protecting the interests of the money that keeps the organization in business.  Every time the airline industry makes a strategic or commercial move to improve its profitability, the BTC pushes back because change does not serve its clientele well. 

Which leads us to Brewer’s Reason #5: “Nobody Really Wants It to Be Fixed.”  Brewer makes a powerful case that things are fine the way they are . . . and, for the most part, the airline industry value chain, consumers and the government know it.

When it comes to low fares,  consumers can shop the internet and find some market on sale (and the same will be true tomorrow if American and others are successful). They may even find the price of a ticket today equal to or less in nominal dollars than a fare charged two decades ago.  When adjusted for inflation, it is hard to find any consumer product that is a better bargain than air travel.

Taxes and fees account for nearly $60 - or 20 percent - of the average price of a ticket today.  This compares to $22, or 7 percent, in 1972.  In other words, the government is getting a bigger share of a shrinking pie.  GDS fees go up as the real price of a ticket is in decline.  Anything that the industry can do to address margin degradation in the business should be considered and be done.  And that is precisely what American is doing.

There are few areas that remain on the income statement where costs can be cut.  Distribution happens to be one just as the industry is asking the government to examine whether the tax burden imposed on the airline industry is disproportionate.   As the old saying goes: Two percent here and two percent there on top of taxes and fees that consume 20 percent of the ticket price adds up to real money . . . money the industry cannot afford over the long term.

Perhaps most compelling is that all the players in industry's value chain -- GDSs, OTAs, airline caterers, aircraft lessors, ground handlers, manufacturers, airports, fuelers, travel agents, maintenance repair organizations and freight operations -- don’t want it changed.  That’s because each earn a higher return on invested capital than the airline companies that keep them in business.

BTC members do not want the airlines to take control of their inventory because it is sure to weaken the powerful grip the GDS and OTA have over the industry today.  Ask yourself, would you really want to be in business if you did not have near complete control over your inventory?  I think not.   Do GDS and OTA know your customers better than you do?  I think not.  In short, a commodity is a product that has a low degree of differentiation.  Over the past decade, the product offered by the network carriers and the low cost carriers have converged to where there is little to no differentiation because schedule and price are the only differentiators.  This must change if the industry is truly committed to achieving a structure where it earns at least it cost of capital.

Loyalty has increasing value to air travel consumers today, in part because elite members of frequent flyer programs typically aren’t charged the ancillary fees other passengers pay.  Base fares will be disciplined by competition whether American is successful in its attempt to rewrite distribution rules or not.  This industry always adapts.  Travel agents continue to exist today even after the industry stopped paying domestic commissions in 2002 – assuming they evolved and adapted to find replacement revenue streams. 

One can make a case that the GDS have been every bit as destructive a tool as constructive.  Any system that promotes adding inefficient capacity should be changed.  They served their purpose when market share was king.  They serve significantly less purpose in an industry increasingly focused on its bottom line.  Short term this may be about saving some portion of a booking fee.  More important is the long term notion that an airline that takes control of its inventory creates value for its customers based on the knowledge the airline has of its customer.  To say the customer loses out is a tired refrain coming from the same "Chicken Littles" that "Cry Wolf" every time the industry tries to institute systemic change. 

Let the restructuring continue.

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