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Sep052011

« American: Limited Options, Pain Likely »

Many readers have let me know that they are not as encouraged about the financial prospects of American Airlines with its massive aircraft order as I was in this piece. After all, the folks at AMR have problems beyond an ancient fleet, including an anemic revenue performance relative to the industry, high labor costs and all the other economic misery inflicted on many airlines in the past ten years.

I believe that AA’s aging fleet contributes some to the competitive disadvantage it suffers, and bright, shiny, fuel-efficient new planes will help impress customers and cut fuel and maintenance costs.  But what comes next?

Anxious analysts point to the fact that the price of oil impacts everyone, yet AA’s performance lags quarter after quarter. And there’s seemingly no significant movement yet in the airline’s labor negotiations, despite years at the bargaining table. With contract costs higher than anyone else in the industry, the company wants more productivity and smarter work rules in exchange for enhancements. All the while the unions have dug in either thinking or pretending that their righteous indignation will somehow turn the global economy and thus the industry around and recoup for labor all of losses in recent years.

American is one of the few carriers out there that didn’t turn to bankruptcy to shed some of these costs. In bankruptcy you cannot restructure the price of oil, but you can shed the leases of the least desirable aircraft, work with creditors to reduce debt and make changes to the labor agreements. But bankruptcy is probably not a realistic option now.

This is not 2002 with the shadow of 9/11 cast over the proceedings. This is not 2005 when the price of oil began its march upward and served as a catalyst for the bankruptcy filings of Northwest and Delta on the same day. 

No it is 2011, 10 years past the date that the country would like to forget.  Now, many airlines are flush with cash and don’t have the liquidity scares that were present when others filed. Many U.S. airlines are making money or at the very least are cash positive, despite jet fuel prices at the equivalent of a barrel of oil at $130. 

American, however, is on the wrong end of the industry today and some smart people question whether it will survive to see it’s much talked about long-term plans take wing.

So, let’s assume that Avondale Partners’ airline analyst Bob McAdoo was right in his May 16, 2011 analysis that American simply needs to shed capacity.  McAdoo cited US Airways as an example, where new management culled 20 percent of jet capacity.  But what he did not figure in is the likely relief American would need from its pilots union to make that kind of correction possible. More on that later.

American still relies on its regional partners to fly 37 and 44 seat jets because they are part of the pilot contract’s “scope” equation that determines the number of larger regional jets American can fly.  A 20 percent reduction in flying, much of it on long haul wide body routes flown by senior crews, would likely result in a furlough of up to another 1,500 pilots.  But American can’t do that either because of the same contract provisions that say American cannot drop below 7,200 pilots on the active roster.  And that doesn’t even take into consideration what the other union groups may have in their contracts that prevent the company from making the kind of changes that may be necessary to save the airline.

So what choice does American Airlines have?  Cutting that much capacity will be extremely painful for employees, and could put at least an additional 11,000 other American Airlines workers on the furlough list and in the unemployment line.  Cutting that much capacity would also redraw American’s network and route structure as we know it, giving its competitors greater strength in some cities and markets where American’s presence would dwindle or disappear.

McAdoo’s analysis calls for American to pull down certain Chicago to London flying; cut flights to Buenos Aires from multiple AA gateways; eliminate service to India;  reduce by half the flights from Chicago to China; and trim transcon service between JFK, Los Angeles and San Francisco.

McAdoo also challenges American’s “Cornerstone Strategy.”  In addition to flying a money-losing route between London Heathrow and Los Angeles, American is building its LAX presence using those inefficient, small regional jet aircraft. The same is true at Chicago and New York JFK.  In McAdoo’s view, Chicago is too dependent on connecting traffic at fares that are not compensatory.  Further he claims that in many instances, Chicago and Dallas/Ft Worth compete for many of same passengers connecting to points east and west and internationally and therefore are redundant service. 

Maybe it is time to de-emphasize LAX because the mix of traffic makes profitability difficult.  Maybe it is time to pull out of O’Hare because de-leveraging a hub is tricky particularly with an aggressive United hubbing in the same market.  Honestly, the only real big bang [removing fixed costs] American may have left is to massacre a hub like Chicago the way US Airways did to Pittsburgh and Delta did to Dallas/Ft. Worth.  The bigger the hub takedown, the bigger the fixed cost savings.

As for New York, American is now third in the market behind Continental at Newark and Delta at JFK and offers less connecting service than does Delta at JFK.  American’s relationship with jetBlue was supposed to address some of these competitive disadvantages but, as McAdoo points out, one can look a long time before finding many jetBlue to American connections in the various distribution systems. 

In the local New York market, AMR’s revenue per seat mile is underperforming when compared to peers at JFK and Newark.  Maybe it is time for American to pull out of JFK except for some select Trans-Atlantic flying, select transcon flying, and turn the rest of the region’s feed over the jetBlue.  But oneworld is depending on American to make New York the best market it can be for the alliance so this would be harder to do.  In fact with more 70-seat aircraft American could actually become more competitive there.  That would, again, depend on the pilot union’s willingness to do the right thing.

There is no doubt that a 20 percent cut in capacity would cause significant pain at American, even if it might be absolutely necessary to address the airline’s structural problems. But what if the cuts go even deeper?  What will be the impact on necessary American Eagle capacity that American has contracted for in the new Air Services Agreement?  If there is no Eagle feed, then there is no need for many mainline aircraft now dependent on the flow from points of all sizes behind and beyond the hub.  The virtuous circle spirals downward. 

At that point, American’s Cornerstone Strategy will be more about Dallas/Ft Worth, Miami and a little New York JFK and Los Angeles.  And the labor savings will come simply by cutting headcount.

To be clear, McAdoo says very clearly that labor costs are not the main driver of American’s weak results.  “Stopping the long haul bleeding has more direct leverage than trying to offset the losses by squeezing labor,” he said.  But in this scenario, labor is a large component of the fixed costs shed.

And on a strict profitability analysis, McAdoo may be right.  But contractual restrictions like pilot scope clauses – and American’s pilot scope clause is the most restrictive of network carriers – hamstring the company from making necessary tactical and strategic decisions. It is pretty clear that that American would not be flying as many mainline 136-seat aircraft today if it were able to utilize 70 seat aircraft like its competitors.  If that were the case, we may not be having this discussion.  And American Eagle would certainly not be flying 37 and 44 seat configurations in today’s fuel environment if not for the mainline pilot scope clause.

These small aircraft, “scope busters” to their critics, are used for many reasons and in this case they are used to average down the seat size of the regional fleet so that larger aircraft can be flown.  By the way, the competition flies 70-seat aircraft at will, primarily with the borders of the contiguous United States.  They can compete on frequency because they have right sized aircraft.  American does not.  Remember CALite?

Those who suggest that there is no labor problem at American should look no farther than the pilot agreement.  Among other common-sense adjustments, either American needs relief from that scope agreement in order that it can compete on equal footing with its domestic peers and provide the U.S. network feed to its oneworld partners that they demand, or the Allied Pilots Association needs to negotiate a regional-like contract for domestic flying as the A319s are delivered.  I wrote about these two options in March 2010 when I asked:  Mainline Pilot Scope: Will Regional Carriers Be Permitted to Fly 90+ Seat Aircraft?

It is unlikely that management at other airlines are going to make any deals that drive up their own labor costs only to have to go back and ask for relief later.

So there is not likely going to be the kind of labor cost convergence American hopes for in this round of negotiations; therefore, American may still have a labor cost disadvantage relative to the industry, particularly on productivity and benefits and scope.  This coupled with continuing economic challenges and pressure from investors and analysts will necessarily limit the extent to which American can sweeten its contract proposals to buy labor peace.  Purchasing labor peace only exacerbates the Ft. Worth carrier’s problems.

By all appearances, even the National Mediation Board recognizes that American does not have the money to satisfy the inflated demands of the unions that seem unwilling to discuss anything that smacks of a concession.

The upshot is that the unions at American may want to think hard about a draw-a-line-in-the-sand strategy that has done nothing but contribute to the airline’s under-performance. The contracts have to be part of an overall plan to get American out of the financial doldrums if the company is going to be able to execute the kind of financial and operational maneuvering that is absolutely necessary to win back the hearts and minds of the investment community – let alone customers and alliance partners.

A failure to make strategic, forward-looking agreements at the negotiations table now could have ramifications well beyond the individual contracts.  And there’s not a lot of time to waste in the process.  With limited options, the structural changes will prove painful.  

Reader Comments (9)

very interesting insight.
one thing that crossed my mind was large number of pilot retirements expected as they are hitting the 65 year barrier + new requirements given rest regulations if they ever come into play. (apologies, can not find proper source at the moment other than this)
http://www.airlinepilotforums.com/major/50030-forecast-aa-pilot-retirements-2025-a.html )

I understand this doesn't cover the cull you mention but don't you think its possible management may sit this out further to be in a better bargaining position - slowly schedule less as they also have fewer pilots, given they don't recall furloughed ones? keep downsizing that mainline...
Next step would be to move more flying to regional level or let Eagle fly 70 seaters (but i guess then there is the promise to A Eagle pilots to move up to AA?)

Best
Mike

09.6.2011 | Unregistered CommenterMike

Just a thought here about work groups giving back to "save" the company as it was put. A few years back the flight attendant work group in particular gave back A LOT to "save" the company.. and as a result played a part in allowing the airline to avoid filing bankrupy. In return the company American Airlines promised to "give back" what was given up by this work group once the company was out of bankrupcy and was able to show a proffit. This however has YET to happen. Even though the company has shown a proffit many times in the years since. And one of the BIGGEST slaps in the face so to speak of to the flight attendant group (and all work groups for that matter) was just a couple years back when it was discovered that upon making a profit for one particular year the entire board of directors voted to give "Management" a bonous for a job well done but NOTHING to any of the other work groups. This...of course was not ment to be leaked to the work groups or the general public but as is often the case when you scheme and lie everyone finds out in the end. So please DO NOT blame the work groups at American Airlines for not wanting to "give back more" to a company that has been much less than honest with them....hmmm...how does that saying go? oh yes...."fool me once ...shame on you...fool me twice...shame on me!" Just something to think about folks! Bob

I hope AMR offers you Brundage's job, I think you'd do fantastic!!

Once we have another bite of their Scope, we'll go for another and another.
If we get them to conceed on 70 seats, then we go for 90 and so on and so on.

They'll never see it coming.

They just don't understand job security or executive compensation.

Seriously...industry executives screwed up. In 1997, pilots traded Scope for a pay raise....then what happened. That pay raise was taken away.

Now you say....trade more Scope for pay raises? I think we know what's waiting down that road.

How bout this...we crush your nuts every contract from now on?

First SWA adjusted rates, then automatic COLA, repeal the RLA, then inflation and work rules reset to deregulated days.

Yep...this profession has that kind of leverage. Who are you kidding?

09.7.2011 | Unregistered CommenterFace Lock

The company could have an agreement with bagage handlers. The TWU offered to give up retiree medical benefits and other conecessions the company wanted for new employees. They refused to accept 1276 job cuts. If the company wants to settle, let the TWU keep those jobs and we will vote yes. The rest of the concessions will save the company a lot of money.

09.9.2011 | Unregistered Commenteraa

Please do more research next time. Eagle flies 50 and 70 seat aircraft. They have CRJ-700's, which you state they do not.

09.10.2011 | Unregistered CommenterSteve

Well Swel’, you’ve done it again. Eight times you mention scope, and six times you mention unions. How is it that your focus on every issue is directly related to labor, especially pilot unions? Could it be that you are pandering to airline management so that they will hire you to be a guest speaker at ATA seminars? Could it be that your blog is a self-serving advertisement?

You have your facts wrong on American Airlines scope seating capacity and aircraft distribution at AA’s hubs. Ever heard of homework?

I couldn’t help but notice that you dropped in a dangling sentence in that has nothing to do with scope or unions (Continental Airlines had no unions or scope clause in the time of CALite). You write, “Remember CALite?” I do, it failed miserably, started unions, and put Continental under the receivership of GE and Boeing. Do you remember Robert Ferguson? CALite was his idea, he was management and dumb as a box of rocks. No scope clause and or union concession could ever make him smart.

Take the blinkers off pal. Labor doesn’t run the airline, management does. Profit is generated from passengers, not employees, and unions come to be after management starts making dumb choices. Remember CALite?

John R

09.11.2011 | Unregistered CommenterJohn R

Hmmmm....I believe AMR can fly all the 70+ seat jets they want? They just have to put pilots on the American Airlines seniority list in the pilot seats. With regional airlines "suffering" from rapidly maturing pilot seniority lists anyway for the lack of desire of senior regional airline pilots to join mainline ranks, the cost differential betwen a junior mainline pilot and a senior regional airline pilot is narrowing every day. Certainly AMR management ccould reach a deal with the APA if they decided to pursue that route? Nah, that would involve thinking outside the box.

09.15.2011 | Unregistered Commenterglobalexpress

Does anyone really believe swelbar is an unbiased researcher? He is a paid shill. He may work at MIT but he doesn't work for MIT. He works for those that fund and direct his opinion. Guess who that is?

MIT Global Airline Industry Program
Current members of the Airline Industry Consortium include:
Air Transport Association of America
Airports Council International - North America
Amadeus s.a.s.
American Airlines
EADS - North America
Federal Aviation Administration (FAA)
Jeppesen Systems
Lufthansa German Airlines
SITA
United Airlines
http://web.mit.edu/airlines/airline_industry_consortium/airline_industry_consort_members.html

09.29.2011 | Unregistered CommenterAnnoyed

Thanks for that info annoyed ! Swelbar exposed.

11.14.2011 | Unregistered CommenterMr Id

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