Funny When the Shoe Is On the Other Foot
A major US industry employing hundreds of thousands of workers that was once the envy of the world is in trouble. Some of the biggest names in the industry have filed for bankruptcy, leading to significant job loss and cuts to retiree health and pension benefits.
No, I am not talking about the state of the US auto industry in 2009. I am looking back to 2002 at the start of the US airline industry's painful restructuring.
On Aug. 11, 2002 US Airways filed for protection under Chapter 11 of US Bankruptcy Code. On December 9, 2002 United Airlines followed suit.. On April 18, 2003 American announced agreements with all of its unions on concessionary contracts to cut labor costs outside the bankruptcy court. On September 12, 2004, US Airways having emerged from bankruptcy too weak to survive, filed Chapter 11 for the second time. On October 20, 2004 Continental announces plans to seek concessions from workers. Then on September 15, 2005, Delta files for bankruptcy, joined within the hour by Northwest Airlines.
Though years apart and radically dissimilar in many ways, the automobile industry might learn a few things from the experience of the airlines . . . then - and now.
US airlines were largely successful in using bankruptcy to reduce bloated operating cost structures, but the agreements between the debtors and the various stakeholders were based on the belief that the companies would achieve some sort of sustained recovery. We now know this not to be the case.
Since 1980, the US airline industry has lost nearly $20 billion. Over the same period, the non-US airline industry made nearly $20 billion. How do we account for the $40 billion dollar difference?
Bankruptcy can help whittle down costs and provide a mechanism to cleanse a balance sheet full of stupid capital. But it does not address government actions that dictate how an industry can compete. So, as “stress tests” become a part of banking vernacular, the very same tests should be applied to other industries struggling to adapt to a new economy.
Stress Test #1: Labor
For most US airlines, bankruptcy did little to address the expectations and entitlements common in unionized industries. For example, there is still scope language in most pilot contracts that serves as a sort of a “job bank” provision and there are plenty of contractual penalties to pay should the enterprise need to shrink capacity. So far, the airlines that have emerged from bankruptcy are anything but agile. One might say that networks were adjusted to adapt the market’s revenue reality, but my view is that they were really just outsourced to a carrier’s regional partners. An economic fix in pilot contracts remains unfixed.
If Chrysler, and possibly GM, is to learn anything from airline bankruptcies regarding labor issues, start from a clean whiteboard and negotiate what you need to implement your new business plan. Airline bankruptcies, while incredibly painful to employees, gave too much leeway to the unions in negotiating the level of concessions. Real change comes in addressing emotional labor issues – many left over from an earlier era of trade unionism – like the work rules and job protections that constrain a company’s ability to be flexible and agile in its operations.
And while the airlines were able to make crude cuts to their cost structures, most retain many of the same labor constraints and “protections” that hindered their success in the first place.
Stress Test #2: Capital
Capital considerations are one area where the government and the auto industry each learned from the airline experience in bankruptcy: legacy costs like pensions and retiree health provisions take a tremendous toll on a company’s economic health and financing flexibility. Cerberus Capital may be the sole exception but, anyway you look at, it is clear that the airlines created a case study for other shrinking industries. A lesson the airline industry would have preferred not to teach.
As costs were cut and capital destroyed during the airline restructurings, it became apparent that, without significant changes to its legacy obligations, United was not going to be able to get to a Plan of Reorganization (POR) that would produce the kind of debt coverage any new capital would require. Other airlines inevitably followed United’s lead -- freezing or fleeing some of these expensive plans -- as the private capital waiting in the wings to fund airline exits offered the money with that as a chief condition.
The auto industry understood this as well demonstrated by the UAW’s significant concessions in the last round of negotiations.
All of this is not to say that other economic factors didn’t play a role. For the airline industry, it was the price of oil in the early stages of its march to unprecedented and unthinkable levels as several carriers began to emerge from bankruptcy. And for the auto industry, the ailing economiy exposed the reality that an industry already diminished in size and economic might cannot pay these bills alone.
Stress Test #3: Government
Isn’t it ironic, then, that some in the US government are trying to legislate and limit international airline alliances at the same time the White House opts to save Chrysler by putting it in the hands of Italian carmaker Fiat SpA. In that deal, Fiat acquired an initial 20 percent stake in Chrysler – a stake that will increase to 35 percent if it invests in US small car technology;and could eventually control 51 percent of iconic US automaker once all government loans are repaid.
Still, in Congress, Rep. James Oberstar is trying to push through new challenges to the very global alliances that help US airlines expand their networks and promote growth. The congressman already has cast a suspicious glare at granting immunity for a proposed oneworld alliance between American, British Airways and Iberia – even though those airlines seek only an even playing field with SkyTeam and STAR – the other alliances that include Delta, United and Continental. Oberstar is also gunning at those existing alliances, trying to subject them to a governmental review every three years .
He [Oberstar] claims he is acting only to protect consumers. But what Oberstar appears to discount is the fact that alliances have produced significant new revenue streams for US carriers and benefits for American travelers. Adding oneworld introduces yet more competition – hence, benefiting consumers.
Without leveraging these international partnerships, there is little new revenue for carriers to mine or easy cost-cuts to make. [Just ask US airline darling Southwest Airlines] Fiat plans to improve the bottom line by employing new technology and finding new efficiencies by joining forces with Chrysler. Why shouldn’t US airlines have the same opportunities by partnering with Lufthansa or Air France or KLM or British Airways?
Interestingly, one of the reasons cited for Chrysler’s continued financial problems was its near sole reliance on the US domestic market to sell its cars. And that sounds an awful lot like an airline industry that has struggled through nearly three decades of unhealthy domestic competition because lawmakers - parochial in their thinking - failed to recognize that competition for competition’s sake can destroy industries.
The US airline industry as we know it is at a tipping point. I don’t believe that foreign capital alone will make everything right in US airlineland. But these partnerships offer great potential, particularly if they provide domestic carriers with the ability to upgrade their products and services so that US airline offerings on transoceanic routes are on par with alliance partners. That would be a smart use of capital.
Foreign capital is not tainted. Hell, does anyone really think that US airline capital is not held by non-US parties today? US airlines need it to bring in new revenues and make investments that produce a product that people are willing to pay for. And airline alliances need to be permitted to go to the next step and reduce expenses as well. Instead, we’ll continue to watch foreign carriers invest in that product while the US airlines slug it out for traffic from Lubbock and Boise.
Stress Test #4: Government Promises
The auto industry is lucky to have the full faith and credit of the United States in back of its restructuring. The airline industry had none of that except for the pension obligations offloaded to the Pension Benefit Guarantee Corporation . . . and for some of the employees affected that amounted to only pennies on the dollar.
But what the airline industry really needs is for the government to fulfill a decades-old promise to invest in the air-traffic control infrastructure that serves as the backbone for the entire industry.. That is a use of “government money” – one likely funded through taxes and user fees -- that actually offers a decent return on investment.
The airline industry has many lessons to teach Detroit.
One, you can’t simply cut labor costs without also getting the operational flexibility a corporation needs to compete effectively.
Two, any industry should seriously question whether equity in exchange for benefit obligations will produce a stronger company in the long run. The airline industry makes clear that smaller companies cannot pay for the past in a highly competitive revenue environment.
It’s a new era. What a difference a few years make when a Democratic President of the United States emphatically believes that transferring ownership to a foreign entity is in the best interest of a US company. This is an area where the US airline industry may finally have a case to make that what is good for one industry is good for another.
As for government promises, I only hope that the US auto industry fares better than the US airline industry.
At some point the duplicity must stop.
After posting, Cliff Winston of the Brookings Institution offered another Stress Test to consider. For those who follow this industry closely you will recognize Cliff Winston as the author of numerous and authoratative pieces on the airline industry. I am a follower of his thoughts and insight and appreciate his offering below.
Let me suggest another “stress test”: Matching Capacity with Demand. That has been the biggest problem for the airline industry, especially because it has experienced several shocks that have made it difficult to forecast demand.
The problem with the US automakers is that they have been able to live in denial. Although their market share has continued to shrink, macro expansions, trade protection, and low gas prices have enabled them to be profitable. But they were losing the quality race with foreign automakers. The attached paper indicates that the entire loss in market share in the past decade can be explained by the US automakers’ inferior attributes. Their share would continue to shrink under those conditions. Add on a shock like the financial crisis and capacity greatly exceeds demand leading to bankruptcy—just like the airlines. BUT unlike the airlines, cutting prices and costs won’t fill much capacity if demand continues to shrink because of inferior attributes.
Regards, Cliff Winston