One fascinating story resulting from the news that Continental and United intend to merge is what might happen to those on the sidelines, namely US Airways and American.
Let’s begin with US Airways. I have written before that US Airways’ route portfolio is inferior relative to other US legacy network carriers. I also have written before that US Airways is hamstrung because of its precarious labor position – a constraint primarily caused by the dysfunction in its pilot corps.
Immediately following Delta’s January 2008 rejection of US Airways’ overture, it was clear to me that US Airways CEO Doug Parker was right in his efforts to be a first mover in the consolidation arena. In making a run at Delta, Parker provided a blueprint for the industry to merge networks, and ensure air service to communities of all sizes, while at the same time reducing fixed costs. But something stood in the way then: Parker’s pilots. He was hamstrung by pilot leadership blinded by the prospect of an unlikely outcome – a better seniority arbitration decision. [See note below: Delta attempt came before seniority list decision was issued] As I wrote then: “For Parker, bringing labor along would certainly have proven expensive – and maybe just too expensive.”
Today the US Airways pilots await a decision from the 9th Circuit Court of Appeals stemming from a lawsuit initially won by the former America West pilots after USAPA, the union that represents the US Airways pilots, refused to honor a binding arbitration decision on seniority integration.
Because of that circumstance—and the consistent objection by USAPA to every strategic initiative generated by US Airways management—last month I challenged speculation that United and US Airways could put together a merger where they twice failed before.
To be fair, as discussions proceeded between US Airways and United, it was becoming clearer to this observer that USAPA was beginning to understand and even embrace the idea that consolidation may not be a bad thing for employees. The math is easy. A $30 billion corporation is in better shape to provide for raises and long term employment stability than is a $13 billion company susceptible to geopolitical, oil and economic shocks. But it remains to be seen if this was just USAPA being opportunistic or a sign that the union is changing its stripes. As I will discuss below, a change in approach by USAPA will be necessary to secure an improvement in pay for the US Airways pilots in the short term and the benefits of consolidation for all US Airways employees in the longer term.
Let’s Put Some Things into Perspective
In recent days, I’ve read many stories that attempt to etch US Airways’ livery on the next gravestone in the airline cemetery. But the rumors of the airline’s demise have been greatly exaggerated. In theory, US Airways, American and other carriers should benefit, albeit indirectly, from industry consolidation. Moreover, most of these stories missed the fact that this consolidation is taking place at the bottom of a recovery cycle, not at the top. Assuming that the health of the US airline industry is inextricably tied to the health of the US macroeconomy, then a rising tide should float all boats. Right?
On May 3, Vaughn Cordle of Airline Forecasts Inc. published a white paper titled: “United + Continental is Good News for all Stakeholders: More Mergers are Needed. Is American and US Airways next?” Cordle writes: “If the industry is not allowed to consolidate in the most rational manner, the result will be a continuation of the slow liquidation and the inevitable failure of US and AA, the two remaining network airlines in need of restructuring. The most likely outcome would be an AA bankruptcy and outright liquidation of US.”
Cordle makes a case for consolidating US Airways and American citing expected future increases in fuel prices, airport charges, security and labor costs against the backdrop of less than credit worthy industry. And these come before the industry begins paying to conform to inevitably new environmental regulations. Don’t misunderstand, I agree that participating in consolidation is the best outcome for US Airways. But I don’t buy the gravestone argument. Let’s take a look at the fundamentals.
Everybody remembers America West Airlines. A legacy-like model—that we all knew ultimately would be combined with another airline—around the turn of the century America West "flirted" several times before tying the knot. Before its 2005 merger, America West survived and produced competitive margins through focused management, the support of labor unions that recognized the company’s place in the industry, and by offsetting a revenue generating disadvantage by maintaining a cost structure advantage. Oh yeah, and the airline was based in Tempe, AZ and run by a guy named Doug Parker. Sound familiar?
Today US Airways does suffer from about a 12 percent stage length adjusted unit revenue disadvantage versus its legacy carrier peers. But it also enjoys about a 12 percent stage length adjusted unit cost advantage versus these rivals. Despite the revenue generating deficiency, for the first quarter of 2010 only United among the legacy carriers saw a bigger increase in total unit revenue than the Tempe-based airline. Like the rest of the industry, US Airways continues to see its corporate revenue and booked yield (passenger revenue per revenue passenger mile) improve.
Maintaining a Cost Advantage Is Critical for US Airways
And this revenue disadvantage is offset by US Airways continuing to maintain a cost advantage. For the first quarter of 2010, only Delta saw its unit cost (operating expenses per available seat mile) increase less than US Airways when compared with all legacy network carriers. As a result, US Airways’ pre-tax margins show little to no difference when compared to other legacy carriers. In fact, during the first quarter, US Airways saw a pre-tax margin improvement of 7.2 points, which compared favorably to its peers. The cost advantage the carrier enjoys cannot be overstated nor can the company hide behind the fact that the vast majority of that difference can be found in lower labor costs. By contrast, United and Continental are only now beginning to navigate what it might cost to buy labor peace, particularly among the pilot groups.
One imperative for US Airways will be to educate employees about the difference between US Airways when compared to Delta and the new United. If US Airways’ unions push the company to match rates paid by other carriers with significantly bigger networks, more profitable hubs and less capacity dedicated to the US domestic market, then Cordle just may be right in predicting the potential for liquidation.
But what if the unions recognize US Airways position in the industry and adopt a longer term approach? What if US Airways can maintain its current cost advantage? Or enough cost advantage to offset the company’s structural revenue deficiency? What if the airline get its internal labor house in order so that old US Airways and old America West contracts are one with matching seniority lists and affordable economics? Is that really any different than America West at the beginning of the last decade? Is this any different than United going back to Chicago in 2008 after being snubbed by Continental and getting its house in order? I think not.
In the US Airways route structure, Philadelphia and Charlotte are gems. I will concede that Phoenix is confounding given the extent of direct competition from Southwest Airlines. And while US Airways does enjoy a 23 percent unit revenue advantage versus its low-cost competition, it also carries a 29 percent cost disadvantage when adjusted for stage length. No legacy carrier has more direct exposure to Southwest. But this is not new and it is not a death knell. Parker and his colleagues have been successfully managing this challenge for 15 years. Rather an important part of the education of US Airways employees and unions need to fully understand the importance of keeping costs low.
It’s Hard to Kill an Airline
In my view, an airline today is like a cockroach. You can beat it, burn it, kick it and starve it, but it doesn’t die easily. And over the last ten years Doug Parker has defied even a cockroach’s odds on numerous occasions. Remember, we are at the bottom of a recovery cycle – a fragile recovery cycle to be sure. US Airways cash as a percent of twelve month trailing revenue is comparable to its legacy peers and relative to its size (revenue), comfortable. Compared to its peers, the company also has fewer debt obligations to be repaid as a percent of revenue over the next two years.
This is not to say that US Airways does not have its issues – some that are easier absorbed by consolidated balance sheets that produce a higher cash cushion. And there are plenty of sensitivities that can disrupt the company’s vulnerable cost advantage: 1) a 1 percent change in mainline unit cost ex-fuel cost the company an additional $60 million per year; and 2) a $1 change in price of a barrel of crude cost the company $34 million assuming that crack spreads stay at today’s levels resembling historic norms. On the other side, as little as a 1 percent change in unit passenger revenue bolsters the company’s top line by $93 million.
Also US Airways’ labor unions need to recognize the value of cooperation and moderation in the near term. Those unions also need to consider that “moderation” could mean significantly improved pay—if they are prepared to eliminate anachronistic scope restrictions and improve productivity. And they need to see that there is a big pay day if US Airways is involved in industry consolidation, and that their behavior—and the terms of their collective bargaining agreements—will play an important role in determining whether that pay day occurs.
Message to US Airways’ Labor Generally; USAPA and AFA-CWA Specifically
Git’r’done. Enough already. The pundits who suggest that US Airways is dead do so partly in recognition of the dysfunction of union leadership at your company. They are not all together wrong. But most are not aware that there may be recognition by US Airways’ labor leadership that their members may actually benefit by participating in consolidation. To participate in a strategy designed to promote industry stability requires labor stability as well – and this is an area that needs improvement at US Airways particularly among the two unions representing flight crews, USAPA and AFA-CWA.
Some suggest in comments to this blog that management is keeping the groups apart to save a few bucks. If that is what they are doing, then shame on them. But no one can make me believe that this is the case. What's in it for Parker to do that? Also it is in everyone’s best interest to negotiate joint collective bargaining agreements with competitive productivity and scope language that permits a company to navigate the complex competitive landscape and to have a single seniority list for the various class and crafts of employees. And it is critical to both shareholders and employees that impediments to mergers be eliminated from collective bargaining agreements.
What makes this round so damn difficult is that every carrier is now a little different and it stems from an individual carrier’s portfolio of flying. For this reason it is increasingly difficult to compare costs at one carrier to another and, as such, pattern bargaining should be a practice of the past. If airlines engage in union efforts to chase the best contract – even when their networks don’t pay the tab -- then they deserve their place in the airline graveyard. The price of buying “labor peace” is too high if it means an airline can’t ultimately support or survive its own labor cost structure.
These negotiations, whether at United, Continental, American or US Airways, are about the future of the airline industry as we know it. As such, the negotiations are about more productivity and flexibility in return for higher wages. Fixed costs must be removed. And a union’s demand that a company carry more employees to do the same level of flying as a competitor simply creates a structural disadvantage any rival can exploit. For a standalone US Airways, the company is in a position to survive given the up cycle ahead. But come next the down cycle, or geopolitical event, or oil at $100 . . . then all bets are off. So at US Airways, the negotiations need to be about ensuring the company's relevance while supporting industry consolidation.
Mirror, Mirror On the Wall: In a couple of years give US Airways a call.
More to come.
I have been made aware of a factual error included in this piece. I have had more than one reader write to remind me that US Airways attempt to merge with Delta occurred before the seniority list decision was handed down by Arbitrator Nicolau.