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May162012

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US Airways - American

$130 here - million I mean.  $100 million there.  Couple hundred here and there.  A chunk of the company for you.  A less than desirable chunk for me.  Hey PBGC, what do you need so we can carry a pension liability on our balance sheet going forward? That’s not a problem since the “old” US Airways terminated its plans!  While we are at it, let’s keep 15,000 more employees than a similar-sized United (each carrier would generate approximately $37 billion in revenue) because, after all, the synergy generation will surely cover it.  It’s the new math - circa 2012.

In its quest to acquire American Airlines, US Airways sounds like a teenager with its first credit card, spending money it doesn’t have.  Paper wealth.  What cracks me up about this “plan” is the new math I mentioned. Critics pan AA’s goal of creating $1 billion in new revenue as bogus because, among other issues, it assumes no competitive response.  Does anyone really think United and Delta are going roll over and let US Airways improve its revenue generation at their expense? Not a chance.

UAL CEO Jeff Smisek said last month a US merger "net, net, that would be good for us." Will there be more competition on certain city pairs?  Yes.  But neither United nor Delta are afraid of competition much less the threat posed by the paper tiger US Airways/American combination.   Smisek and Delta’s Richard Anderson are smart. They know the synergy formula US has seduced some media and AA’s unions with is but a calculation at this point.  Even American’s own pilots admitted in bankruptcy court this week its faux “deal” with US doesn’t include cost assumptions or valuations.

In other words, US is spending money it has no idea whether it will actually have. It is one thing to have a term sheet and quite another to have written contractual language.  My bet is United and Delta see that the first mover advantages created by mergers have already been mined.  For AMR’s creditors – including the labor unions – there are a host of other issues with this proposed takeover.  It is my opinion that US’s new math adds up to the likelihood that they may need to visit out-of-court cost cutting exercises within a very short time to finish the job that they are choosing not to finish during the courting stage – particularly if exogenous shocks again plague the industry.

Showdown in Houston

Most readers of www.swelblog.com know I was asked by United to help study the findings of the Houston Airports System (HAS) report about Southwest flying internationally from Houston Hobby Airport.  HAS and its consultants originally claimed that 23 flights by SWA from Hobby would create in excess of 18,000 jobs and generate more than $1.6 billion in new economic activity for the City of Houston. 

Stratospheric numbers like those don’t pass the sniff test, yet Southwest executives Gary Kelly, Bob Montgomery and Ron Ricks reference the HAS findings as if they were they were gospel.  More on this later.

I believe the HAS study is seriously flawed and is based on what has become known as the “Southwest Effect.”  Problem is, the “Southwest Effect” is a largely a thing of the past.  It got its name from a study completed more than 20 years ago by the U.S. DOT when jet fuel was the equivalent of $30 per barrel.  The fundamental premise is lowering fares will create a disproportionate level of “new” demand in a market. 

Despite the fact Southwest has no experience in flying to international markets, the HAS study assumes traffic will increase 180 percent.  Relevant empirical data shows Southwest’s (135 city pair markets entered since 2006) entry into new markets over the past five years resulted in traffic stimulation of only 10 percent. The latest data shows fares in those markets have actually increased – not decreased.  The HAS study, at a minimum, grossly exaggerates the benefits of a Southwest entry into duplicative markets and is based on a host of unrealistic assumptions. Publicly available cost data shows international flying done by Southwest from HOU would lose more than $76 million per year.  Even Southwest is not flying markets that lose that kind of money despite its self-proclaimed benevolence toward the air travel consumer.

The economic stimulation predicted by the HAS study claims that prices will decrease 55 percent lower than United’s fares.  The truth is, what Southwest calls “stimulation,” is comprised mostly of the cannibalization of IAH traffic which adds nothing to the Houston economy.

The “Southwest Effect” does not drive benefits to local economies as it once did.  Even Gary Kelly agrees.  When pinned down by the Houston City Council on the number of jobs that would be created at Southwest from its limited entry to routes already served, Kelly admitted that total number (nationally) would be 700 and direct Southwest jobs created in Houston would be 50-100. Kelly went on to say that even these 50-100 jobs would be achieved only if Southwest flies the maximum number of flights in its projections several years after entry.  

Even with outrageous multipliers, the number of direct, indirect and induced job creation cannot even begin to approach 10,000 – let alone 18,000.  Not even by relying on the long-obsolete conclusions of a 20 year old study.

The United Pilots

The United pilots are at it again.  While the Delta Air Lines' pilots reached an agreement seven months early, the United pilots are busy building websites whining about outsourced jobs (their term, not mine) and the salaries of United Airlines’ executives. 

Labor leaders in the pilot ranks would have you believe this “outsourcing” (international code sharing and the use of regional flying within the network) is all about management abusing provisions of their collective bargaining agreements to enrich their shareholders. In fact, reducing costs through the relaxation of scope provisions has been labor’s “quid” in return for increases in compensation (or to give less in a concessionary contract) and benefits for 20+ years [the “quo.”]

Among many myths portrayed on the website, United ALPA (Air Line Pilots Association) claims that after the tragedy of September 11, 2001, the management of United Airlines launched a strategic plan to offshore and outsource jobs in an effort to cut costs.  Look no further than the unaffordable contract negotiated between United and its pilots in 2000.  The pilots significantly relaxed scope provisions in return for increased wages, work rules and benefits.  I rest my case.

First of all, the fundamental economics underlying the health of the U.S. airline industry began deteriorating during the second half of 2000.  September 11 ensured that there would be no return to prior industry conditions particularly on the revenue line.  The incursion of the low cost carriers and the use of the internet for airline ticket distribution were every bit as powerful forces as 9/11 in compelling the industry to restructure.  The operating models sought by the network carriers were to find cost savings much like the low-cost carriers – a sector that outsourced a significant portion of its maintenance.  The advent of the regional jet in the mid-1990s was the catalyst driving a reduction in pilot and other costs.  Pilots at all network carriers permitted extensive use of the regional jet well before September 11, 2001.

Perpetuating myths to a public that largely doesn’t care (pilots are much better compensated than the average passenger) is probably a disservice to United’s ALPA members.  Put energy into negotiations like the Delta pilots and you might actually get somewhere.  That requires leadership and telling the entitled pilots at the old United that things are not going to return to the days when the company negotiated contracts it couldn’t afford.  It is just not going to happen.

Concluding Thoughts

Delta Air Lines just continues to do things a little differently.  When it merged with Northwest, Delta made the pilots “buy in” to the concept that consolidation was inevitable and that it was in their best interests to participate.  Delta’s financial performance relative to the industry has been very good quarter after quarter.  Then it buys an oil refinery and negotiates a deal with pilots seven months before the amendable date.  Hell, most negotiations have just completed the uniform section at this point in the proceedings – maybe.

It is clear Delta’s largest unionized group understands industry realities.  That’s a rare thing these days when, too often, reality is sacrificed for political expedience.  Simply look at how much has been made in the media about American’s unions joining hands with US Airways.  That was the easy part.  Which union wouldn’t agree to give up less and suffer fewer job losses?  It sounds great to members and union leaders can knowingly smile and say, at the very least, they’re putting pressure on management.  But reality says they’re weakening their own position, opening themselves up to my favorite term – unintended consequences and simply ignoring the truth that US Airways would have to carry 15,000 more heads than United, while generating the same level of revenue.  That’s not reality; that’s fantasy.

There is little doubt industry consolidation has helped catapult financial results beyond what could have been imagined for the industry based on past performance.  In that reality, my guess is Delta just made it more expensive for US Airways - and United - yesterday by negotiating yet another joint collective bargaining agreement.  US Airways needs those lower labor rates because its network produces below industry unit revenues. So now US is in the position of not only promising American’s pilots increased pay, but having to actually pay its own pilots at Delta +.

But hey, what is a couple of hundred million here and a couple of hundred million there?  After all, the margins for the US airline industry are plentiful.  Right?

References (7)

References allow you to track sources for this article, as well as articles that were written in response to this article.
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    Musings From the Last Five Weeks - Aviation Articles and Commentary - Swelblog / Swelbar on Airlines
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    Musings From the Last Five Weeks - Aviation Articles and Commentary - Swelblog / Swelbar on Airlines
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    Musings From the Last Five Weeks - Aviation Articles and Commentary - Swelblog / Swelbar on Airlines
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    Musings From the Last Five Weeks - Aviation Articles and Commentary - Swelblog / Swelbar on Airlines
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    Response: Live Telefonsex
    Musings From the Last Five Weeks - Aviation Articles and Commentary - Swelblog / Swelbar on Airlines
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    Musings From the Last Five Weeks - Aviation Articles and Commentary - Swelblog / Swelbar on Airlines
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    Musings From the Last Five Weeks - Aviation Articles and Commentary - Swelblog / Swelbar on Airlines

Reader Comments (13)

Mr Swelbar,
I was pleased to see you disclose that United funded your Houston airport study. In the interest of full disclosure are you or your institute currently taking money from AA, DAL, or continuing to accept money from UA? CNBC contributors must disclose their stakes or dealings with companies they comment on, it seems in the climate of more openness you would be willing to disclose your "attachments" also.

Thanks,
BK

05.17.2012 | Unregistered CommenterBill Keating

Mr. Swelbar, what are your thoughts on other cities airports? In particular South Florida. Spirit seems to be quite successful and expanding their FLL market, just a mere 27 miles away from AA and their MIA gateway. The greater Miami area has a population of 5.6Million residents. On the other hand HOU and IAH are approximately the same distance away, 31 miles apart and the population of the greater Houston area is 5.9Million residents.

05.17.2012 | Unregistered CommenterOW

Mr. Swelbar..
How would you feel if your job was taken up by someone "cheaper"?
How would you feel if your company asked you to take a pay cut in order to save it and never paid you back or reinstituted you back into your pay level while management started making record salaries (United CEO made $16 while Delta's made much less and did a much better job!)
How would you feel if your company did everything in their legal power and make you stay 24hr in a row without rest (just because there are loopholes in the FAA regs)? Does that sound safe to you (being at the controls of a passenger jet and having not slept in 24hrs)?

You are as cluless as they come..
I almost tend to think UA gives you some kind of commission or perks to keep you wirting so blindly..

You ignorance is painful.. very painful

05.17.2012 | Unregistered CommenterX

Your assertion that the new AA will have 15,000 more employees than UA is in error. Due to significant attrition from early-outs offered at American and also to US Airways flight attendants, plus AA mechanic layoffs already scheduled in the US Airways plan, various passenger service redundancies and management overlap, the new AA's actual employee count will end up closer to about 95,000 once all the dust settles. This is actually quite lean when you consider the new AA's fleet will be larger than United's by over 200 planes. Sounds like a pretty lean operation to me...

05.18.2012 | Unregistered CommenterImperial Platinum

I try to keep quite when I read these things, but here goes...

X, nobody is saying that the management of the airlines has been perfect...what they are saying is that if someone can do your job equally well for a lower cost, then they'll do it. That's capitalism. Second, the pay cuts that you took often occured while the company was in bankruptcy or while the company was losing money at least. Should management have awarded themselves bonuses...symbolically, probably not. But what you are arguing for is that now that a $37 billion company has made a profit, still around a $1 billion (or less than a 3% margin), that it should immediately sign a contract that gives at least half of that back...never mind that we are in a economic environment ripe for external shocks. That would be what they have always done, and with any luck they are smarter this time around. Third, whether you agree with the man or not, it is not polite to insult someone that you don't know...reasoned argument is the alternative, of which you provided very little.

Imperial, US Airways to date has said that they will eliminate roughly 8,000 jobs...so either they are providing incomplete information, or they are lying if they are going to get down to 95,000 employees. Second, if you are right in your assumptions, you are still talking about an airline that has survived through lower cost that is somehow going to survive while raising all of their employee salaries to match those at AA (I believe second in the industry to Southwest), and an airline with 200 additional airplanes worth of cost but the same top line as United. Even outside of the employee numbers, these are still issues that have not been addressed by US.

05.18.2012 | Unregistered CommenterBA

The author has it right; USAirways cannot--competitively--carry the thousands of extra employees proposed in their faux deal with the AA unions. It would be a stunning, self inflicted wound for USAirways to voluntarily assimilate more disgruntled employees. The only rational option is for AA to shed labor costs via the bankruptcy court and only then consummate the deal.

What the industry really needs is fewer airlines.

05.18.2012 | Unregistered CommenterDave

Dave, It seems to me that you are ignoring my point altogether. AA is set to shrink by 6000 mechanics under the US takeover plan. At least 1500 AA flight attendants will take an early out. It will also be offered to US flight attendants, although the number is not certain. There will be layoffs in passenger service at AA, who are not unionized, and whose layoffs need not be negotiated or announced in advance. THere will be management redundancies. So to say that there are 15,000 more employees in a merged AA than in a current UA is a flat-out lie.

As far as your assertion of disgruntled employees, from what I know and have read, it seems the reason they are disgruntled is because they have no faith in, respect for, or trust in the current AMR management team. They wholeheartedly believe, and have the advice of many experts to support the position that their route to improved morale is also the route to the ultimate long-term success of American Airlines.

It is widely known by most serious and truly objective industry analysts that Mr. Swelbar posts these very same pro-AMR opinions (as yours) quite regularly on other forums to spread AMR propaganda, and that he is being paid by them to do so. You and he seem to be in lock-step, and your wording is almost the same as I have read in many of his rants. Funny, isn't that? I wonder why that might be...

05.19.2012 | Unregistered CommenterImperial Platinum

As a member of one of AA's unions, I can say the vast majority of our membership has no interest in hearing anything or anyone critical of USAirways plan. They're hell-bent on getting AMR management out at all costs. It's very disappointing to me that they are blindly trusting the union leadership and can't even see the wisdom in, at least, questioning the "superiority" of a business plan hatched by a CEO desperate for a merger and promoted by union leadership, likely, blinded by their anger. I, for one, hope that the unions don't have as much power as they think they have in deciding this matter.

05.19.2012 | Unregistered CommenterJC

Bill Keatings request for Mr. Swelbar's full disclosure I feel is completely valid considering that Mr. Swelbar's affiliation with MIT in "research" could me misleading given MIT's excellent reputation in academic research and Mr. Swelbar's special program at Sloan.

Mr. Swelbar writing style and lack of disclosure of his groups conflict of interest with regard to AA I imagine would be quite frowned upon at MIT but if you read a little about the program it should clear things up a bit. You can find a link to the program description on this webpage where the short list of sponsored members including AA is available for review...

http://web.mit.edu/airlines/airline_industry_consortium/airline_industry_consort_members.html

05.20.2012 | Unregistered CommenterMG

MG, anyone reading this already knows Swelbar is a paid shill, lapdog, poodle, someone who should not be confused/compared with real researches.

Ya, delta does things "differently" by not treating their pilot group with the extreme arrogance used by UAL. After reading DLs TA I'm sure UALs negotiating team is now regretting not offering something reasonable years ago. As I've said before airlines get the execs that can't make compete in profitable industries. UALs negotiators are now the idiot poster children.

05.24.2012 | Unregistered CommenterUAL pilot

Here is UAL CEO Smisek's letter to the pilots concerning DAL TA

"The new Delta TA raises the market pay for commercial airline pilots, and effectively sets a new competitive standard for pilot pay. We will be responsive to the impact of the new Delta TA in our negotiations and will need to adjust our current contract proposal to be competitive with the Delta TA. Our proposal will include significant pay rate increases that are competitive with the new Delta TA...."

Jeff is a smart guy tring to do the right thing. Unfortunately he listened to his flunky negotiating "team" and pie in the sky dreamers like Swelbar ("if only we could have 200 seat RJs flown by Marv Renslow clones willing to work for a bowl of rice and a chicken a week...)..

Swelbar failed his masters this round..

05.24.2012 | Unregistered CommenterUAL pilot

I find it interesting (and a little arrogant) that someone with absolutely no access to US Airways internal accounting records can opine that the airline is spending too much money. We're all entitled to an opinion, but we're not entitled to pitch any old thing as fact.

05.30.2012 | Unregistered CommenterDesertGhost

There are a lot of comments made that seem to be valid. I guess Mr. Swellbar can ignore them as long as he wants or try and actually own up to it. While I'm not a commercial pilot I know several of them and see what they go through. Simply put it's crap!

07.20.2012 | Unregistered CommenterH. Edwards

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