swelblog

Consolidation; the National Mediation Board; APFA; Republic Holdings and Captain Prater

Last week, Reuters held its Travel and Leisure Summit in New York.  A number of airline CFOs participated, including Kathryn Mikells of United, Tom Horton of American, Derek Kerr of US Airways and Laura Wright of Southwest.  It was, overall, a really good group of voices who spoke pretty much in concert about the challenges facing the airline industry. Then came the sour note, from another invitee, Captain John Prater, president of the Air Line Pilots Association, whose. comments nearly caused me to choke on Cheerios. But more on that later.

Consolidation was the big storyline in the coverage.  Southwest continues to not rule out the possibility of a merger, although Wright made it clear that organic growth is its preferred route.  Mikells talked more broadly about consolidation and did not limit herself to discussing consolidation within sovereign borders.  Kerr, too, spoke favorably about consolidation but suggested that merger activity would have a more positive effect on the industry’s fundamentals if it involved a carrier with a US domestic presence.

"It's five major carriers, it's too fragmented," Kerr said of the U.S. airline industry. "You have too many hubs, all chasing the same passengers trying to connect through the country. We believe that it needs to be consolidated."

One issue that puzzles me though is that the consolidation discussion focuses only on the five legacy carriers. I think the most interesting sector for consolidation is the regional sector (on which, as it turns out, Prater appears to agree with me.)  But why are names like Alaska, jetBlue and AirTran not part of the discussion? What about Air Canada?  Is consolidation limited to just two carriers?  What if United, or American, or US Airways, wanted to sell part of their domestic operation to one carrier and another part to a third carrier? That concept is not so different than the slot swap deal that Delta and US Airways negotiated only to have the government make such dramatic changes to the terms of the deal that it now makes no sense.

Now back to Prater. In his remarks, Prater said that ALPA is for what he called the “right: consolidation – one that “actually protects and enhances jobs and creates a profitable carrier."  Just to be sure, I read it twice.  Yep, those were the words of the same pilot leader who has done little to nothing for his membership for the past three years.  Then I remembered that it is an election year at ALPA. Maybe that is why Prater’s words and tone have changed to better mirror what Captain Moak said and carried out at Delta during its largely successful merger with Northwest. 

Where was Prater when the US Airways and America West guys needed leadership?  If my memory serves, I believe he was flexing his muscles after winning election on a “we will take it back” campaign.  Of course, there is still little evidence to suggest that United is any better positioned than any other legacy carrier to return to the days of the bloated and inefficient labor contracts that helped tipped the carrier into bankruptcy. So Prater might be testing out a new campaign platform to convince UAL pilots that he deserves a second term.

From the management perspective, the CFOs wholeheartedly agreed that capacity discipline is the key for the industry to become and possibly remain profitable.  They also agreed that alliances are here to stay as the industry’s answer to mergers across borders that are forbidden by rules and regulations. 

"What you will see United and other industry participants doing, is basically within the regulatory framework that we have today, trying to get some merger-like benefits without merging," United's Mikells said.  The discussion that followed focused on the big three alliances and their efforts to find cost synergies as well as the revenue synergies already in place.

And that’s where airline labor comes in.  In the past, many unions have been cool to any merger that might threaten the union’s stranglehold on flying for its own members, even when that flying comes at a high price. Prater’s ALPA, for example, is a loud opponent of global mergers, even when the alliances in place today support so many pilot jobs in the US.  Surely he does not think that each of the five legacy carriers would be as big as they are even today if they were not carrying alliance partner traffic?  So the “consolidation that actually protects and enhances jobs” he talks about actually occurs every day when that United flight leaves Washington Dulles for Frankfurt with 60 percent of its passengers bound for points beyond Frankfurt on STAR partner Lufthansa.  Just like the American Airlines flight leaving Washington Dulles for Los Angeles that is carrying a cabin full of passengers connecting with Qantas to Sydney and beyond?

Republic Is Confusing, Confounding

What the Hell Is Republic Doing?  I get notes from really smart people in the industry asking me this question.  After all, I was really jazzed over the prospects for Republic’s purchase of Frontier and wrote a lot about the possibilities here on swelblog.  Now I am confused.  First, I have not understood the level of management energy spent on the presumption that Midwest can be reborn.  TPG had already destroyed the carrier literally and figuratively.  I can see the possibilities of keeping in place some of Midwest’s best flying.  But messing with Frontier’s brand to right-size Milwaukee makes absolutely no sense.

Ann Schrader of the Denver Post wrote about Republic’s “bumpy integration” in her February 21 story Merger muddles Republic Airways' branding. I appreciate that piecing together an airline is much easier said than done.  But every day Republic seems to further confuse the confusion.  And if serious industry watchers are confused, then just imagine how former loyalists to Midwest and Frontier must feel. It is those loyalists that are the brand – or maybe were the brand?  I am a Daniel Shurz fan and I have every confidence that he can get the right aircraft in the right place at the right time.  But there is much more to this delicate exercise than moving airplanes and picking markets.

I will buy the decision to dismantle Lynx (Frontier’s regional operation) given that it would have taken many more aircraft in the Q400 fleet to realize scale economics.  Now Republic has placed an order for Bombardier’s C-Series airplane.  On paper the aircraft is interesting – but why have orders been so hard to come by – unless someone needed to trade out of an aircraft type?  Then Republic puts an unproven engine on a not yet embraced airframe.  Confused. 

A big part of the Frontier and Midwest brands was the people.  This is about as bad a job of managing work forces as I have witnessed.  Given the new representation rules likely coming this week from the National Mediation Board, Bedford’s Republic promises to be a ripe target for union organizers.  Surely this is not Bedford making these calls?  I have gone so far to say that Republic will play in tomorrow’s US domestic market in a meaningful way.  Now I am not so sure.   And I am simply confounded by any decision to upset the work force at Frontier.

The way this seems to be playing out is that under Republic, both the Frontier and Midwest names will disappear.  So why then buy Frontier, an acquisition clever because Republic was buying a great brand. The deal in fact gave Republic an actual airline – something Republic is not.  The purchase also bought Republic a management team that knew how to run an airline and an IT infrastructure that made the deal really interesting.  But now it seems that Republic’s management team thinks you can feed a cookie (Midwest) to Grizwald or Montana (Frontier) and out comes Herman the Duck (Republic).  Remember that brand?

The National Mediation Board

This is a week to pay attention to the National Mediation Board. Jennifer Michaels at Aviation Week reports that the Board’s “cram down” representation rule change will be published in the Federal Register on Friday.  I believe that there will have to be some comment time or at least that is the way things used to work in Washington prior to this administration.  Unfortunately this issue is playing out the way the health care debate is playing out – along party lines.

The other story playing at the NMB this week involves American Airlines’ which is again in “lock down” negotiations with its flight attendant union, APFA.  The APFA already has threatened to request a release from the NMB if the two sides fail to reach a deal by the end of this round of talks. Whether the NMB will do so is questionable given what I see as the administration’s reluctance to risk a strike in the midst of a fragile recovery.  Moreover, we typically do not see releases during the busy travel season – particularly when economic recovery is at stake.  And rarely do we see releases when, by all reports, the parties are still pretty far apart based on what the union is demanding and the company believes it can afford.

The APFA, in all that I have read, does not seem willing to embrace any productivity in return for increased income for its members.  American has been transparent in communicating its proposals, including on a public website. So what might the NMB do with the parties if a deal is not reached?  Grant the APFA a release?  No.  Grant the APFA its release with the full intention of creating a Presidential Emergency Board?  Maybe. Put the negotiations on ice?  Maybe.  Set new dates for the parties to resume negotiations?  I think not.

Will the Board be proactive in trying to close a deal?  That is the question.  It is what watchers of this incredibly difficult round are trying to discern.  How will this NMB deal?  So far, with only a few airline labor negotiations cases closed, the NMB has not yet been pushed to the brink. But there are still 82 open cases.  The AA – flight attendant deal might be the first big test.

Europe and Strikes

Speaking of the APFA and its loose-lipped talk of strikes, last week was most interesting in Europe.  The Lufthansa pilots.  The BA flight attendants.  The French air traffic controllers.  And of course, all things Greece

Europe is undergoing today what the US airline industry has been experiencing for the past 20+ years: the need to continually transform business models with relatively high cost structures in the face of declining revenues.  Unbridled competition in the US domestic market was its catalyst to reduce costs, particularly labor costs.  The decline in premium class revenue and the blurring of borders that used to protect individual flag carriers will serve as the catalyst for the European carriers to also reduce their labor costs.

The labor instability in the European airline industry demonstrates an expected collision of socialist policies promoting entitlement with an industry forced to adapt to market forces.  I expect that there will be more weeks like this one as the European unions come to grips with market realities that could make any number of flag carriers irrelevant in tomorrow’s global airline industry. Unless, that is, those unions instead choose to adapt to the industry’s evolution . . . a story that has played out in the US in the names of Pan Am, TWA and Eastern Airlines to name a few.

It’s not just Europe.  Look at what is happening in Japan where JAL, another legacy carrier with outsized costs relative to revenue, is in bankruptcy.  Following 9/11, more than half of the US airline industry was in bankruptcy at one time.  European airlines – and their respective unions - are not immune to the same market forces.  And there are certainly lessons that can be learned from the US experience. 

It is that time of the year again when it is time to put the packages under the tree. The packages represent my 12 days of Christmas, or the 12 airline industry issues that took place in 2009 that I find important. I have placed my packages under the tree in descending order of importance.

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I started writing this on Thursday as the 109^th US Open golf championship got underway on the vaunted Black Course at Bethpage State Park on New York’s Long Island. At 10:17am on Day 1, play was suspended due to heavy rains that added to the overnight rain resulting in standing water on numerous parts of the course.

As the tournament played out, the weather - and what side of the draw you were on - was as much the story as the winner. For golf fans, the US Open annually represents a most stern test designed by the United States Golf Association to identify the world’s best player.

The US Open is as much a test of mental strength as it is physical skill. There is not one player that would enjoy being subjected to US Open conditions week in and week out. Well, maybe one, and I am not sure he enjoyed this year’s version either.

It seems as if the US airline industry has been playing under this year’s US Open conditions every week since October 2000. But the airline industry does not get play suspended when conditions are less than ideal. Rather, the industry has been forced to adapt to one economic and geopolitical event after another. And there is no end in sight.

There have been a number of good stories over the past few weeks that have looked at individual carrier’s fates. During that time, I have been on a speaking tour where it is clear that, whatever the audience, the question of airlines’ survival is top of mind.

And congratulations to Lucas Glover on winning his first golf major.

Meanwhile, I have just completed updating the 2008 analysis in the MIT Airline Data Project that puts a klieg light into the cost side of the US airline world. At the same time, I got a glimpse of the new revenue report from the Air Transport Association and together, the picture for the industry is pretty ugly.

The ATA report reminds me of the impossible lie David Duval encountered Monday morning on his first shot after Sunday’s suspension due to darkness that led to an undeserved triple bogey.

While the US airline industry has endured much bad luck over the past eight years, it, like Duval, has continued to persevere and take advantage of what the course offers. But in an Open, it is next to impossible to win after making such a score on an individual hole. Fight as he did, Duval ultimately finished two shots out of what would have been a most unlikely – and welcome - win. The same just may be true for some carriers out there that may be near the point where one more misstep – or one more bad bounce - will eliminate any chance of competing as well.

For long-time readers, you know I love the game of golf because of what it exemplifies and what it represents. You can find me glued to a television during any of the season’s four majors. The sadistic side of me appreciates the course set up of US Open’s as it challenges the world’s best players in ways that weekly tour stops rarely inflict.

But you always know that it is only a few days each year that golfers face this brutal test. The US airline industry has endured the unthinkable since late 2000. With rare exception, there is not one year that can be described as a whole, but rather a tale of two halves. Even the year 2000 was that way when the first half had all stars aligned and the second half was the beginning of a revenue decline that still continues.

As fuel marched from $90 per barrel in early 2008 to $147 on July 11, unit revenues were on the rise. Ancillary fees became a part the industry vernacular. Then in late summer of that year, as fuel prices dropped nearly as fast as they rose, unit revenues began to freefall. And they continue.

The Airline Data Project demonstrates that passenger revenue for the airlines covered increased $3.8 billion in 2008 while fuel expenses increased some $11 billion. Year-to-date passenger revenue in 2009 is down some 20 percent thus far, while capacity has dropped 8 percent.

Generally, I care a hell of a lot less about the relationship of traffic to capacity as I do about the relationship of revenue to capacity. The trends defy the usual rule of thumb that a drop in capacity leads to pricing traction. That simply is not happening. And that tells me that this industry should be even smaller than it now is.

The Airline Data Project also shows that legacy carrier capacity is now roughly equivalent to what it was in 1997. But the combined capacity of legacy carriers and “low cost” carriers is 15 percent larger than it was in 1997, and that excludes the affiliated regional carriers like Republic, SkyWest, Pinnacle et al and includes Alaska, Hawaiian and Midwest Airlines. So the industry is not smaller – it is bigger. The legacy carriers simply have a smaller slice of the pie.

The MIT data will show that the legacy carriers spent more than $20 billion in 2008 on their contracts with regional partners – an expense largely contained in transport-related expenses. American spends the least on regional flying, while Delta/Northwest spends double plus 20 percent more than number two on the list -- United. What does this tell me? We have to cut back. We have to cut back!

At least the US Open sets strict boundaries on how many players qualify for a national championship. The same is not true for the US airline industry. As I say often, if you have a dollar, have an aircraft, and find an airport with security, you too can have an airline. There’s a lesson in that data. It’s time for limits on entry unless and until there is real change to the industry’s business model and structure. I am no protectionist, but anyone who challenges – or even suggests– that a lack of completion exists in the US airline industry fails to acknowledge the bottom line.

Unlike the US Open, the open market in the US airline industry does not identify the best. Rather it just keeps expanding the field until someone less than the best is crowned the best because they are younger - if only on a quarterly basis based on our fixation with results. Labor leaders should look at seniority as the only real weapon the upstarts have to whipsaw you. Management must make the best business case it can to stop the madness of continually having to average down labor costs as the only controllable means to manage overall costs.

The US airline industry, like the US Open, should be an examination of competition between the best. Instead it is about luck – and timing. It is about playing the “river.” I don’t know which airlines will survive. But I do care about the integrity of the field – something that is fundamental to the rules of golf. Like in the US Open, the field should be the best. Many are fit but few can deliver the full range of consumer service that established airlines offer.

Lucas Glover, David Duval, Ross Fisher and Soren Hansen earned finishes that may get them named to a Ryder Cup team. In that event, they’ll be required to play team events like 4-ball and Foursomes.

Too bad that, in the US, too many politicians view team events like consolidation and alliances as a threat to competition and the sure path to domination. Who has won the majority of the last two decades Ryder Cup matches? Not the US. And the same will be true of survivors in the global airline industry if we do not change our thinking about global competition.