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Thursday
Dec062012

We The People: Does BTC (Business Travel Coalition) Really Stand For Bamboozling The Consumer?

[Note:  much of this blog is directly lifted from the trial transcripts AMERICAN AIRLINES, INC. v. SABRE, INC. ET AL)

To bamboozle is to trick or deceive someone through misleading statements or falsehoods. That is precisely what Kevin Mitchell and the Business Travel Coalition (BTC) are up to these days – yet again. From my perspective, this means protecting monopolists by conspiring with anybody and everybody to inflict harm on anyone or anything that might bring competition to the Global Distribution System (GDS). It is time someone calls them out on it.  For too long, the industry has looked the other way in allowing the fox (BTC) into the chicken coop (air travel consumers) under the guise that the BTC advocates on behalf consumers against the big bad airlines.

In its latest façade, the BTC has started a “We The People” campaign urging the administration to enact measures against the industry that will ensure that the “all-in” cost of air transportation is made available to all distribution channels, including the GDSs.  The petition reads:  

“Proceed immediately with a U.S. Department of Transportation rulemaking to restore air travel comparison shopping for consumers.

Airlines have been charging for services such as for checking bags and have been hiding fees by withholding information from travel agencies such that consumers cannot efficiently compare the prices of alternatives and must visit numerous airline websites. This unfair and deceptive marketing practice is harming consumers.

Airlines have been able to withhold fee information for 5 years - evidence of a failing market. Importantly, when Congress deregulated this market, consumer protections were consolidated at DOT leaving travelers with no legal recourse under state consumer-protection laws.  

DOT must require airlines, via a rulemaking, to provide fee information to sales channels where they offer base fares so consumers can see, compare and buy the complete air travel product.”

What BTC thoroughly ignores in its petition is that innovation is already solving challenges of distributing ancillary products which the airlines reasonably want to sell in as many channels as possible. But the larger question is why BTC is taking on this fight when there are far greater issues in play that impact flyers? The answer is, of course, that the consumer is not BTC’s interest here.

You see, it is impossible for the BTC to represent air travel consumers because it represents, and advocates for, a sector of the industry that monopolizes airlines.  The distribution sector of the industry conspires against airlines that challenge that monopoly even if it means harming the very same consumers BTC now claims it wants to protect.  I’ve reviewed transcripts from the American Airlines v. SABRE, Inc. trial - the best public record to demonstrate this activity by the GDS and the large travel interests, but it could be any airline in the way this plays out.  The AA-Sabre trial was settled before a jury had the opportunity to decide the case in which SABRE was accused of conspiring to harm American in numerous actions not limited to setting up boycotts and ensuring that the airline suffered economic harm.

BACKGROUND/SIMPLE PRIMER

At the heart of the matter is the relationship of the airline industry to the Global Distribution Systems. Every time a consumer works with a travel agency, the agent offers information most likely provided by a GDS. It is the airlines that supply that data to the GDS.

First, a brief history.  In the early years following deregulation, GDS were mostly owned by airlines and used to provide information to intermediaries like travel agents to sell tickets. The systems were biased toward the airline(s) that provided the technology and built using pre-internet technology. GDS were compensated for providing and maintaining these vast private networks and for acting as gatekeepers between agents and airlines.

In fairly short order, the government stepped in to regulate the bias. As a result, the GDS were no longer a distribution tool aiding the airline(s) that invested in the technology directly; instead they became a tool of the travel industry to sell a service. Today, the airlines pay an intermediary to distribute their own product – and are paying a price much higher than the GDS transaction costs. The airlines’ costs reflect an outdated model burdened by expensive technology as the GDS fight to sustain their large networks and maintain their role as gatekeeper to an airline’s own customers.

Two companies control 90 percent of US GDS services to travel agents despite the fact that there are other channels that can provide the very same information for a fraction of what airlines now pay.  But don’t be fooled:  It is the consumer who ultimately pays these costs, despite what the BTC and its members will tell you.

THE TRIAL – A STORY

Six years ago, in a boardroom of a very powerful company, a decision was made to bring American [replace with any “problem” airline] to its knees with a series of attacks to get what the powerful company wanted. These attacks hurt not only American Airlines, but also American consumers, because this is a story about how a very powerful company in a very secret way spent years planning to crush new competition to preserve their monopoly.

That plan had many parts and only began by hiding or dropping a problem airline’s flights from their display. Remember, the main product of the GDS is the display – that’s what travel agents use to book flights for their clients. So you drop one airline from the mix, and that airline doesn’t get the booking.

Next, they decided to double the problem airline’s fees overnight. And organize industry boycotts. And threaten exclusion of a problem airline from the GDS.  And use false excuses to blame American.  And hide behind secrecy and deception.  And more.

Airlines know there are two ways to sell tickets to corporate travelers. The old way is the GDS way.  The new, better, more innovative way, is through technology called Direct Connect. It can cut their costs. It can personalize the interaction with their consumers. It offers greater flexibility and a better way to sell tickets and other services and products. These are advantages already used by other airlines, including Southwest and Air Canada, to their great benefit. And in this case they are advantages American wanted, too.

Every company operates for profits, but this case details evidence that Sabre had a plan. Because Sabre is owned by private equity groups hoping to sell within five years, that plan provided a five-year exit.  It was called Project Sovereign.  The essence of the project was to do anything to protect the rich cash flows enjoyed by Sabre in order to maximize the sale price in five years. 

The  airline Direct  Connects are  attempting to have  systems where  they  can  have  the  complete view  of their  customer and  offer  these  specialized deals  for their  clients using  modern  technology. They'll be personalized. They'll be up to date. And  hopefully they'll give  the  traveler exactly what  they  want  at the best  price  for  that  customer.  The threat to the legacy GDS model is to go directly to the consumer – bypassing the middleman (GDS).

Sabre had one primary goal: To neutralize American and it’s attempt to disrupt the model. The GDS was their fortress.  In a word, Sabre would seek to delay and destroy American’s Direct Connect. 

Then in 2006, a mere two months after the new contract between Sabre and American was signed, a Sabre executive sends an e-mail to just a small group of top executives and he says, let's do an initiative -- that's corporate speak for "plan" -- let's do an initiative that targets getting as many things as possible in place. To do what? Neutralize American. Neutralize American's market move to disrupt the model.  American found out about the plan through a mis-directed email.  The plan was first called Five Plus Five so as to disguise it in case American found out about it.  Ultimately the plan was renamed Project 99. 

The plan, in the complex language favored by the GDS, involved "deployment of tools for marketplace awareness and promotions and other non-GDS airline activity."  Or, in simple terms, Project 99 would monitor American and track what the airline is doing that doesn't involve a GDS.  It also sought to "put contractual hooks into the travel agents" – referring, of course, to the corporate agents so critical to an airline’s business travel.  The goal?  To handcuff them to Sabre, and determine how to stop or limit American's marketplace actions.  Finally, it sought to "get clarity on algorithm changes" -- GDS- speak for exactly the kind of biasing the government was trying to restrict.

It began on Christmas Eve, 2010, after Sabre already had been conducting six weeks of secret biassing. According to the e-mails, on December 24 the companies doubled the intensity of the bias, from 60 percent share to 30 percent share, meaning that American’s fares were that much less likely to show up on agents’ screens.

And when did this happen? 4 a.m.  Because when you do something at 4 a.m. on Christmas Eve you do it hoping that no one will notice.  This isn’t to say everyone that ended up being a part of this plan was a willing conspirator.  The evidence showed that some big travel agencies did not want to participate. One of them was BCD Travel, which Sabre executives described as “livid” at Sabre's actions.   In the end an under pressure, however, even BCD agreed to bias in over 6,000 markets. Project 99 was operational.

At the same time all this was happening, Travelport began to put a new tax on American’s flights and then add that tax to the fare price so American’s flights fall all the way to the bottom of the list. Then Expedia started biassing and American’s flights pretty much dropped out altogether. Soon, all the big travel agencies joined the boycott and the biassing.

Enter the Department of Transportation. It takes a hard look at what’s going on and deems it deceptive and wrong.  The DoT inspector even calculated damages at hundreds of millions of dollars. That includes $188 million for Sabre’s six-year sabotage of Direct Connect and $544 million in lost cost savings and product sales.  Add another $261 million from what investigators believe were illegal contract terms and lost web sales for a total of nearly a billion dollars. Exactly what Sabre intended.

But that is only how an airline was hurt.  What about corporations?  Air travel consumers? Travel agents?  We just don’t know.  And we certainly don’t know at what frequency some of these activities take place.  Why do major travel advocacy groups ignore these actions?

THE ONLY CONSUMER ADVOCATE NOW SHOULD BE DOJ, CERTAINLY NOT BTC

On August 25, 2012, The Economist wrote:  The GDSs, meanwhile, are lobbying America’s Department of Transportation to force airlines to include “core” extras (such as bag fees and check-in charges) in the fares they quote to the GDSs, to make for fairer comparisons with carriers that offer all-inclusive fares.  My fear in this action and why BTC is pressing for signatures on a petition is only to ensure that the GDS receive information that only guarantees that their monopoly is emboldened going forward and that new technology like Direct Connect is forever blocked from mounting a competitive product.  Stifling innovation is after all what the GDS want – particularly their owners who want to sell monopoly revenue streams back to the market.

Bottom line: we desperately need an industry correction that allows a natural evolution in business practices so the free market can work. A federal lawsuit may achieve that. Free competition will spur the innovation that anti-trust laws are designed to promote. A federal lawsuit may do that. When competition wins, the consumer wins. When innovation is allowed, the consumer wins. Don’t be fooled by the GDS industry and its supporters hiding behind the false boogeymonster of “hidden fees”. Consumers have no idea how much it already pays to an industry that stifles competition each and every day. And the largest cost is the opportunity cost imposed by the GDS industry that would rather direct consumers’ attention elsewhere.  We do not need an advocacy group with these interests pretending to be the best in protecting air travel consumer interests. 

Before the DoT makes another rule, let’s hope that DOJ completes its investigation of the distribution sector so monopolists can no longer conspire to stifle innovation.

Tuesday
Aug092011

Global Distribution Systems and the Pretense of Consumer Protection?

This past weekend, I found myself immersed in the messy divorce between airlines and the Global Distribution Systems (GDS) that used to be their “partners”.

In this case, I was looking at complaints filed by American Airlines and US Airways against Sabre and related companies, and then Sabre’s and Travelport’s complaints against American Airlines.  Readers know that I believe this is one of the more transformational events in the industry and I finally found the time to read in detail each party’s take on an increasingly tense situation.

In coming weeks, this fight is likely to again come to the fore.  The story is about monopolies and not market power. 

There is no elevator speech on this topic.  Within the industry, it’s all inside baseball. To the outsider, it’s incredibly obscure. But here’s the crux of the matter:  American, US Airways and other airlines are trying to retake their inventory from the GDSs that have for years listed their flights and taken a piece of the ticket price. 

What the airline’s want, in other words, is broader competition through an alternative mechanism to sell airplane seats and other travel related products – not to eliminate the GDSs.  

After all, airlines understand competition. Airlines understand fragmented markets.  Airlines understand pricing dictated by competition and macro economics, and monopolies and duopolies of vendor industries.  There is no global airline company with more than a 7 percent market share.  Even the top 10 airlines in the world together have less than a 40 percent share of global capacity. 

But when it comes to the GDSs, it is a different story.  Sixty percent of airline tickets are sold through travel agents and it is this sector of the industry that is ripe for competition.  According to MIDT data today, three players dominate the field in the U.S.: Sabre with 58% of the market; Travelport with 33%; and Amadeus with 10%. 

Travel agents make money by using the GDSs. The contracts between the vendor and the agent impose such significant switching costs that the financial penalty is too steep for most agents to consider an alternative booking channel.

As US Airways wrote in its complaint, the American Society of Travel Agents confirms the industry’s dependence on the legacy GDSs.  As of the end of 2009, 85.7 percent of travel agencies use only one GDS.  94.9 percent of travel agents using a GDS have not changed their GDS provider in the last two years and a remarkable 86.7 percent of agents are using the same primary GDS that they were seven years ago when the GDS industry was deregulated.    

As a business model, the GDSs are more about suppressing competition than spurring innovation.  Seven years after deregulation, barriers to entry in the GDS space have blocked all new competition. Contrast that with the domestic aviation market where low cost carriers now fly more than 31 percent of ASMs flown.

Market power is a seller's ability to exercise some control over the price it charges. In our economy, few firms see perfectly elastic demand. All products have a differentiation, whether due to consumer tastes, seller reputation, or location, as with airlines that convey upon a seller some degree of pricing power. Thus, a small degree of market power is common and understood not to warrant antitrust intervention.

Market power and monopoly power are related but not the same. The Supreme Court has defined market power as "the ability to raise prices above those that would be charged in a competitive market," and monopoly power as "the power to control prices or exclude competition."  In many markets, but not all, airlines do have market power in that they are able to set revenue in excess of marginal cost.  The last thing they are is monopolists as they have no ability to control prices or exclude competition.

In its complaint against American, Sabre makes a feeble and even laughable attempt to point to American’s monopoly power over certain routes at Dallas/Ft. Worth, Chicago O’Hare and Miami.  Sabre goes so far as to name non-hub cities like Abilene,TX; Augusta, GA; Brownsville, TX; Champaign, IL; and Dubuque, IA as city pair markets where American has monopoly power.  But it is simply wrong to suggest these cities are examples of monopolies, when each is blessed (given their population and underlying demographics) to have entry into the nation’s air transportation grid and each faces some direct or indirect competition. It is just as wrong to suggest that American has no competition on its Augusta GA to Dallas/Ft. Worth route when Delta flies those skies multiple times a day. 

This is a network business and American Airlines holds a 15.2 percent share and US Airways 9.6 percent of capacity in the domestic network market. In fact, the top five airline competitors hold an 80 percent market share in the U.S. domestic market, with the largest carrier, Delta, garnering a 20.1 percent share of ASMs.  This is a far cry from Sabre’s 58 percent share of the U.S. GDS market and that three firms have 100 percent of the U.S. domestic market.

To read the GDS’ complaints, you would think that we’re back in 1978 when schedule and price were the only consumer consideration. Thirty-three years later the GDSs still force the airlines to compete only on two factors; schedule and price. By limiting how airlines compete, the product is the definition of a pure commodity.  

After all, Southwest does not turn its inventory over to the GDSs. How can you have a discussion on price and service without Southwest – which now competes in markets that account for 95% of domestic demand – as part of the dialogue?

GDS advocate Kevin Mitchell, Chairman of the Business Travel Coalition (BTC) has a questionable take on the issue.  In Sabre’s complaint, Mitchell says: “The stakes in this conflict are clear: either an improved airline industry and distribution marketplace centered around the consumer, or one that subordinates consumer interests to the self-serving motivations of individual airlines endeavoring to shift costs and impose their wills on consumers and the other participants in the travel industry.”

He’s right on one point: the stakes are clear.  This is a battle about an improved airline industry – one that is sustainable over the long term; and a distribution marketplace centered on the consumer. But that’s only going to happen when the airlines have control over their own inventory.  Only when airlines have the ability to package their product based on their knowledge of consumer behavior will it become all about the consumer.  To protect and advocate for the GDSs in fact subordinates consumer interests because this legacy distribution vehicle does nothing but thwart competition and stifle innovation. 

Perhaps it is OK with the GDSs and the BTC that shifting (cutting) labor costs in bankruptcy was an appropriate strategy as long as the annuity from the airlines to the GDSs to the travel agents was not affected.  But that assumes an annuity in perpetuity, and fewer and fewer of those exist in today’s airline business. The business of the GDSs can be done cheaper and better by those with technology younger than 1960.  What the GDSs and the BTC claim is an entitlement is anti-competitive at its core.

Mitchell also proclaims to be a consumer advocate.  Remember it was he and Kate Hanni who teamed to advocate for the three hour tarmac delay rule which, with the help of the gullible Secretary of Transportation Ray LaHood, purported to “protect the rights” of some fraction of one percent of all passengers.  Today he supports a monopoly making its money off of 60 percent of air travel consumers.  Now it is Mitchell who rails against what he calls “Hidden Fees” like seat upgrades, baggage fees, and charges for pillows and blankets to name a few of the 16 specific revenue items the Department of Transportation wants the airlines to report.

This, keep in mind, is an industry that earned a scant two cents on every dollar in 2010 and yet the government wants to dig further into the file cabinets of every airline in the country in a misguided attempt to account for the money those fees are bringing in. In case you have been living under a rock, the genesis of ancillary fees has been among the most covered and scrutinized stories since 2008.  In 2010, US airlines generated $3.4 billion in baggage fees and another $2.3 billion in reservation change fees for a total of $5.7 billion.  What about the fact that the industry’s fuel bill in 2010 was $6.5 billion higher than in 2009?  The Air Transport Association forecasts that the industry’s fuel bill in 2011 will be $14 billion more in 2011 than it was in 2010.  Remember, it was the rising cost of fuel in 2008 that served as the catalyst to unbundle the airline product in the first place.

The airline industry already pays more than its share of taxes and fees.  But if it is transparency of “hidden fees” that the regulators (and Mitchell) want, then I as a passenger also want to know how much of my ticket price goes to the GDSs just as I want to know how taxes on my airline ticket are disseminated to various government agencies. 

To me GDS fees and taxes are similar as they both support legacy interests/ideals – some might argue outmoded models -- without any meaningful return to the airlines. That said, there remains an ongoing need for GDSs, particularly with respect to the support they provide to the thousands of travel agencies worldwide and to their international reach.

Today, the GDS industry earns $7 billion in revenue with no product other than the airlines own schedules and prices.  Is that innovation?  Some estimate that the work of the legacy GDSs could be done for 20 cents on the dollar.  That’s a lot of money spent on something that belies innovation.

The GDS role was relevant until about 2002 when market share was the name of the game.  Now the industry is focused on profits.  In fact, this is an industry that would have lost money in 2010 if not for the fees that Mitchell decries.  The GDSs need time to develop the software necessary for it to “up sell” better seats on US Airways.  Imagine how long it will take for the legacy GDS systems to account for 16 fee buckets as defined by the Department of Transportation (a potential new regulatory requirement).

But Mitchell bangs the consumer drum while advocating for an industry serving the airline industry that has monopoly powers over the very companies it calls customers.  

Concluding Thoughts

According to the U.S. Department of Justice (DOJ), “U.S. antitrust laws reflect a national commitment to the use of free markets to allocate resources efficiently and to spur the innovation that is the principal source of economic growth.”  Today’s GDS industry, circa 1960, represents anything but free markets or innovation.  Rather is about protecting a monopoly revenue stream at the expense of allowing the consumer to customize the travel experience depending on their wants and needs.

According to the US Airways complaint, the DOT made four assumptions when the GDS industry was deregulated: 

1) Airline divestiture of their interests in the GDSs made it less likely that a GDS would favor one airline over another;

2) Forthcoming technological changes – including online, direct-to-consumer ticket sales – would operate as a check on the market power of the GDSs;

3) Airlines’ ability to control access to their own content, including webfares and other discounts offered through an airline’s own website or select distribution channels – would reduce the GDSs market power; and

4) Vigorous anti-trust enforcement would help ensure competitive markets.

No matter how well-meaning those assumptions, they haven’t held water largely because of the power of the legacy GDS industry. So perhaps it is high time that the DOJ file suit against the GDS industry.  Why is it OK that Amazon.com is able to offer recommended products to consumers based on past purchase behavior and the airlines cannot?  Why can the consumer pick from a variety of offerings when picking a cable television or cellular phone plan but is so limited in options for air travel purchases?   

Today, all the consumer can do when buying from a travel agent is to make the purchase decision based on service and price.  Limiting indeed.

We desperately need an industry correction that allows a natural evolution in business practices so the free market can work.  A DOJ suit may achieve that.  Free competition will spur the innovation that anti-trust laws are designed to promote.  A DOJ suit may do that.  When competition wins, the consumer wins.  When innovation is allowed, the consumer wins.  Don’t be fooled by the GDS industry and its supporters hiding behind hidden fees; the consumer has no idea how much it already pays to an industry that stifles competition each and every day.   The biggest thing hidden there is the opportunity cost imposed by the GDS industry that would rather direct consumer’s attention elsewhere.

Sunday
Apr242011

Pithy Ramblings On The Past 24 Days

In the 24 days since I last wrote, I have given multiple lectures, participated on a panel at the EU Forum on Transatlantic Competitiveness, prepared to present at Atlantic Southeast Airlines' Spring Leadership Conference and am working with two MIT students, Kari Hernandez and Joe Jenkins, on what I believe will be an insightful and important study on airline industry efficiencies and community access to the nation’s air transportation grid.

The worst NCAA national championship game in history ended three painful weeks made more so by my abysmal picks for the tournament.  And the Master’s golf tournament began and ended with no American at the top of the world ranking, just as no US airline can be said to be atop of the global airline industry.

With earnings and proxy season in full swing, it’s clear that most airlines are scrapping their way to respectable results even as high fuel costs depress their performance and executives continue to get paid executive salaries even at the sharp objections of unions.

And with so many union contracts still under negotiation, labor disputes continue to dog the industry, here and at airlines around the world.  I looked with hope to the pilot negotiations at Air Canada, where it appeared that the union was willing to consider less onerous restrictions on domestic flying in recognition of economic difficulties in the domestic Canadian market.  But rather than put an agreement out to vote, the union instead recalled its Chairman, doing little to strengthen the airline for the future. In response, the Centre for Pacific Aviation said it best: “That Air Canada needs something dramatic to make it sustainable is as obvious as the maple leaf on the national flag.”

I made the same suggestion in my presentation to the FAA's 35th Annual Aviation Forecast Conference.  But in doing so I often feel much like the Chairman of the Air Canada pilots union with plenty of readers who want to recall me when I look economic reality in the eye and recommend dramatic change.  One reader warns of a looming pilot shortage citing the law of supply and demand.  But that law will apply only by depressing the demand for pilots as the industry in the US will get smaller yet before it gets bigger.

At most of the US network carriers, cost structures are still too high to continue domestic flying at current levels.  And those high cost structures make it hard to justify investment in the hundreds of new narrowbodies necessary to replace fleets performing domestic flying today, particularly if today’s managers are truly serious about achieving a return on capital that actually exceeds the cost of capital.

Speaking at a CERA Conference in March, United-Continental Holdings CEO Jeff Smisek acknowledged that United-Continental, the product of the merger of United and Continental, will shrink in the U.S.  “We'll have the domestic [operations] sized solely to feed the international traffic," Smisek said.

Warring words between pilots and management have been increasing in volume in Australia too. Qantas had it relatively easy domestically once Ansett, the largely domestic carrier, was liquidated in 2002. When Virgin Blue grew to replace Ansett, Qantas responded by forming Jetstar, an airline within an airline.  But then came Tiger Airways Australia which now leads pricing in the Australian domestic market.  So legacy Qantas, with a cost structure once supported by a near monopoly in its domestic market, has now lost its competitive way.  Add to that pressure from the Middle East carriers internationally, a route system that is nothing more than a spoke to the world’s hubs is under challenge from all directions.

We can expect to hear similar noise from union halls in Germany, France, the Netherlands and the United Kingdom.  This is a region with social cost structures that look more like that of the state bureaucracy in Wisconsin than what will be needed to compete for tomorrow's global traffic.  I increasingly believe that what is being built in the Middle East will challenge the competitive integrity of each of the three global alliances.  Given that these alliances are nothing more than Band-Aid solutions to maneuver around archaic rules and regulations governing air transport, the bandages will begin to lose their adhesion one by one.  Global airlines built organically, particularly through cross-border mergers that build a brand, will begin to win the day. 

Not surprisingly, the response to the Middle East carriers from Canada, Germany, France and elsewhere has been protectionist at best. First the world wanted to open the skies.  Now that the skies are largely open for some, the talk has turned to restricting access to markets from new, innovative and vibrant competition.  I agree that the new competition should not be allowed to access cheap capital that is not available to all.  But to limit access because of presumed subsidy, cheap fuel, little or no airport costs and whatever other excuse to limit the growth of Middle East carriers is just plain wrong. Until a forensic accounting of Middle East carrier finances is available, it is all heresay to me.  Even Willie Walsh speaking at the EU Forum said he sees nothing abnormal in the numbers being reported today.  

In my mind, the US network carriers already have faced this type of competitive challenge to their domestic operations from upstart airlines with a labor cost advantage, new, more efficient aircraft and a cost structure that reflects the realities of today’s market in part by doing things like outsourcing ground services.  Why was it OK for the low cost carriers in the US to take 20 points of domestic market share away from incumbents and it is not OK for more efficient operations in other parts of the world to challenge incumbents in Europe and Canada?  Let’s not forget that one of the benefits of LCCs in the US was stimulating new demand that filled airplanes painted with new and old liveries. 

Finally, a few words on the battle between American Airlines and the global distribution systems/online travel agencies. We cannot talk about the airline ticket distribution system without mentioning the Business Travel Coalition – the advocacy group that tells the world it is all about protecting consumers when it is doing nothing more than to ensure the sustainability of its business with cash flows from the distribution duopoly.  In the past month alone, the BTC News Wire put out communications that, among other things, suggested that airlines are lying to Congress, railing against airline fees and urging consumers to write Congress in protest.

As I wrote 24 days ago,  despite the rhetoric from BTC and the constituents it represents, the coalition is doing more to protect an outdated mode of operation and stifle innovation than support a strong airline industry.  The GDS duopoly cannot move fast enough for an industry that sells “time saved” no matter how painful it is for the BTC and the online travel agencies to have the revenue tap turned off.  It’s time for the GDS to recognize they can’t support interests other than their ultimate customer – the airlines that actually do serve the air travel customer.

Much more to come.

Tuesday
Mar292011

To The GDS's: Either Evolve Or Dissolve -- It's That Simple

In the March 12 Economics column of The New York Times, University of Chicago economist Richard Thaler correctly titles his piece as it pertains to the airline industry:  “This Data Isn’t Dull. It Improves Lives.” The column then goes on to distort the intentions of the airline industry. 

At the heart of the matter is the relationship of the airline industry to the Global Distribution Systems (GDS).  Every time an air travel consumer works with a travel agency, the information being supplied by the agent is likely provided by a GDS.  The data necessary to enable the agent is supplied by the airlines to the GDS.   

In the early years following deregulation of the airline industry, GDS were largely owned by airlines and used to provide information to intermediaries to sell tickets on particular carriers.  The systems were biased toward the airline(s) providing the technology to the travel industry community.  These massive networks were built using the technology prevalent at the time – prior to the advent of the internet – and GDS were compensated for providing and maintaining vast private networks and for acting as gatekeepers between agents and airlines.

In fairly short order, the government stepped in to regulate the bias.  As a result, the GDS were no longer a distribution tool aiding the airline(s) that invested in the technology directly; rather they became a tool of the travel industry to sell a service.  Today, the airlines pay an intermediary to distribute their product – and they are paying a price much higher than the prevalent transaction costs. The airlines’ costs reflect an outdated model replete with older and more expensive technology as the GDS fight to sustain their large networks and maintain their role as gatekeeper.

But the intermediaries don’t pay the airlines for the airline-created content they use to lure customers to their respective websites so they can sell hotel stays and rental cars.  It makes no sense.

Name a financially successful industry that turns over control of its inventory to an intermediary. I can’t think of one either.

Airline travel is now available for purchase on multiple channels via the internet, including through the airlines’ own websites. Those sites typically provide carriers with the most control over the shopping experience while also being the lowest cost channel for the transaction. It is simply much cheaper and more efficient to use newer, internet –based technology to distribute tickets without the need for a “gatekeeper” between airlines and agents.   

Now the airlines also want to be able to go directly to their customers via their own channel.  Not that the airlines do not value the higher yield business that comes from agencies.  The motive is not, as some detractors have said, because airlines want you only to shop at their sites or not reveal what the cost of a trip is if you check two bags.  Rather, airlines are looking for ways to differentiate themselves by offering additional products and services to their customers that enhance the travel experience. This information is something the GDS cannot provide today without a significant investment in their systems.

Duopolists are typically reluctant to invest new capital unless it is absolutely essential to protect its cash cow

The airlines don’t necessarily want - or need – to drive all transactions to their sites and there is still a role GDS can play in this process. GDS could be content aggregators, allowing customers to easily compare fares. Right now, though, that’s a role GDS seems unwilling to take on perhaps worried about risking their fees.  

There are other factors at play here as well. First, airlines know their particular customers better than the government or the GDS. Plus; the GDS haven’t evolved as the industry has dramatically changed.  

Today’s GDS force the airlines to compete only on two factors; service and price. By limiting areas how airlines compete, the product offered is the definition of pure commodity. This was true in 1983 just as it is today. 

Despite the airline industry’s efforts to remove more than $20 billion in expenses over the past decade, the price of another commodity essential to its business increased more than fourfold – oil.  The airline industry is left with little choice, if it is to ever be a sustainable business, but to begin the process of de-commoditizing its product and finding new revenue sources.  To do so, means fundamentally altering its legacy relationship with the GDS and recapturing control over its inventory.

The airline industry has found new ways to generate revenue by offering customers products they value and are willing to pay for, including seat upgrades, passing through security faster or day passes to airport clubs. Bag fees, now charged by the majority of U.S. carriers, reflect a more accurate way to pay for what you use. In other words, customers that don’t check bags no longer subsidize the cost of those who do.  

Yet the GDS and supporters claim airlines aren’t being “transparent” in their pricing that they do not want to reveal the total cost of trip to a passenger.  Few industries have price transparency like the airline industry – compare it to cell phone contracts – and the majority of customers know exactly what they’re paying for when they travel.

Thaler is right; the data supplied to the GDS is anything but dull and service and price competition have benefited many by making air travel affordable to the masses. This will certainly continue as the competition is as hungry today as ever.

This is not a fight about defending the purity of data or somehow withholding it from those whose only aim is to presumably help customers. No one, including the GDS, can really dispute that this information comes from the airlines.

Despite the rhetoric, it’s also not about protecting customers from an industry desperate to reach more. This is about protecting an outdated mode of operation and stifling innovation.  The GDS duopoly cannot move fast enough for an industry that sells “time saved”.  The GDS doesn’t want its revenue tap turned off. It’s time the GDS recognizes it can’t support interests other than their ultimate customer – the airlines.  The airlines are simply looking to adapt to new economic realities and help their ultimate customer – the person who actually buys a ticket.

Duopolist.  Monopolist.  Neither is accepted in the airline business.  Now the airline business says it is time that vendors servicing the airline industry cannot be duopolists or monopolists either.  It is all part of the evolution of the business that began in 2002. 

Monday
Jan102011

Unbundling, Rebundling and Now De-Commoditization

As the new year begins, I’m encouraged that airline industry is truly making changes necessary for long-term survival.  Over the past decade, airlines have engaged in a restructuring period like no other since deregulation – in fact making the kind of meaningful structural changes some thought deregulation itself would bring .

American Airlines’ aggressive posture in restructuring the way airline tickets are distributed is an obvious next step in this process.  In most businesses, low-hanging fruit is found where a middleman is involved, as is the case with the aggregators like Orbitz and Expedia.  For the airlines, this effort has some risks and involves more than just cutting costs.  It is about addressing some of the core issues that plague airline pricing and can be termed the de-commoditization of the very product airlines sell – a seat from A to B.

On November 25, 2009, Swelblog wrote about a presentation that former Air Canada President and CEO Montie Brewer gave at MIT titled:  Five Reasons Why the Airline Industry Will Never Be Profitable.  According to Brewer, one significant reason the industry will fail to earn a profit over a sustainable period is the presence of the Global Distribution Systems (GDS).   Now before our very eyes, American Airlines has taken the leadership to challenge the roles played by the Online Travel Agencies (OTA) and the GDS.

Reason #1 cited by Brewer as to why the industry will never be profitable is that the capacity-lead business model causes “constant overcapacity”.

Since deregulation the airline product has been commoditized.  In the commodity framework, the only way the industry, or an airline, can grow revenue is to grow capacity.   But that model didn’t work for airlines, where Computer Reservations Systems and the GDS’s institutionalized the notion that in order for an airline to grow revenue, it needed to offer more and more capacity even before demand warranted.

The addition of capacity led to low and lower operating costs.  On the margin, revenue exceeded cost.  Uneconomic capacity was being deployed each and every day.  Ultimately, it created an industry too big to be sustainable.  If not for the price of oil, the airline industry would never have shed the level of capacity it did between 2008 - 2010.   

The GDS were a major contributor to the commoditization of the airline product.  Therefore, airlines that distribute directly to the consumer have the best likelihood of differentiating, and more importantly, not commoditizing, their product.  This fact contributed to the trend in which certain airlines did well even as much of the industry suffers. Note the one airline in the US that does distribute directly to the consumer:  Southwest.  And Southwest has differentiated, not commoditized, its product. 

What is a commodity?  According to Miriam Webster, a commodity is a good or service whose wide availability typically leads to smaller profit margins and diminishes the importance of factors (as brand name) other than price.  Commoditization can be defined as the process of prices moving substantially lower because of strong competition. Commoditization happens because too many competitors enter a market when they see the large returns that can be earned on certain products. However, those returns soon disappear as competition drives prices lower.

Each defines the airline industry.  Each defines patterns that today’s industry executives are trying to break.  Just because it was done one way or another yesterday does not mean it is the best way of doing business tomorrow.  Enter the Business Travel Coalition (BTC).  Under the veil of protecting consumers, the BTC is doing nothing more than protecting the interests of the money that keeps the organization in business.  Every time the airline industry makes a strategic or commercial move to improve its profitability, the BTC pushes back because change does not serve its clientele well. 

Which leads us to Brewer’s Reason #5: “Nobody Really Wants It to Be Fixed.”  Brewer makes a powerful case that things are fine the way they are . . . and, for the most part, the airline industry value chain, consumers and the government know it.

When it comes to low fares,  consumers can shop the internet and find some market on sale (and the same will be true tomorrow if American and others are successful). They may even find the price of a ticket today equal to or less in nominal dollars than a fare charged two decades ago.  When adjusted for inflation, it is hard to find any consumer product that is a better bargain than air travel.

Taxes and fees account for nearly $60 - or 20 percent - of the average price of a ticket today.  This compares to $22, or 7 percent, in 1972.  In other words, the government is getting a bigger share of a shrinking pie.  GDS fees go up as the real price of a ticket is in decline.  Anything that the industry can do to address margin degradation in the business should be considered and be done.  And that is precisely what American is doing.

There are few areas that remain on the income statement where costs can be cut.  Distribution happens to be one just as the industry is asking the government to examine whether the tax burden imposed on the airline industry is disproportionate.   As the old saying goes: Two percent here and two percent there on top of taxes and fees that consume 20 percent of the ticket price adds up to real money . . . money the industry cannot afford over the long term.

Perhaps most compelling is that all the players in industry's value chain -- GDSs, OTAs, airline caterers, aircraft lessors, ground handlers, manufacturers, airports, fuelers, travel agents, maintenance repair organizations and freight operations -- don’t want it changed.  That’s because each earn a higher return on invested capital than the airline companies that keep them in business.

BTC members do not want the airlines to take control of their inventory because it is sure to weaken the powerful grip the GDS and OTA have over the industry today.  Ask yourself, would you really want to be in business if you did not have near complete control over your inventory?  I think not.   Do GDS and OTA know your customers better than you do?  I think not.  In short, a commodity is a product that has a low degree of differentiation.  Over the past decade, the product offered by the network carriers and the low cost carriers have converged to where there is little to no differentiation because schedule and price are the only differentiators.  This must change if the industry is truly committed to achieving a structure where it earns at least it cost of capital.

Loyalty has increasing value to air travel consumers today, in part because elite members of frequent flyer programs typically aren’t charged the ancillary fees other passengers pay.  Base fares will be disciplined by competition whether American is successful in its attempt to rewrite distribution rules or not.  This industry always adapts.  Travel agents continue to exist today even after the industry stopped paying domestic commissions in 2002 – assuming they evolved and adapted to find replacement revenue streams. 

One can make a case that the GDS have been every bit as destructive a tool as constructive.  Any system that promotes adding inefficient capacity should be changed.  They served their purpose when market share was king.  They serve significantly less purpose in an industry increasingly focused on its bottom line.  Short term this may be about saving some portion of a booking fee.  More important is the long term notion that an airline that takes control of its inventory creates value for its customers based on the knowledge the airline has of its customer.  To say the customer loses out is a tired refrain coming from the same "Chicken Littles" that "Cry Wolf" every time the industry tries to institute systemic change. 

Let the restructuring continue.

Wednesday
Nov252009

Montie Brewer: Five Reasons Why the Airline Industry Will Never be Profitable

Stuffing Romy’s Thanksgiving Turkey with Items for Secretary LaHood to Consider

On Friday, November 20, Montie Brewer, most recently Air Canada’s President and CEO, made a presentation at MIT titled:  “Five Reasons Why the Airline Industry Will Never be Profitable.”  Prior to making his way to Air Canada in 2004, Mr. Brewer (Montie) held senior positions at United Airlines, Northwest Airlines, Republic Airlines, Braniff and Trans World Airlines. He has planned and developed over 20 hub operations worldwide and played an integral role in the founding of the STAR alliance. 

I sat down with Montie following his presentation with the intention to write about it, but also to use his talk as context as Secretary of Transportation Ray LaHood considers establishing a Blue Ribbon panel to study the woes of the U.S .airline industry.  It seems like the perfect stuffing for 2009’s Thanksgiving turkey.

Brewer’s Five Reasons Why the Airline Industry Will Never be Profitable

The boom and bust cycles of airline industry earnings are well documented, as is the fact that subsequent down cycles to industry up-cycles destroy those earnings and more.  The fact remains that any annual airline industry profits rarely exceed the average pre-tax earnings for U.S. corporations. As a preface to his talk, Brewer made clear it would be wrong to surmise individual airlines will not be profitable. Instead he contends the industry will always suffer due to structural reasons.  

  1.  It’s A Capacity Lead Business Model (Causes Constant Overcapacity)

Since deregulation the airline product has been commoditized.  In the commodity framework, the only way the industry, or an airline, can grow revenue is to grow capacity.  Then, the Computer Reservations Systems and the Global Distribution Systems institutionalized the notion that in order for an airline to grow revenue, it needed to offer more and more capacity even before demand warranted.

The addition of capacity led to low and lower operating costs.  On the margin, revenue exceeded cost.  Uneconomic capacity was being deployed each and every day.  Ultimately an industry too big to be sustainable was created.   

The GDS’s were a major contributor to the commoditization of the airline product.  Based on this fact, airlines that distribute directly to the consumer have the best likelihood of differentiating, and more importantly, not commoditizing, their product.  This fact contributes to the notion that certain airlines can do well while the industry suffers. 

  2.   Airplanes Don’t Go Away (They Just Become More Efficient)

A bad airline industry assumption is consolidation of the industry, whether through a merger or carrier liquidation, leads to industry capacity reduction.  The airline industry time and again has demonstrated that once a carrier’s capacity is pushed to the edge, that carrier’s capacity (efficient and inefficient) does not go away.

With the working premise that the only way to grow revenue is to grow capacity, then new aircraft need to ordered.  The problem is aircraft do not go away, and: aircraft do not make their way from an inefficient operator to a more efficient operator; aircraft CAN fly forever; even when an airline tries to retire aircraft, they come back like a bad spaghetti sauce (remember ValuJet using Delta’s DC-9s to compete directly with them in Atlanta); and, when carriers grow they realize great efficiencies. 

An example of those efficiencies is a 3 percent growth in capacity results in only a 1 percent increase in total operating costs.  However, this works in reverse when carriers pull capacity down as the cost savings cannot be achieved commensurate with the reduction.  This fact is what plagues the industry today as a floor is created on just how much capacity can be reduced by any one airline.  

[Note:  If Brewer had his way, Airbus and Boeing would each be allowed to produce 10 new aircraft per year but he would allow the manufacturers to charge whatever amount they could earn on each of those 10 aircraft.]

  3.   Labor Leverage (Political Organizations Cannot Manage Commercial Reality)

Labor organizations are not structured to manage the responsibility they possess.  In Brewer’s view labor has tremendous leverage over the industry.  However, they are highly simple political organizations and, as such, only have a short-term view.  For the politicians, the short-term view is to remain in their elected position.  To overcome this flaw, labor organizations need to completely overhaul their governance structure. 

Like the ordering of airplanes, management historically reaches agreements with labor at the very end or the peak of economic up cycles and then faces the prospect of paying the bill during subsequent downturns.  Given the high fixed costs of the industry, airlines can rarely afford a strike or intermittent work stoppages.  During negotiations, both the airline and labor pretend management is in control.  According to Brewer, the working assumption is management will not allow labor to take too much, but in reality, labor can take all it wants - - then both live with the outcome.  Brewer believes, when costs like labor, fuel, maintenance, airport fees are factored in on a daily basis, the typical airline has 10 - 20 profitable days a year.

With 10-20 days of revenue to spend, some in labor have asked, “Why would management agree to a contract it can’t afford”?  Well, because somewhere during the year, fuel exceeded budget, or the government issued a new airworthiness directive involving aircraft in an airline's fleet, or airport fees increased, or…….the false belief that management will contain labor’s desires from doing stupid things.

  4. Input Costs are Too Volatile (Revenue Cycle and Cost Cycle Out of Sync)

Even in the best of years, the airline industry is a low margin business where it is not uncommon for any number of input costs to increase at least 20 percent.  A low margin business with volatile input costs is a toxic mix.  A good example occurred in 2008 when the price of oil increased from $80 per barrel to $147.  As is typical in the airline business, tickets are often purchased months in advance.  During the first half of 2008, it was not uncommon for passengers to be flying in June on a ticket purchased when oil was $50 per barrel cheaper.

Is the relationship of volatile costs relative to revenue impossible to manage?  No, but it would require companies to maintain outsized cash balances. Cash balances that look good to labor during contract negotiations and to financial raiders seeking to buy a company to harvest that cash.

  5.  Nobody Really Wants It to Be Fixed

Brewer makes a powerful case that things are fine the way they are… and, for the most part, the airline industry value chain, consumers and the government know it.

When it comes to low fares, the consumer can shop the internet and find some market on sale. They may even find the price of a ticket today equal to, or less, in nominal dollars than a fare charged two decades ago.  When adjusted for inflation, it is hard to find any consumer item that is a better bargain than air travel.

Taxes and fees are nearly $60 - or 20 percent - of the price of a ticket today.  This compares to $22, or 7 percent, in 1972.  The government is getting a bigger share of a shrinking pie. 

Perhaps, most compelling is the industry's value chain like airline catering, aircraft lessors, ground handling, manufacturers, airports, distribution systems, fueling; travel agents, maintenance repair organizations and freight operations.  Each of these industry sectors in the airline industry value chain earn a higher return on invested capital than the airline companies that keep them in business. 

Some Questions for Secretary LaHood to Ponder

  • Can a commodity business (airline business) that does not have to be a commodity business (too much supply) be permitted to change sufficiently by its stakeholders to achieve sustained profitability? 
  • Can an industry where inefficient capacity never leaves achieve sustained profitability? 
  • Can an industry where organized labor has outsized leverage but cannot manage the inherent responsibilities that come with that leverage change sufficiently in order for the industry to achieve sustained profitability? 
  • Can an industry with widely volatile input costs raise sufficient capital to manage its business without being raided by either a financial investor or a stakeholder seeking outsized payments?
  • Can an industry where every stakeholder seems to be happy with the way it is, including governments and their constituents, consider making the necessary changes in order for the industry to achieve sustained profitability?

Any Discussion Must Begin With a Plan for Roads, Rail and Runways

To date, the only public suggestions that I have seen for the Secretary to consider in forming the panel come from Kevin Mitchell at the Business Travel Coalition.  Mitchell, who participated in the Secretary’s discussion with various stakeholders on November 12, wrote LaHood outlining five issues that need studying by the proposed commission:

  • No National Air Transportation Policy
  • Airline Over-Scheduling
  • Broken Industry Work Force Model
  • Obsolete Air Traffic Control Technology
  • Airline Industry Financial Failure

Mitchell also outlined causes of each, including unbridled faith in market forces; lack of government and industry foresight and leadership; lack of a productive labor-management model; unworkable industry financial model; ineffective FAA management; fragmented industry positions and lack of Congressional leadership. While Mitchell is thoughtful about the problems and their causes, parts of his list of those affected sounds more like advocacy for his clients.

Swelbar’s View

Among the best of Mitchell’s observations is the need for a coherent transportation policy.  That policy, though, should not focus on an alleged broken regional airline business model; tarmac delays; that the industry is no longer a desired profession; pressure on safety margins; loss of skilled jobs; lost service; or a loss of international leadership. 

The transportation policy should be about roads, rails and runways -- period. After all, there must be some very good reason why Warren Buffett is spending $34 billion to buy Burlington Northern? For aviation specifically, it should address the need to define, resize and equip the desired infrastructure for the 21st Century. For airports that might be disenfranchised from the air transportation grid, do highways need to be built that easily facilitate a different access point for those air travel consumers?  It should not be about championing a unique labor force that already has considerable power and very good paying jobs relative to the overall work force or the calls of various consumer advocates.

Organized labor was a force behind LaHood's consideration to form a commission to study the airline industry.  But nowhere based on what I have read does labor accept any responsibility for the current condition of the industry.  Times have changed, and unions need to understand that. For organized labor – and by extrapolation, airline labor – to be successful, the unions can no longer be in the business of keeping themselves in business. It has to be about meaningful change. Change that entails understanding the new economic realities, or as the Harvard Business Review recently opined “that there will be no going home again…that the landscape of business has been forever altered.” [actually this question can be asked of every airline industry stakeholder] Can unions change or adapt to the idea that instead of being in business to secure decent jobs for the greatest number of people it might be better off securing great jobs for fewer workers?

Mitchell identifies the right stakeholders, but doesn’t ask ALL of the right questions.  Brewer poses the right questions and does not suggest the market can answer them all.  The answers lie in what this blog is about -- change:  can industry stakeholders change and surrender unrealistic expectations of the past?  Despite all of the cuts, we still have too much capacity, leading to too many inefficient operations, which lead to a government that really does not want to get out of the way --- because it has a stake in that inefficiency.

I hope that the administration is really going to evaluate the industry and recognize that all stakeholders need to change.  And much of the change that needs to take place begins and ends with government accepting that an industry 50 years old ... well, needs to change.

More to come.

 

Thursday
Sep182008

Dynamic, Dynamic, Dynamic; Bless Air Canada; and the Education of Stakeholders

Like Holly Hegeman at Planebuzz.com, I am having my own computer week from hell and as a result I am cranky. In my crankiness, I am actually thinking about the shot-gun wedding of airline labor and airline consumers, destined to fail, first initiated by the Business Travel Coalition.

This post is kinda about international alliances. Moreover, it is kinda about international alliances not being on the same page. I understand that without Anti-Trust Immunity (ATI), carriers are limited in their discussions with one another. But I find that Air Canada’s decision to rescind second bag charges at a time when United announced it would double its fee for a second bag to be a black eye for the STAR Alliance. North America is one thing. Tomorrow is not about North America.

What good is my STAR Alliance Gold Card if I do not have a clue? And I pay attention. Let’s be honest and frank here, Air Canada, under the leadership of Montie Brewer, has done great things with the internet. They have taught us about simplicity and transparency while teaching the air travel consumer about the concept of “value-added” services when making decisions to purchase an Air Canada product. These include preferred departure times, seats, meals etc.

Further, let’s not let it be lost that Air Canada’s approach, begun long before US carrier’s decisions about ancillary fees, gives them a leg up on the consumer education aspect. So, rather than charge for a second bag, Air Canada will roll its previously stated fuel surcharge associated with buying a seat on a particular sector into the base fare.

Ben Smith, Air Canada’s Executive Vice President and Chief Commercial Officer said: "These initiatives are made possible by the recent relief from all-time high oil prices and even though fares will remain dynamic”. Dynamic is the key word in this phrase. It simply means volatility. We can expect volatility going forward. The fact that a barrel of oil has dropped $55 per barrel in a little over 60 days after rising nearly $60 per barrel in a little over 200 days we should not immediately jump to the conclusion that the global industry is out of the woods. For statistical types: what is the standard deviation?

Air Canada does have it right. If dynamic cost increases are plaguing the industry, then let fares be dynamic. Addressing, and implementing, these processes goes a step further to educate the consumer and labor on the argument that the industry simply cannot sustain a fixed cost, fixed fare, environment that does not produce a profit for those providing the metal. Moreover, dynamic pricing is about addressing the boom and bust cycle that has plagued this industry for nearly three decades. It is about the education of stakeholders.

US carriers are using volatility to create rigidity through ancillary charges. And that is what defines legacy in many ways. Dynamic should be the word of the day. Dynamic is the action that needs to describe the immediate future of this industry as well as the outcome of the next labor negotiations – any airline’s largest controllable expense. Sadly, no US carrier is articulating this point.

Whereas labor continues to assimilate consumer issues into its leverage-grab for higher wages, dynamic base fares versus second bag charges best exemplify the issue describing why we need a flexible labor construct. This boom and bust cycle simply must end. We really need to think about this.

And if we are going to make an alliance argument, let's make one as differentiation is lost.

Monday
Jun302008

The Reality Show Called Airlines

The Biggest Loser(s)

Reality shows have become a fixture on American television. Like them or not, the ratings of many are hard to ignore. So at a time when US carriers consider whether charging by the pound would be good practice, the title today seems appropriate. 2008’s second quarter comes to a close today. Red ink will again be the color to describe the financial results for the US airline industry. Red will also be a color prevalent in calculating changes in liquidity positions for many of the US carriers.

Red should also be the color of the faces of analytical team employed by the Business Travel Coalition as they made public their latest of a long list of scare tactics. It is has been nice to see other bloggers and observers make their views known regarding the information and “analysis” that has been emanating from this group. There are many smart observers of this industry. To even allow BTC’s latest missive find its way from the idea table is head scratching enough. To allow a piece into the public domain without the supporting data and analysis underlying the “findings” is even more bothersome.

My guess is the BTC’s leader is nothing more than a pawn for Jim “Hell NO”berstar and the socialist ideals he thinks are best for the US airline industry.

Closer To Another Method of Treatment, Than A Cancer

Many times I have written about Willie Walsh, British Airways’ Chief Executive and his views on US regulation and its hindrance to the natural evolution of the global airline industry. Today, Mr. Walsh’s views were expanded upon by Martin Broughton, the Chairman of British Airways PLC in an interview in the Wall Street Journal by Daniel Michaels. Some of Mr. Broughton’s comments that I found to be spot on are as follows:

· An eventual relaxation of US airline-ownership rules would spark a world-wide wave of cross-border deals over the next five to 20 years. That would help the troubled aviation sector function more like other industries.
· Mr. Broughton still sees it [US – EU Open Skies Phase I] as a lousy deal because it opened Heathrow, but only opened a small crack in the US market for EU carriers.
· Mr. Broughton hopes economic pressures will do what diplomacy couldn’t. It could be the financial exigencies of the day that finally make for a breakthrough.
· In Europe he cites two cross-border mergers that have shown the potential of multiairline groups: Air France/KLM; and Lufthansa/Swiss. In Latin America, he cites the tremendous success of Chile’s LAN Airlines SA. In Asia he points to the success of Kuala Lumpur-based budget carrier Air Asia.
· Mr. Broughton points to the frustration of Lufthansa’s Chief Executive Wolfgang Mayrhuber with airline-ownership limits. He quotes Mr. Mayrhuber as saying this industry shouldn’t be treated like railroads. It should be like car makers or chemical companies and operate globally.
· Mr. Broughton called America the biggest impediment to relaxing the aviation industry’s ownership and nationality rules. He suggests that if you break US resistance then you have made a big breakthrough on a global scale.
· Broughton believes that financial considerations may soon overtake nationalistic ones. He suggests that even labor should welcome the changes because foreign investment is investment and that is something US carriers have lacked in recent years.


So as we carefully dismantle/deleverage the last 30 years of network architecture as a method to discover individual carrier’s profitable cores, I long for the day when we begin to grow again whether organically or through other means. The combinations cited by Mr. Broughton are those carriers that are leaders in a global context as far as return on invested capital; growth in virtually any measure; and in market capitalization. Moreover they are proof of successful models of cross-border combinations that are producing the right kind of returns for many stakeholders, not just a few.

US Airlines and Portfolio Theory

Attributes of a successful US airline industry are no different than an individual investor or a portfolio manager. Instead of diversifying a portfolio of financial assets, airlines hold a portfolio of routes. Modern Portfolio Theory (MPT) proposes how investors will employ diversification to optimize their portfolio of assets. The model that proposes this diversification assumes that investors are risk averse meaning that if the expected rates of return on two separate investments are equal, then the investor will choose the one with the least risk. On the other hand, an investor will not accept more risk without a commensurate increase in the expected rate of return.

Parochial-thinking lawmakers, regulators and aforementioned observers somehow think that the US airline industry should continually accept more risk all the while accepting a commensurately lower expected rate of return largely driven by policy -- all in the name of competition I guess. For the largest US carriers, the portfolio is simply made of up too many domestic routes. This is how you can characterize the first 30 years of deregulation. Now it is time to break the boom and bust cycles that have characterized this industry.

During the down cycles: Unhealthy competitors remained due to high barriers to exit; new entrants emerged, because of the very low barriers to entry, looking to exploit weaknesses; leading one to argue that this has led to the overcapacity situation that will begin to be addressed immediately after Labor Day. Compounding the “excess capacity” issue, the airline industry emulates other capital intensive, commodity industries by over-expanding during the up cycles.

Surely the Naysayers Recognize that Something Is Wrong?

So here we sit. With nowhere to run, nowhere to hide, and few options to find new capital to invest in a lacking product that will require the consumer to pay more for as a result of high oil prices over the coming months – it will get interesting. Moreover, the consumer will surely have an expectation that increased prices sure as hell better produce an improved product.

I like the idea of foreign capital for this very reason – the need to invest in product that facilitates a new cycle where the ultimate US flag bearers in the global industry begin to differentiate themselves from the local service carriers (formerly called Republic, Ozark and Western) – or today’s equivalent (Southwest, jetBlue and AirTran) – tomorrow. But if I had capital I would not make that investment without commensurate voting power either.

So over the next 12 months or so, it will be interesting to see just who gets voted off of the show.

Wednesday
Jun252008

Is Oil A Cancer Or A Cure?

As I write this morning, I am without an internet connection. On Monday and Tuesday of this week I was in Chicago speaking to, and participating in a roundtable discussion with senior executives of the International Association of Exhibitions and Events. A most enlightened group that depends heavily on the airline industry to deliver people and goods to the large trade shows they run. Rather than run from the issues plaguing this industry and others, this group was meeting to strategize on proactive stances and rethink their many successful approaches – many of which were designed around a low fuel environment.

Today, I sit in rural Maryland as the coolest, little guy in my world, Sam, plays in his first Titleist Tour event. Not being the doting one, I watched him hit a very good tee shot down the right side of the first hole then strap his bag on his back and begin play. And I found a quiet spot under a tree to write. In case you have not figured it out by now, the game of golf is a passion and it is way cool to watch Sam embrace the game and pay respect to the many traditions that make the game so great.

I Think We Are Beginning to Actually Define Overcapacity

The naïve notion that high load factors somehow suggested that there is no overcapacity is in the process of being put to bed. A better term to have used would have been uneconomic capacity because we know that on many flights that there are somewhere between 10 – 30 seats that too often get sold for less than the cost to carry the passenger occupying one of those seats.

My guess is some readers here have also been questioning my lack of writing over the past 4-5 weeks. For the same reason that I got out of the day to day grind of the consulting business where I devoted an inordinate amount of time to restructuring airline labor agreements. How many ways can you tell someone or a work group that their collective bargaining agreement has cancer? How many ways can you write that the treatments being recommended may/or may not work? Another attribute of cancer survivors is attitude – a positive attitude has proven time and time again to transcend many things that require wholesale change. And it does not take an Oncologist to tell anyone that.

Is the price of oil a cancer or a cure for the industry’s ills? I do not know the answer and the question is probably best left to the individual. For some, the price of oil is a cancer in that its very presence will prevent certain stakeholders from achieving what they somehow believe they are entitled to. More than likely a positive outcome will be prevented by the lack of acceptance that additional treatment is necessary and succumb to the “woe is me” attitude. For others, they will accept that the treatments taken over the past 5 years are simply not enough and that more has to be done – and the only path left is invasive. [for those that will comment that I am suggesting more concessions, I am not]

Already this week, labor news surrounding the industry has been plentiful. I wake up in Chicago on Tuesday morning to the headline on the front page of the Chicago Tribune that United will furlough 950 pilots between now and the end of 2009. Later that day, the Delta and Northwest pilots announce that they have reached a tentative agreement on a joint contract covering both the Delta and Northwest pilots. In addition, a protocol agreement has been put in place to merge the seniority lists prior to closing of the transaction. Today American Airlines began to detail its previously announced service cuts. And New York is prominent on that list.

The United news of pilot furloughs is the first real indication just how far that carrier is willing to go to find its profitable core. Clearly, the carrier recognizes that major changes/treatments are necessary. United has been quite busy of late announcing an alliance with Continental; making a number of fare rule changes including bringing back the unpopular Saturday night stay provision; being so bold that it would put down 100 aircraft units; and entertaining any and most of the ideas – including some of their own - regarding charging for most unbundled services.

Layoffs associated with aircraft retirements will be many as we work toward the fall and winter months of 2008. But I do not see the numbers of jobs lost approaching the 125,000 jobs lost post 9/11. Unless we liquidate a large airline or two.

The Confused Business Travel Coalition

On the heels of the Business Travel Coalition testifying against the proposed Delta and Northwest merger on two separate occasions, the confused advocacy group underwrites a study suggesting that the current crisis (the price of oil) facing the industry is leading to a catastrophe. A crisis for some stakeholders to be sure. But a catastrophe?: absolutely not. Why is it a catastrophe if inefficient players are finally removed from the industry? Or if uneconomic capacity is finally removed from the system?

This industry will be here after this storm has passed. Only the liveries on the tails will be different unless invasive treatment is accepted, implemented and met with a survival attitude. Based on this group’s track record, I thought it was a catastrophic event if carriers merged. Now everything is a catastrophe. Maybe the upcoming lesson on network economics in the fall will shed some light on approaches other than the group's tired refrain that the “sky is falling”.

In this environment combined networks, whether it is through merger activity or through the formation of an alliance, promise to preserve more capacity than if carriers operated individually. As carriers begin the process of weaning capacity, the industry will get a real live lesson on the interdependencies between nodes that exist within network industries. We will take a cue from consumers as to whether the Southwest’s, jetBlue’s and AirTran’s can satisfy all consumers wants from air travel in the domestic industry. I am prepared to bet that all consumers will not be happy with their limited services - but we will see.

So while the news is bad and additional dislocations are all but assured, I see the price of oil as a cure to 30 years of cancer that never received the proper treatment. When we come out of the other side, however long it takes, it will be better as many bad business practices that have plagued this industry will have been eliminated. And not thought to have been eliminated when they were actually in remission.

Thursday
Apr242008

Reflecting on Today’s Congressional Testimony in the DL-NW Deal

I did my best to listen to as much of each hearing as I could today. I certainly found the Senate hearing much more interesting than the House hearing. The only players to testify in each hearing were Delta CEO Richard Anderson and Northwest CEO Doug Steenland. For the most part, similar testimony was offered in each the House and Senate hearings.

I did think both CEOs were much better and much sharper in the Senate give and take. But I sure did feel the pain for Anderson as he tried in many ways to describe how networks work and how networks can create new product as the nodes are leveraged post-deal. Both were particularly good in the afternoon discussing the fuel issue and Steenland finally reminded everyone of the fact that the weak dollar versus virtually any world currency is just another issue weakening the competitive posture of US airlines today.

But the other two panelists in the Senate session?………And for me the most interesting testimony was from Kevin Mitchell of the Business Travel Coalition.

12 Mitchellisms

I just cannot help myself and will spend a little time picking out some of my highlights from the testimony of each Kevin Mitchell of the Business Travel Coalition and Dr. Darren Bush of the University of Houston Law Center -- and I am just not sure what he was saying. No, I will spend virtually all of my time with Mr. Mitchell’s testimony as he has been around this industry a long time, and well…….should know better on many points.

In his first full paragraph of his overview, Mitchell rightfully discusses the importance for the Department of Justice to evaluate competition from both a city pair and network perspectives. Then the 5 minutes of scare tactics begin. Mitchell #1: “Moreover, Congress needs to understand the total consumer costs resulting from massive service disruptions and the degradation of the reliability of the system. The direct, indirect and opportunity costs for mid-size communities that lose efficient connectivity to important business centers around the country and globe need to be quantified”.

The reliability of the system? Don’t you think that the government has a significant stake and has failed the consumer, and small and mid-size communities, by failing to upgrade the very air traffic control system within which the carriers operate? It seems to me that even without these high fuel costs that the industry may not be in such “dire straits” if it did not need to add time to the schedule each quarter because of the system’s inefficiency. “money for nothin’”.

If the economics are not there, just because an airport has a runway, a terminal and security does not mean that the airport market is entitled to air service. Maybe another question could be: how have global forces impacted that community and possibly moved much of the economic base away because they were simply not competitive? A fair question to ask before laying it all at the feet of the industry. More simply, if those customers are willing to pay the cost for the service, then they will continue to receive the service.

Mitchell #2: “The managements of Delta and Northwest drove their companies into painful bankruptcies”. Based on what we know about Gerry Grinstein, my guess is bankruptcy was the last arena he preferred to visit. As for Northwest, they along with their labor, worked arduously to avoid a trip to a court-assisted restructuring and stood with labor on the pension issue along that troubled road. Management did not drive anyone in. Market forces did. And each carrier had very different competitive reasons for filing.

Mitchell #3: “With respect to Delta / Northwest, how can one accept that there are billions of dollars in revenue synergy when there are no plans to restructure either network? Unless Delta can convince expert outsiders of something on the order of $5 billion dollars in readily achievable synergies, there is no possibility that this merger could benefit consumers or the public interest”. No plans to restructure either network? Why did they want a complete pilot deal done first? So they could immediately begin to move aircraft around the network to best match aircraft to market sizes I thought. $5 billion in achievable synergies? Well you must have been much more a fan of the US Airways hostile as it did involve capacity cuts that would have been much greater than anything considered here even with the announcements made on each of the carrier’s earnings calls.

Mitchell #4: “The Delta / Northwest proposal emphasizes all of the features of past mergers that have consistently failed and doesn’t exploit any of the synergies of the rare mergers that did produce positive returns, e.g., TWA / Ozark and Northwest / Republic”. You did forget Delta-Western. What I find most interesting about your statement is that each of these mergers, except Delta-Western removed a competing carrier sharing the same hub. Talk about anti-competitive!? My flip comment on the mergers in the mid 80's was if they approve these, then anything goes.

Mitchell #5: “Megamergers create a risk of an operational meltdown that could cripple the nation’s aviation system". Fuel prices and the lack of merger-related synergies would create huge pressures to cut corners on implementation spending, creating pressures that would exacerbate conflicts with (and among) employee groups”. You are right, economic forces, competitive forces, antiquated air traffic control systems and uncontrollable crude and refining costs have no effect at all – so blame it on M&A activity [please read with tongue in cheek].

And further each carrier today, operating as a stand alone, will avoid the fates of Aloha, ATA, Skybus and Frontier? For someone that has made fares a career, do not forget that it is an accepted principle that volatile prices are most unsettling on commodity industries – and the US airline industry has become a commodity industry. Any one of your members should do a net present value calculation on travel expenditures and compare it to other input costs that they have paid.

Mitchell #6: “Merged mega airlines will leverage their route structures to dictate terms and conditions (pay more for less) to corporate buyers, even for those airline pairings without significant route overlap”. Mr. Mitchell, consumers are going to pay more. And if they don’t, labor is part of your constituency and they would not get anymore either. On the more for less issue. Short-term maybe. But this industry knows it has been lacking in making both aircraft and non-aircraft capital expenditures in the business and the most recent earnings announcements suggest they will get further cut back. For virtually every carrier, another trip to bankruptcy is not an option – and Southwest, jetBlue and AirTran are not the option for the constituency you represent.

Mitchell #7: “Coordinated Effects. Going from 6 to 5 airlines would make fare increases easier to stick, especially if Northwest were absorbed into another large carrier because this carrier has often played the role of the “spoiler.” And of course, the problem with fare increases is even more enormous if the industry goes from 6 to 3 super major carriers. United Airlines recently brought back the infamous Saturday Night Stay requirement that will virtually fence-off lower-priced fares for business travelers increasing ticket prices by hundreds of dollars”. Market forces are the catalyst. All sectors of the industry are affected by the current environment. No more free lunch. But again I impress on you to do that net present value analysis I suggested earlier.

Mitchell #8: “Congress should be concerned with the market power of super-mega airlines and their incentive and means to frustrate new airline entry at hub airports”. With the low cost carriers approaching 30% of US domestic market share, your scare tactic that suggests low barriers to entry are simply not true. The US market should not fear individual carrier failures or consolidation. Indeed, this market has demonstrated time and time again that where competition is vulnerable, a new entrant will exploit that vulnerability. Where there are market opportunities, there will be a carrier to leverage that opportunity. Where there is insufficient capacity, capacity will be sure to find the insufficiency.

Mitchell #9: “Congress should also view with great concern the increased joint purchasing power of the global alliances (buying groups) with respect to their ability to exercise monopsony power and drive supplier prices below competitive levels”. To suggest the current laws and regulations even permit this type of action by US airlines is yet another scare tactic. Yes the world will evolve. And alliances are nothing but a band-aid to access the world.

Mitchell #10: “The primarily objective and dirty little secret of these megamergers is the permanent end to meaningful competition between the U.S. and Continental Europe—two airline competitor groupings would control 90-95% of a profitable, growing market of over 30 million people, where there would be zero possibility of new competition”. This is among the more laughable suggestions. Whereas the European-based carriers are healthy today, have you noted the downgrades on British Airways; the story surrounding the continent’s sixth largest carrier, Alitalia; continued moves toward further consolidation that make the Europeans stronger? Further have you noted that Europe’s next competitor originates in the Middle East? To suggest that the game’s conclusion is now decided is another unfortunate scare tactic.

Mitchell #11: “All of the potential external funding for Northwest / Delta and United / Continental would come from the European airlines that would be the leaders of this two-airline duopoly, Air France and Lufthansa”. Interesting comment. Most interesting, as they are not participating in the deal that has been presented. I am not saying that Air France will not, but interesting. And Lufthansa invested $300 million in jetBlue but you did not mention that.

Mitchell #12: No comments on your conclusion.

Thank goodness, Cliff Winston of the Brooking Institution testified today so that market forces could get entered into the record. Not sure what the unions were trying to accomplish as you cannot have a seat at the table until you set the table. My guess is you will have a seat once you have made it clear that that a collective bargaining agent outweighs other options.

Much more to say. Much more to come.