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Tuesday
May192009

Colgan 3407: Fatigue, Commuting and Compensation

Justin Bachman at Business Week is fast becoming a must-read aviation reporter. In a May 17, 2009 column, Bachman asks: Have Airlines Cut Too Deep? This question of course was also being asked at the NTSB hearings on Colgan Airlines flight 3407. What makes Bachman’s work a must read is the context he provides on the economics of the situation. That is what the best reporters do.

But context in the reporting on Colgan 3407 was generally lacking in many of the press accounts. We read about the most sensational aspects of the story, like one pilot commuting from Seattle; like the other sleeping on a couch in the crew lounge; like the salaries paid at regional airlines; that somehow flight time/duty time was at issue; and of course fatigue. You didn’t need to read too far between the lines to see the supposed correlation between salary and safety.

 

Fatigue and Commuting

Unless the flight crew was on a suicide mission, this is a grossly unfortunate attempt at sensational reporting. It is incumbent on flight crews that choose to commute to arrive at their domicile rested and fit to fly a schedule that complies with flight time/duty time regulations. And through it all, there was no mention that “Sully” Sullenberger lives in Danville, CA and is based in Charlotte, NC. Or that the same flight time/duty time limits that applied to Sully’s trip applied to the Colgan crew’s trip as well.

Fatigue is a difficult issue. To conduct a meaningful scientific study, one must first assume that the crew is rested prior to the trip that they are scheduled to fly. That is their responsibility. In the case of the Colgan crew, the two pilots did not meet that obligation to the company, their fellow crew members or the passengers on the doomed plane. What is certain to come will be scrutiny on the issue of commuting and a debate as to whether we will return to the days when crew members are required to live in their domiciles.

Already some claim that low salaries force airline employees to live in places other than the metro areas where hubs are located. But that’s an individual choice, and most cities have a broad range of housing available.

The subject didn’t come up in the Sully case in part because, as a captain for a major carrier, he likely makes a pretty good living even after the concessions imposed on US Airways employees and so many airline workers as the industry struggles to turn a profit. But I’m pretty sure living in Danville, CA is not cheap, nor is Seattle known for its budget housing.

But long commutes for airline professionals should be reviewed and possibly prohibited if there is a connection between that travel and fatigue. And the fatigue issue cannot be studied until commuting practices are completely divorced from the regulations covering time on duty for flight crew members.

My guess, however, is that as the Colgan investigation continues, the real debate is going to involve pay.

Over the past weeks, there has been discussion here and elsewhere about the role of seniority in the airline industry and a system that chains flight crews to the fortunes of a single carrier because they risk losing the benefits of seniority if they change jobs. I’ve joined others in advocating for a national seniority list that will help crews preserve the seniority credits they’ve earned in the event of a merger of two airlines. A national seniority list also would provide portability in the event of furloughs or an airline’s shut down, meaning a pilot or flight attendant wouldn’t have to land at the bottom of another carrier’s list and all but start over.

This system wouldn’t offer a job guarantee – there’s no such thing in the airline industry -- but in the event a surviving airline is hiring, an employee would have the opportunity to compete for an open position and be paid in keeping with his or her experience.

As I envision it, a national seniority list would not serve the whims of those who perhaps want to fly for a carrier in Florida in the winter and a different carrier the rest of the year. Seniority is not necessarily an indicator of the industry’s or a company’s best employees – as important as experience is. But it does serve as the structure that governs pay and benefits.

So let’s talk about pay. Today’s regional industry is yesterday’s B-Scale. Back when the industry began experimenting with a tiered pay scale, the unions argued to get rid of B-Scale wages because one employee doing the same job with the same seniority should not be paid less than another. While the advent of the B-Scale compensation structure in the mid-1980’s led to explosive growth for the industry, the unions were successful in eliminating the two-tier wage scale in the subsequent round of negotiations.

Today, regional carriers like Colgan, Comair, American Eagle and others account for roughly half of all domestic departures. The regional sector has experienced explosive growth because small jet aircraft have allowed airlines to continue to serve smaller markets that couldn’t support bigger planes, in addition to cost and competitive pressures in the industry that have forced down average wages and benefits.

Here is where Business Week’s Bachman provides the proper context: “Anyone horrified by Shaw's [first officer on Colgan flight 3407] salary must also confront their own primary motivation when booking an airline ticket: finding the lowest possible fare. The two are connected, say airline executives and pilots. "People will spend three hours on the Internet to save $8," says Arne Haak, vice-president for finance at AirTran Airways (AAI). "You know this! You do it yourself."

 

So, What to Do?

Pay rates for pilots have been largely dictated by the size and weight of a particular aircraft type. Supporting this is the idea that more responsibility is associated with flying 250 people versus 130 or 50. The recent NTSB hearings highlight the pay discrepancies between mainline pilots and regional pilots. They are very different sectors flying very different revenue generating flights. But . . .

The pay differences between the mainline and the regionals have become too great. In many ways, the gap between what captains earn and what first officers earn has grown too large. It used to be said that unions employ practices that eat their young. But with an industry in contraction, we have reached a point where current pay practices even eat the old. As the legacy carriers are forced to reduce capacity even further, we now have former captains flying as first officers on the mainline. That’s taking seat progression the wrong direction.

Much has been made about executive compensation in this industry and across the US. But perhaps we should look at pay practices elsewhere in the industry as well. Should a pilot flying 130 passengers be paid three times more than a pilot flying 50 passengers? I think not. Just as it is time to rethink seniority; it is also time for the airline industry to rethink how flight crews are paid. With lighter materials ensured on tomorrow’s airplanes, weight becomes less of an issue. Carriers’ fleets are increasingly made up of smaller aircraft. Perhaps it is time to shed the complex calculation that goes into pilot pay, and consider salaries for cockpit personnel and flight attendants.

Such a system certainly would have better served the first officers at the mainline today who once sat in the captain’s seat. Those pilots took a disproportionate cut in pay relative to the captains that were not forced to move from the left seat to the right during the last restructuring. Given that segments are typically divided between captains and first officers, the industry should reconsider the 35-50 percent difference in their pay. And differences between the mainline and their regional partners should not be 200 percent.

I am certain that a transition to a new pay system will increase costs to the industry. But either the unions get their arms around the issue and come up with a more equitable system, or someone will make that decision for them. Pilot wages are inextricably linked to the industry’s ability to bring in revenues. As we continue to rethink what will help strengthen our domestic airline industry, we should also be thinking about how we allocate those pilot labor dollars.

I am suggesting a sea change in thinking about compensation. Further what I am suggesting will require a challenge to those who fail to recognize new realities in the industry, among them some of the union leaders who have responded to new competitive challenges with nothing but stubborn recalcitrance. In an industry that cannot earn a profit on a sustainable basis let alone earn its cost of capital, maybe the compensation structure that Captain Sullenberger speaks to should be changed to in order to obtain the best and the brightest on all levels.

The upside would be less but the perception that somehow safety of the airline system is somehow tied to salary would be addressed. Moreover, a salary structure is more stable, more predictable, more in line with revenue picture that drives the global industry and certainly more in line with an industry that will not experience the rampant changes in technology that drove productivity of employees in the past.

It is a conundrum. But while in the restructuring mode, address the fundamentals. The airline industry can learn from the head in the sand mistakes made in the auto and steel industries because if not fixed, the industry will continue to contract.

Tuesday
Jul222008

Leverage Detoxification: Banks and Airlines

With second quarter earnings releases in full swing and a four-letter word starting with “F” being used to describe the impact on the industry’s earnings at each and every carrier, the discussion turns to the what actions each and every carrier is taking to address the new macroeconomic reality. The unequivocal response for the industry’s carriers, with the exception of one I guess, is the level of capacity that will be taken out of the system beginning later this year.

The Banking Industry

Over the weekend, and in between 4 rounds of competitive golf in 95 degree heat and matching humidity, I was drawn to a series of articles in the July 28, 2008 copy of Business Week. Peter Coy wrote a piece entitled: The Credit Chokehold. Breaking the vicious cycle of tightening will take time, but how much? He writes how the cover story explains how each dollar of loan loss can force commercial and investment banks to reduce lending by $15 or more. He goes further to suggest, that by one estimate, mortgage-related losses alone could cause a trillion dollars in credit to vaporize”.

Think About All Network Industries – Not Just Banks

In the second Business Week story by David Henry and Matthew Goldstein: How Bad Will It Get?, ….the concept of leverage is raised. The authors write: “Traders, investors, bankers and economists are waking up to the possibility that Wall Street’s recovery from the worst financial disaster since the Great Depression could grind on for years. ……its aftermath will weigh on banks, other companies and consumers alike.”

“One thing is for sure: The new normal won’t be as fun as the recent past. Banks will be smaller and fewer. Capital will be harder to get for some consumers and companies”. The writers ask: Why hasn’t the healing begun? The answer lies in the mechanics of leverage, or borrowed money, which banks not only provide to customers but also use themselves. Leverage is a powerful but dangerous tool, intoxicating on the way up and devastating on the way down”.

The authors continue: "Banks live on the stuff [leverage]: When they post profits, they borrow money to make more loans and book still more profits. During the boom, bigger mortgage loans pumped home prices until people couldn’t handle the debt and the bubble burst. Then the banks, poorer from the losses, had to cut back their own borrowing, too. Now the damage is spreading. How far? Simplified, for every dollar of bank wealth lost, government-regulated commercial banks must eliminate some $10 of lending; for investment banks, the figure can be $30”.

The article includes a graphic demonstrating “The Leverage Multiplier.” Banks used borrowed money to amp returns in the good times.

1. By borrowing $15 for every $1 of capital – or leveraging up 15 times – an investment bank could turn $10 billion into a portfolio of $150 billion.

2. But leverage also amplifies losses. The authors describe when the value of a bank’s portfolio drops by 2%, or $3 billion, the bank loses 30% of its capital, cutting the original $10 billion to $7 billion.

3. Those losses have ramifications that go beyond the bank. If its leverage ratio remains the same, the firm may have to cut back its lending – in this case by $45 billion ($3 billion X 15). That tightening hurts the economy”.

Airlines: Struggling With Just How Much Capacity to Pull Down – For Many of the Same Reasons

The airline industry that lawmakers, communites, employees and other stakeholders have come to know was born of an industry addicted to leverage.

Whereas banks utilize financial leverage to improve returns, the airline industry employs operating leverage. Each node, or new city added to an airline’s map, benefits multiple other flights on that airline’s network by generating new traffic and revenue. Both of these industries are network industries and leverage is a critical component in sustaining existing, and generating new, scale economics.

As the Business Week piece suggests that traders, bankers and economists are waking up to the fact that the banking industry’s recovery could drag on for years - airline industry consumers, employees and communities of all sizes should be considering the same. The article suggests that the banking industry will be smaller and have fewer players. So too will the US and global airline industries. Air travel consumption will prove harder for many consumers going forward. And yes, there will be some dislocations from the air transportation system.

The leverage of capacity growth since deregulation has been both a powerful and dangerous tool for individual carriers. For the industry, it has been intoxicating on the way up as air travel has been made available to the masses. But we are about to experience some devastation on the way down as networks are deleveraged.

Wright Analysis Still Describes Hub Dynamics

The one thing readers will discover about Swelbar: I have advocated one position or another during a career and have done so with conviction. I have made my conclusions over the years with supporting analysis. In fact, the internet makes it impossible to hide from what you have done and said and honestly, that is good. In 2005, I was retained to assist American Airlines in its defense of the Wright Amendment.

Based on work done earlier in a career (the United-US Airways merger attempt in 2001), American asked for an analysis of what “could” happen to the DFW hub if AA were to match Southwest’s expected three frequencies per day into 15 of the largest US markets from Love Field? It was assumed that these 90 inbound and outbound flights would be operated at Love instead of DFW. The (Eclat Consulting’s findings at the time on this project where I was the lead) conclusion was that if American were to move those 90 operations from DFW to Love, an additional 279 flights at DFW would be negatively impacted. The analysis was a ”bottoms up” analysis of load factor impacts of all flights arriving or departing DFW based on the movement of these 90 operations.

Of course you can question whether all 279 would have been uneconomic as market prices were not considered. The analysis found that a 3:1 leverage ratio existed (one mainline flight from 15 large markets supports 3 other mainline and/or regional flights at DFW). It is not totally unreasonable. Moreover, we are about to witness in real time the delicate cutting of capacity that is being considered by each of the hub and spoke carriers.

I was attacked on the analysis of hub degradation then, but it applies to the industry’s decision to cut back capacity today. Wall Street is saying that 20% is the number that gives the industry pricing traction. I do not disagree. But isn’t it also about a 20% reduction within a carrier’s competitive footprint that matters? Why is it being suggested that each carrier pull down capacity approximating 20% that makes it right in the eyes of the Street?

I have been public in my analysis that the industry needs to be judicious in capacity cuts. There is a leverage ratio for airlines too. Competitor capacity cuts within each airline’s footprint need also to count toward that 20 percent. But Delta’s 20 percent is different than United’s 20 percent is different than American’s 20 percent. Right? By the actions already announced, just how much previous capacity will vaporize based on the deleveraging of the industry? Capital has vaporized and so too will existing capacity – or at least we hope.

The healing for the airline industry will only begin when a sustainably profitable model is found that benefits all stakeholders - and this time it will need to benefit shareholders too.

Congrats to United on a very nice earnings call earlier today.

Monday
Mar242008

Not Time For “Hush Money”

The Status Quo Is the Issue; Not Firing CEOs

Today I received a comment from Carmen on my latest blog post. Carmen is a frequent reader here, student of the industry and a person that is not afraid to say and write what he believes. Even if it means that he is not the first person other pilots seek out in the crew room when he checks in for his trip. He suggests that invoking force majeure might incite a revolution – and I paraphrase.

Carmen is not a current member of his union and his philosophical differences with his union have been written here and on multiple blog sites that cover the industry. Carmen, like others, point to the lack of a people element in the US airline business today is what stands in the way of a successful and sustainable industry when contrasted to the industry we know that perpetually teeters on the edge.

I Said I Would Not Acknowledge

Regarding Carmen’s comments, I responded in a pretty matter of fact tone. After responding, I started thinking back to Bob Reed's piece in Business week last week entitled: It's Time for United's CEO to Go; UAL should keep United Airlines in Chicago—but send Glenn Tilton, its deal-hungry CEO, packing. OK, for those that know me, you know that I have an affinity for Tilton. Do I agree with everything that has been done at United under his watch? No, I do not. Where I absolutely agree with Mr. Tilton is that the status quo does not work for any stakeholder group. Period.

So Mr. Reed, my question to you: are you singling out Tilton or are you joining hands with certain industry stakeholders that are looking for any leverage to maintain the status quo and perpetuate the self-imposed gridlock toward change which afflicts the US industry? It seems to me that any question you asked in your article could have been asked of Richard Anderson at Delta, Doug Steenland at Northwest, Doug Parker at US Airways and yes, even Larry Kellner at Continental. And I am going to include Gerard Arpey of American and I will discuss that later.

And Mr. Reed, I am sure glad you mentioned Continental and its transformation. From my read, about the only thing in your article that comes close to even describing the competitive reality that faces this industry each and every day is the fact that Continental survived the “controversial and oft-despised” Frank Lorenzo era. And I quote further: “the airline survived his tenure (along with two bankruptcies) and eventually morphed into one of the country's most successful large carriers. Now Continental is enjoying solid financial returns, improved customer satisfaction, and stronger employee relations. What's more, its CEO doesn't want to merge and is even ordering new planes”.

Pretty bold statement on the intentions of Continental’s current CEO who has done anything but rule out merger efforts should other carriers in the industry decide to join hands. Then again, it is hard to talk about joining hands when you are encumbered by a golden share that also serves as golden handcuffs. And even bolder to insinuate that other airline CEOs would not want to achieve the same thing that took Continental 10 years to begin fully realizing. And for that matter, that type of success is what CEOs want to be paid for. But the type of transformation that continues at Continental is more akin to a marathon than a sprint.

Where This Whole Post Started

Like today, the industry then was engaged in a shakeout and survival of the fittest when Continental began its transformation. For any Continental, PEOPLExpress, Frontier, New York Air, Texas International (see comment section) and Eastern (did I leave any carrier out?) employee of the time there are plenty of horror stories. But 20+ years later, we continue to witness the legacy carrier that first underwent necessary quadruple bypass surgery to transform itself to a US industry leader.

The only thing different today is that the transformation is more difficult. In the 1980s it was important to build a network, with a cost structure, that gave a carrier some form of presence/dominance within a particular US geographic region. Today it is about building an entity that maintains is preeminence in the US domestic market while spreading its reach to all world regions with a cost structure that allows it to compete where external forces are increasingly complex. Mr. Reed, airline labor, airline consumer activists and Rep. Oberstar would all have us believe that today’s airline world should remain focused on Altoona rather than Auckland; Duluth rather than Dubai.

Carmen in his comment to me mentions pandering and appeasement against a backdrop of a leadership void. Where I am stuck, is that I think there is finally leadership within the industry and there is a vision as to where this industry needs to morph to. When there is leadership and vision, there will be reasons to say no. And today’s CEOs are saying no to a return to the way things have been. They are saying very clearly and in their own way, no to the various issues that led each of their respective entities into bankruptcy or restructuring.

Definitely Not the Time for Hush Money

I asked Carmen in my response: “but isn't what labor wants is an historical return to pandering and appeasement? Throwing good money at the age old problems only makes people happy in the short term. Then the industry has to return and ask for concessions because they can no longer afford the hush money that was negotiated. I am all for saying no and trying to find a way to break this age old pattern. And I think finally this industry has a group of CEOs that can and will say no rather than push off the tough decisions that have been deferred over the past 3-4 negotiating cycles. Popularity contest -- NO. Necessary action – YES”.

It seems that the Northwest employees were more than willing to vote Steenland out in the event of a Northwest – Delta deal. And apparently he was willing to drop his “ego” and step aside in the event of a transaction that he and his board deemed in the best interests of all stakeholders.

My bet is Mr. Tilton and others would/will do the same in return for a deal that satisfies a vision. United has been out front in the consolidation view to be sure. But, United has been out in front suggesting they would put down capacity in the event of high oil prices also. And that simply sounds like managing the business to me. Mr. Reed pleads with United’s Board to “give Tilton his due, provide him fair compensation for time served—and begin the hunt for an executive who can build on his accomplishments and take an independent airline to greater heights”.

But Tilton’s work at United is not yet done and therefore the United Board should no more pay Tilton his hush money to walk today anymore than the prior United administration should have paid the United pilots the hush money to end the dreaded “Summer of 2000” that ultimately landed the carrier in bankruptcy. And certainly Mr. Arpey should not be paying his pilots, flight attendants or any other employees the amounts of hush money they are seeking over an executive compensation plan designed by American's Board. A compensation plan that could have been altered by the Board, not by Mr. Arpey and his management team.

Breaking the boom-bust cycle is much more important than perpetuating the status quo. Maybe we should invoke the force majeure clause on the self-imposed gridlock toward change which afflicts our industry …

To call for one CEO's head when an entire group of industry CEOs recognize that the status quo just does not work is well.......unfortunate.

More to come.