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Entries in Globalization (3)

Thursday
Sep112008

The Global Airline Industry and Its Interdependencies

It Is Not Just the U.S. Anymore

As this blog approaches its one year anniversary, I have written about many topics. While much of my writing thus far has been US-centric, we have often written about airline happenings around the globe. We have written about the forces of globalization and how US carriers have lost competitive traction when compared to the global elite carriers like AirFrance/KLM, Lufthansa/Swiss, Singapore, Cathay Pacific, Qantas and others. Yesterday, I wrote about the falling price of fuel and concern that announced capacity cuts might not become actual capacity cuts.

When it comes to fuel though, it is global forces that impact its price and they range from demand by rising industrial powers to the relative strength of currencies to market activity. As I do my lunchtime reading, I ran across a must read article written by Derek Sadubin, the Chief Operating Officer of the Centre for Asia Pacific Aviation in The Australian entitled: Deflation in price of oil not all good news for airlines.

Sadubin does a nice job of intertwining economic, competition, currency and oil events from around the globe to discuss the immediate future. He talks about a bear market for oil; business travel stalling; a difficult economic environment proving difficult for the weaker players; competitors rising to challenge incumbents in many parts of the world; a mention of Emirates and their plans to fly through the current difficulties and grow at the expense of other’s weaknesses; and the shift in the relative strength of currencies and the impacts on certain carrier revenues. This references only a few of his points.

But I suppose I liked the article also because he shares my view that the Boeing strike may not be a bad thing for the global industry. In an interview I did with Ted Reed of The Street.com last week, I was quoted as saying that a Boeing strike is not a worse case scenario. You know how it goes in this industry; we order planes in the up cycle and take delivery in a down cycle. It is not the US carriers that hold control over the order book, it is the international carriers. And maybe, the time may not be right for them to expend capital on new equipment to fly to new markets as the global economy slows.

If nothing else, the read reminds us of the global fundamentals that govern this industry and the interdependencies the many forces have that dictate this industry’s successes and failures.

More to come.

Monday
Jun092008

A Recent Swelbar Interview

The ANALYST is the flagship publication of ICFAI University Press* which caters to a niche segment comprising finance professionals, bankers, academicians, economists, corporate executives and students. Just published.

The ANALYST: Delta Air Lines and Northwest Airlines have recently agreed to merge in a $3.1 billion deal. How do you see the deal?

Swelbar: I see the deal as the real beginning of the second phase of the restructuring of the US airline industry. The first phase began with the bankruptcy filings in 2002 and concluded with the emergence from bankruptcy of Delta and Northwest in early 2007. The industry (largely the legacy carriers) shed nearly $20 billion of cost during this period with nearly 60% of that being reductions in employees, rates of pay and benefit reductions. But the necessary cost reductions were designed to address a revenue environment that was increasingly influenced by the low cost carrier sector of the industry that had grown to nearly 30% of industry capacity. This created more competition with an industry that was producing $30 billion less in revenue as the relationship of revenue to GDP fundamentally shifted beginning in early 2001. The restructuring cuts were not made with the idea that oil would increase from $45 per barrel to $117 per barrel today. And it is the cost of oil today that is the catalyst underscoring that the restructuring work to make the industry sustainably profitable is far from done.

The ANALYST: What are the parameters considered at arriving at the deal?

Swelbar: I will answer this as the catalysts to consolidation: high oil; a softening economy both domestically and globally; increased global competition; and tightening credit conditions to name a few. The US domestic market, where all US carriers have the strong majority of their capacity deployed, remains a highly fragmented and hypercompetitive market. Therefore it is a most difficult space to realize higher fares absent the push from higher fuel. Today fares are on the increase domestically but not near enough to offset the cost of higher commodity prices. Therefore the industry is exploring two different paths: 1) consolidation of industry capacity through merger and acquisition activity; 2) consolidation through liquidation of airlines; and 3) consolidation of industry capacity by removing uneconomic capacity. Both strategies are being employed simultaneously and can be expected.

The ANALYST: What are the expected synergies of this deal?

Swelbar: Delta and Northwest, while announcing some capacity cuts prior to announcement of the deal, are betting that the linking of two end-to-end networks is the way to drive increased revenues without increasing flying expense. This is possible through a larger network providing for an increased number of new city pairs to sell. On the cost side, the combined carriers see that the ability to best match aircraft size to city pair markets will provide a cost savings going forward. As to other benefits, the North Atlantic alliance with Air France, KLM, Alitalia and CSA will remain and can only become more robust. Obviously Northwest's delivery position for new transoceanic equipment is a benefit. But most of all this is a step, among many, to continue to work toward finding a more stable platform for employees, communities and stockholders that stand alone plans cannot begin to guarantee. Is there risk? Yes. But there is arguably more risk with a stand-alone plan.

The ANALYST: What could be the challenges to this merged entity?

Swelbar: The obvious challenges are the age old challenges that present themselves when the US airline industry looks to consolidate: the regulators and organized labor. Change is difficult but an industry that took $20 billion of cost out of their combined operations and produced only two years of industry profitability underscores that the current industry structure is far from healthy. In addition the Congress is sure to raise consumer issues. But concerns that consolidation will raise prices are muted by the industry's fuel bill increasing by nearly $20 billion in 2008 versus 2007. Fares have to go up, otherwise we will have a bankrupt industry rather than a few bankrupt carriers. And the US market under deregulation has proven time and time again that if one carrier tries to gouge consumers in certain markets, there will be a lower cost provider ready and willing to exploit that market opportunity.

The ANALYST: How do you see the future of US airlines industry?

Swelbar: Honestly, I am concerned. Our market remains the most regulated, deregulated market in the world – or so it seems to me. And some of that regulation stems from parochial interests on Capitol Hill that somehow believes that if there is a runway, a terminal building and security that the airport is somehow entitled to air service – not whether the economics make sense. Consolidation along the lines of Delta and Northwest and others that might follow is but one step along the way. Globalization is an economic force that cannot be ignored. Recognition that the airline industry is a global industry would be a good start for the US policy makers. Recognition that US airlines need to be freed of the shackles that largely tie them to the US market need to be unlocked. Unless labor and policy makers can move their mindset away from believing that the US airline industry can support jobs and remain US-centric will only ensure that we continue to experience the boom and bust cycles that have been the rule for the industry over the last 30 years. And that has not proven to benefit anyone.

The ANALYST: Any other comments?

Swelbar: Unless something changes along the way that paves the path for a more globally focused US industry, I am afraid that we will see another icon like Pan Am or TWA disappear from the US landscape. Thank you for the opportunity to talk with you.

*this interview was done $20 per barrel ago.

Sunday
Nov042007

My Beginnings and Increasingly Appreciating Tilton's Message

This little bit on me should go a long way to helping you understand where I came from and how it impacts my views on the airline world today. I now have history to reflect upon – I did not when I began in the industry and was forced to make decisions as a union leader to ensure that my carrier survived the war of attrition.

Glenn Tilton, UAL’s Chairman and CEO said last week in a speech to the Nikkei Global Management Forum in Tokyo: “If there is one imperative for every business in the global economy today, it is simply this: evolve, adapt, reinvent . . . or risk irrelevance in the global marketplace”. He went on to say: “As everyone here today knows well: the reality of our world is that globalization is relentless. Think of any industry represented in this room; choose any business listed on the Tokyo Stock Exchange; and one can be sure: it looks nothing like it did ten years ago; and looks nothing like it will ten years from now”.

Some Personal Background

In 1979, I was a sophomore at the University of Minnesota in Minneapolis. And like many, going to school required I worked a job or two to make ends meet. In trying to incorporate all things important in life at the time -- beer, going to class or not going to class, going to work, girls, beer and getting up to do it all again, one thing was clear - I was not getting much out of school that felt particularly inspiring.

It was at this time that I had a conversation with a cousin who had been a flight attendant for TWA; she suggested that the job would allow me more than sufficient time off that I could finish school. I was turned down by Braniff and ultimately hired by North Central Airlines. While I was in training, North Central and Southern merged to form Republic Airlines. So, by the time I graduated in 1979, I was a Republic flight attendant on an airplane to be based in Detroit.

I had no idea what I was getting into, but it was more than I bargained for. I sat reserve for the first six months, constantly putting in for lines on the Convair 580. Soon, I was able to hold a line that had me overnighting in Huron, SD after making 11 landings from Detroit and facing 10 landings back the next day. So, in that first year at Republic, there was no school for me. The industry was deregulated just nine months before I was hired. Republic grew quickly and my relative seniority allowed me hold a line of illegal overnights. With that relative security, I enrolled at Eastern Michigan University.

There I was blessed to find a great academic environment with only 20 declared economics majors. Classes were small, the professors were engaged and, finally, the lust for learning emerged. I carried 15-18 hours per semester while flying my line and finally finished my undergrad in 1982. My flying took me from Huron to sleeping in the basement of the Sault Ste. Marie Airport on Friday, Saturday and Sunday nights. With only rare exceptions, I flew two years and never left the State of Michigan – flying at night from Detroit to Traverse City to Pellston to the Sault and then retrace those steps again beginning at 5:30 the next morning. Often the basement of that airport was my study room.

In 1981, the industry began an era of massive change promised by the deregulators. The dinosaurs, free from the yoke of regulation, began to rethink their approach to the business. What followed was the the quick liquidation of Braniff, the rapid entry of carriers into markets of all sizes based on the hub and spoke network model, the grounding of the DC10s, the PATCO strike, the birth of upstarts like New York Air and PEOPLExpress, multiple mergers and the era of Frank Lorenzo. By the end of 1981, Republic had acquired Hughes Air West and I got to experience a merger firsthand.

Republic and its lineage were highly dependent on government subsidies that encouraged airlines to serve the small communities I flew to on a daily basis like Pellston, Muskegon and Ironwood. And as this subsidy was coming to an end, it was clear that Republic's costs and their revenues were falling out of alignment. Between 1981 and 1983, airlines across the industry negotiated several concessionary contracts during an era of change in which concessions were the rule rather than the exception. The contracts were in effect for only a few months at a time because most people assumed that the economic cycles were similarly short-lived ... and in virtually all cases, as soon as the concessions came to end, the return to the bargaining table was not far behind.

As I neared graduation, I was encouraged by my co-workers to run for President of the Detroit domicile, a position I won in the middle of this concessionary era. I crunched numbers and made some mistakes, but also began a different phase of my education in an industry well into transition. By mid-1983, the five Republic unions were tired of this constant return to the concessionary bargaining table and formed a steering committee to explore a leveraged ESOP of the company where I served as the flight attendant representative.

Our first job was to hire the professionals needed to do the job. We hired an airline economics firm, an investment banker, a labor lawyer, a lawyer familiar with ESOP law and a communications firm. Our second job was to figure out how to pay them – a task we accomplished by assessing the members of each union.

With professional arsenal in tow, we began to create a business plan that required hard discussions about the amount of labor concessions that would be required to fund an LBO. In our view, it was well worth the effort to try to fix the company rather than be forced to endure more and more concessions that amounted to mere Band-Aids that labor was putting on a carrier that was hemorrhaging cash as the industry changed around us.

The centerpiece of the union’s business plan was a the build up of the Detroit hub. So with business plan in hand, it was off to New York to talk with banks that might be interested in lending us inmates the $400 million or so it would take to buy the asylum. For the most part the five unions stayed together. The IAM and its maverick investment banker at the time, the late Brian Freeman, were in and out, but generally on board with a deal.

During one trip to New York that took us to Citibank -- Republic’s lead lender -- Republic CEO Dan May was relieved of his duties and replaced by a very tall man in red suspenders. Into the room walked Stephen Wolf. As Wolf came on board, the negotiations moved away from a leveraged deal to a more traditional give-and-take with equities as the quid in return for concessions – and take they did.

In the end the flight attendants agreed to a 23.5% pay cut and some work rule changes. In return, the best we could negotiate for all employees was approximately 20 cents on the dollar for concessions granted, a return on our “investment” made up of common stock, warrants and a liquidating preferred stock that was paid down with earnings. Following Northwest’s purchase of Republic in 1986, the employees at Republic were made whole for their concessions. That is the “upside” of variable compensation that has left an indelible mark on my thinking.

21 Years Later

Today’s airline environment feels about the same as it did in 1986. Structural change. Consolidation talk. And many people attempting to convince themselves that the Band-Aid approach to labor costs will only need to last through one cycle before they can get it all back.

This time, however, it is not so simple. For one thing, foreign airlines now play a far greater role in the important “domestic markets” that span the globe. Events like the Air France – KLM merger will dictate commercial strategies. Strategic models like the one LAN is implementing are sure to have made a lasting impact on commercial airline development when we look back in 2028. The two great unknowns are how Asia will develop and what will transpire in the nations comprising the United Arab Emirates. This region will certainly force change across the globe over the long term and will surely cause the European market to look in the mirror in the relatively near term.

Twenty-one years ago, we didn’t have the same rules of engagement or recent history as our guide - as there was none. In a changing marketplace, it took a proactive approach to make a flailing/fledgling carrier live to see another day and “create value” for a new platform when leveraged across a much bigger network.

UAL CEO Glenn Tilton, one of the most maligned CEOs in the US industry, began talking about the changes necessary for the industry and his carrier to survive soon after United emerged from bankruptcy. As can be expected, a lot of people took shots at the messenger, as they did at US Airways' Doug Parker who echoed Tilton’s warnings. But these chief executives now have company in the form of nearly every CEO at the major US network legacy carriers in discussing consolidation in their third quarter conference calls.

It’s time we accept the fact that this is a time of opportunity for both management and labor. Just as it was during immediate period following deregulation of the US domestic airline industry, the dinosaurs face continued, significant change or extinction. The old ways are certain to face additional challenges from the new, with youthful competition making inroads into our respective markets and new competition from airlines emerging from previously unknown dots on the world map.

The Pentultimate Question

In his Tokyo speech, Tilton asks the following question: “As globalization gives rise to new economic powers within the developing world, the real question for all of us operating in mature economies today is this: will the legacy systems that contributed to the success in developed nations in the 20th Century be an asset or an impediment to growth in the 21st Century”?

He goes on: “The airline industry is a perfect platform from which to focus this discussion, because it is subject to virtually every imaginable challenge -- every human challenge, industrial challenge, financial, regulatory, and security challenge -- throughout the global economy. And then, of course, we also contend with the weather”.

Aloha