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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.

Monday
Mar172008

Invoking the Force Majeure Clause: Oil Taking Its Toll

...and Thinking About Northwest - Delta

As I prepared to write this week, I had outlined a piece around the NCAA basketball tournament generally and Selection Sunday specifically. I was going to talk about how the Delta-Northwest deal, destined for a #1 seed a month ago had become a “bubble” deal over the past month because of a less than stellar end to the conference schedule and “one and done” in the conference tournament. And then I was prepared to place them in the last 4 teams out group.

But rather than just isolate Delta-Northwest, I think it is time for the industry to think about consolidation in yet another way. Typically we think about consolidation as two entities combining through merger activity. But there is financial consolidation as well. It is similar to what we experienced during the 2002-2006 period where an industry contracts on its own volition. It is probably time to begin another round of contraction as the price of oil makes it very difficult for the industry to maintain its current service offerings.

Introduction to Force Majeur for Those on Capitol Hill
and a Refresher for US Airline Labor

From where I sit, the NCAA tournament will make great theater as always but will pale in news as to what I see coming for the US airline industry. In my last blog post, I purposefully left the piece hanging on an issue for labor and the politicians to seriously consider: “Politicians and labor should think real hard about the fallout that could stem from the current economic environment [read to include high oil prices] versus what the perceived fallout could be in a consolidation scenario”.

As the market opened this morning, oil traded near $112 per barrel. Whereas the price has pulled back from those highs, it is becoming clearer that oil is going higher as the highs get higher and the lows get higher. Heeding warnings from the industry that capacity will be closely examined at these prices, I began to write this piece.

Then as I was writing, I did my usual check of the headlines as the day wore on. In one check of the day’s news, I read, as everyone should when you are not reading here to steal a Maxon line, a blog post by David Field of Airline Business on his blog named appropriately Left Field. Mr. Field cites quotes directly from Delta’s Anderson, Northwest’s Steenland and Continental’s Kellner each questioning the size of their respective networks in the face of $105 per barrel oil.

Defining Force Majeure

Typically we do not like to talk about force majeure issues in the industry, but I am thinking it is time. Wikpedia defines force majeure as:

Force majeure (French for "greater force") is a common clause in contracts which essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties, such as war, strike, riot, crime, act of nature (e.g., flooding, earthquake, volcano), prevents one or both parties from fulfilling their obligations under the contract. However, force majeure is not intended to excuse negligence or other malfeasance of a party, as where non-performance is caused by the usual and natural consequences of external forces (e.g., predicted rain stops an outdoor event), or where the intervening circumstances are specifically contemplated.

Time-critical and other sensitive contracts may be drafted to limit the shield of this clause where a party does not take reasonable steps (or specific precautions) to prevent or limit the effects of the outside interference, either when they become likely or when they actually occur. A force majeure may work to excuse all or part of the obligations of one or both parties. For example, a strike might prevent timely delivery of goods, but not timely payment for the portion delivered. Similarly, a widespread power outage would not be a force majeure excuse if the contract requires the provision of backup power or other contingency plans for continuity.

A force majeure may also be the overpowering force itself, which prevents the fulfillment of a contract. In that instance, it is actually the Impossibility defense.

The understanding of force majeure in French law is similar to that of international law and vis major as defined above. For a defendant to invoke force majeure in French law, the event proposed as force majeure must pass three tests:

Externality

The defendant must have nothing to do with the event's happening.

Unpredictability

If the event could be foreseen, the defendant is obligated to have prepared for it. Being unprepared for a foreseeable event leaves the defendant culpable. This standard is very strictly applied.

Irresistibility

The consequences of the event must have been unpreventable.

A Non-Lawyer Discussion of Force Majeure

Force majeure (French for "greater force") is a common clause in contracts which essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties, such as war, strike, riot, crime, act of nature (e.g., flooding, earthquake, volcano), prevents one or both parties from fulfilling their obligations under the contract.

Name any airline that spent time in bankruptcy and was required to file a plan of reorganization that correctly estimated the price of oil in that plan. United assumed $55 per barrel and that was $50+ per barrel ago. Northwest just recently emerged and it assumed oil $40+ per barrel ago.

Based on the assumed price per barrel of oil, contracts were entered into with the regional affiliates of the major carriers. The price of oil has long been described an uncontrollable expense for the airline industry. Is this an act of nature, I do not know. What I do know, is that this rise in the price of oil is beyond the control of the industry. Moreover, this recent price push makes oil more expensive than it was on an inflation adjusted basis in the early 1980’s and we know that the period will always be defined as an oil crisis.

However, force majeure is not intended to excuse negligence or other malfeasance of a party, as where non-performance is caused by the usual and natural consequences of external forces (e.g., predicted rain stops an outdoor event), or where the intervening circumstances are specifically contemplated.

There is no negligence here by the industry or malfeasance by anyone. This is the market at work. The causes for the oil price increases are many but cannot be isolated to any one catalyst. And none of this is as predictable as rain on a hot summer night.

Time-critical and other sensitive contracts may be drafted to limit the shield of this clause where a party does not take reasonable steps (or specific precautions) to prevent or limit the effects of the outside interference, either when they become likely or when they actually occur.

To say that the industry has not taken reasonable steps to prevent or limit the effects of the outside interference would ignore the painful attempts to address cost structures that were simply not sustainable. As Jamie Baker pointed out last week in his research note, since 2002, the price of oil will have increased some $25 billion for the US industry while savings from labor over the same period amounts to $7 billion.

Through the restructuring period and practices that continue today, the industry cut costs to combat a declining revenue environment and to address the rising cost of oil. The industry has used hedges; pared domestic capacity as a way to reduce exposure to an unhealthy domestic market; increased international capacity as a way to increase revenue; cut back on amenities; cut distribution costs to a minimal level; reduced ownership costs; cut employee wages; improved employee productivity; improved asset utilization; terminated pensions; outsourced flying; outsourced maintenance; outsourced administrative activities; and experimented with hub structures to name a few of the hundred of cost cutting activities that have been employed.

Most, if not all, reasonable steps have been taken to prevent or limit the continued losses for the US industry – except for that outside interference called oil.

Included in the definition: A force majeure may also be the overpowering force itself, which prevents the fulfillment of a contract. In that instance, it is actually the Impossibility defense. As for the externality, the industry has nothing to do with the event’s happening. As for unpredictability, this industry has done everything it can do to counteract its influences. As for irresistibility, the consequences of the oil price rise were not preventable.

Delta and Northwest

About one month ago, I remember Bob Fornaro, CEO of AirTran Airways, referring to proposals made to his pilots in an oil-denominated way. Like Fornaro, Messrs. Anderson and Steenland I only hope that you tell your pilots and all other employees that the terms of the agreement you made in order to have a single collective bargaining agreement in place are now off of the table. You made an agreement where some of your pilots would receive 30% pay increases at $85-90 oil, surely those agreements should not be made at $105 oil. Invoke force majeur.

$20 per barrel ago, you said that your networks would be largely kept intact. Now today you seem to be hinting that the size of your networks may need to be reconsidered. Let’s just face the fact that there are too many regional carriers and too many hubs and as a result too much money being spent on serving communities that cannot economically support the frequency of access to the air transportation system today. Cutbacks like those Doug Parker of US Airways suggested were probably unavoidable at some point and at $105 oil, well……invoke force majeur.

In each case, these suggested actions seem prudent and can easily be explained by an unpredictable externality whose consequences could not have been predicted by you. Invoke force majeur.

Consolidation is still right. But as everyone has said it has to be the right deal for all stakeholders and given the externalities facing the industry, much harder choices will now have to be made.

More to come.