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Monday
Feb082010

February 2010: Short on Days, Long on News

This month promises to be full of news in the airline industry, and potentially in a big way.  February is the month where we celebrate Groundhog Day.  And like the movie of that name, we’ll probably see some of the same stories emerge, over and over again.

Colgan, Congress and the Regulators

One of the biggest, in my view, is the ramifications of Colgan 3407, the subject of many megabytes on Swelblog.   The tragic crash of the Colgan Air flight came last year on February 12 and there have been a number of Congressional hearings since focusing on the safety of the airline system generally and the regional airline system specifically. Last week, Federal Aviation Administration Administrator J. Randolph Babbitt and DOT Inspector General Calvin L. Scovell III testified before the House on the status of the FAA’s response.. 

In its Call to Action, the FAA is looking at fatigue; crew training; pilot qualifications; training program review guidance; pilot mentoring/experience transfer programs; pilot records; and code share agreements.   

New scrutiny on code sharing comes courtesy of Reps. James Oberstar and Jerry Costello, who have demanded that the DOT IG investigate these widely-used agreements between airlines. The congressmen ask, at a minimum, that the investigation consider:

  1. Whether the DOT and the FAA have the legal authority to review code -share agreements between mainline carriers and their regional partners;
  2. How mainline carriers ensure that their regional partners operate at the same level of safety; and
  3. Whether the flying public has adequate information about code-sharing arrangements to make informed decisions when purchasing a ticket.

As if this story needed fuel to fire the debate, PBS Frontline will air an hourlong investigative report on the Colgan crash on February 9.   If PBS publicity on the subject is any indicator, then this piece will be will be as much about sensational journalism as it is about half-truths.  Already, Frontline is making much of the low salaries some regional pilots earn in a story centered on Colgan but that by all appearances paints all regional operators with the same brush. It will be important to parse the information offered and the story-telling in this piece. 

oneworld and an Immunized Atlantic (and Pacific?) Alliance

As STAR and SkyTeam fortify their alliances with new partners, anti-trust immunity and “metal neutral” joint ventures; American, British Airways, Iberia, Finnair and Royal Jordanian await word as to whether the third time will be a charm for oneworld to operate with immunization across the Atlantic. In a January article, Lori Ranson of Airline Business writes about some of the issues before the regulators.

This is only one big decision affecting AA – another is the continuing saga regarding whether Japan Airlines will stick with oneworld or submit to entreaties from Delta and join SkyTeam.  [NOTE:  JAL announces its intention to stay with oneworld on 2/9/10]  The media has been all over the board on this one, with this week’s predictions going oneworld’s way. This story has had more leads from unnamed sources than even the rumored merger talks in past years involving Continental and United, and United and US Airways.

But one thing is certain, and that is February 10, 2010, when four slot pairs become available to US airlines to serve Tokyo’s Haneda Airport under an “Open Skies” agreement between the U.S. and Japan. [DATE moved to 2/15 due to weather in Washington DC]  Initial applications for those slots are due this Wednesday, with final submissions due to the US Department of Transportation by March 1, 2010.  The winner could be flying as early as October of this year when the fourth runway at Tokyo’s downtown airport is scheduled for completion. 

As part of the pact, Japan also made immunized alliance relationships for JAL and ANA a condition of the deal. And it has long been thought that if applications for immunity were not made by mid-February then it would be difficult for the US government to complete the necessary analysis in order to meet the October deadline.  Few, if any, ATI applications have been approved in eight months or less.

United/Continental/ANA have already applied.  JAL is bankrupt but needs to pick a partner soon.  That means that the ongoing soap opera playing out in Japan may soon be coming to an end. 

The National Mediation Board and Airline Strikes

On January 21, 2010 the Association of Professional Flight Attendants (APFA) ended a two-week intensive bargaining session with American Airlines without reaching a deal. Leading up to these talks, the union had been working hard to rally its members, even going so far as to stage a mock strike with limited impact. Next up:  yet another round of mediated negotiations in Washington, DC beginning February 27.

Serious industry watchers may conclude that a a round of talks in Washington at this relatively advanced state of negotiations could mean that a “release decision” is imminent.  Another viewpoint is that the NMB might be more likely to put the negotiations “on ice” given the wide gap between what the union demands and the company believes it is able to provide.  Even in historically difficult times for the US airline industry, the APFA’s rhetoric suggests that the union will pay little to nothing in efficiency in return for the improved economics it seeks.  So these talks may be the next milestone marking how Obama’s NMB will deal with labor negotiations in the airline industry.

If nothing else, the APFA has been reckless in talking about a strike.  Long-term observers may recall that the union pulled off a coup in 1993 with a strike even the airline didn’t think would happen; and the union leaders seem to think they could do it again.  So as APFA’s strike talk continues, American did what a responsible airline must do, confirming in a media story that it is working with the FAA to prepare, if necessary, to train replacements if the APFA strikes.  Clearly the news story made a few APFA members nervous as, shortly thereafter, APFA President Laura Glading criticized the company, calling its contigency plans "an ill-conceived and doomed strategy." My question to Ms. Glading is:  How, then, is your strike rhetoric not an ill-conceived and doomed strategy not only for your members but for all employees at American Airlines?

As a footnote, last week the story took an amazing turn with news that former TWA flight attendants – nearly all of them furloughed after the APFA put them on the bottom of the seniority list following AA’s acquisition of TWA's assets -- would be willing to cross a picket line and work if the APFA went out on strike. Now I wonder how much time Glading is spending reliving the strike of 1993 when faced with the prospect of an airline ready with trained replacements at hand, including a group of flight attendants with an axe to grind against her union?

Finally, February may be the month we get a decision from the NMB following the effort of two Board members to change by fiat the law that governs labor law in the railway and airline industries and would make it far easier for unions to organize workers.  The decision has, however, generated a tremendous amount of comment and controversy, so we may be waiting until March Madness for that story to break.

Stay tuned. It may be a wild ride.

 

Wednesday
Jan132010

A Battle for JAL or the Threat of Competition?

In this post, I’m going to pick sides in the mighty contest for the JAL bride.

But before we begin, let’s dispense with some business.

First, let the record show that I have long been a fan of Delta Air Lines on many fronts, particularly how it went about its merger with Northwest.  I applauded the strategy CEO Richard Anderson led in demonstrating the benefits of an “end to end merger” versus the old model merger with “significant network overlap.” It is interesting to me how Delta is suggesting to the world that getting immunity for a relationship with JAL will be fairly easy.

Second, I was recently asked by to present at a one-day seminar on the subject of anti-trust immunity hosted by American’s legal counsel Jones Day.  I am not retained by American in this matter, but the airline did cover my travel expenses.

My views are my own. And they are based on a very firm foundation of data.

Now, let’s talk about alliances.

The North Pacific Market

In the U.S. – Asia market, the two most important Asian gateways are Tokyo Narita and Seoul Incheon.  And just as airlines compete, gateways compete for the same traffic. Tokyo and Seoul offer services that can facilitate 10.4 million U.S. – Asia passengers a year.  Of those, 10 million passengers can be accommodated by either Tokyo or Seoul, while only 400,000 are uniquely served through Tokyo’s Narita gateway.

Airlines form alliances to partner with other airlines and more effectively participate in traffic flows between world regions. Alliances permit a carrier to leverage its own network across its partner’s network to create benefits that would not otherwise be logistically possible or economically viable. 

Now Japan Airlines is the “it” airline in a global contest to win its favor and woo it from one alliance to another.  The troubled airline’s current partners in the oneworld alliance are determined suitors in their effort to keep JAL happy at home, while Delta is playing the part of home wrecker, posing and making promises that the opportunities are greater for JAL as part of the SkyTeam alliance.

If I am Delta…..

I would be pursuing JAL as well.  Why?  Because Delta has the most to lose from any new competition into the U.S. – Japan/U.S. – North Pacific marketplace.  Why?  Because of the extraordinary rights Delta has to fly beyond Tokyo and Japan and carry traffic that originates in Japan.  Why?  Because the route rights granted to Northwest (Orient) in 1952 came at a time when Japan was dependant on the U.S. in its post war recovery.

The bilateral agreement in place between the U.S. and Japan has been largely unchanged since 1952.   Both sides have thought the pact unfair, but little progress was made until 2009.  To Japan, the bilateral was imbalanced, with too many NRT slots held by U.S. airlines using them to provide local intra-Asian service.  To the U.S., the bilateral was viewed as anticompetitive as it restricted frequencies, favoring incumbents and preventing market-driven price discounts.  Those incumbents are Northwest and United, which bought the rights from the late, great Pan Am.

What complicates the DAL’s JAL play is that Delta in effect already owns most of the rights of a Japanese flag carrier as a result of the 1952 bilateral agreement.  Along with its immunized relationship with Korean Airlines, Delta already enjoys a commanding market position in what promises to be one of fastest growing markets over the next 20 years – the North Pacific.   

Those route rights now held by Delta as a result of its merger with Northwest give the carrier significant market power.  Those route rights have over the past six decades enabled Delta to build a U.S. – Asia network via Tokyo that could only be rivaled by United.

Only now, under an Open Skies pact between the U.S. and Japan, can that incumbent status be truly challenged.

Oberstar and the Fear Mongers Sure are Quiet

As this story unfolds, one thing we’re not hearing is the usual braying from Congress’ self proclaimed, air travel consumer protection cop James Oberstar.  Is it because the situation involves his former hometown airline?  Or is it because the Congressman is just waiting to pounce?  In either case, the man who has previously been quick to try to apply regulatory and legislative “solutions” to the airline industry’s complex challenges is atypically quiet.

As regular readers know, I am no fan of the Minnesota Congressman’s approach to competition in the industry.  But as we approach a situation in which the term “duopoly” will describe inter-alliance competition should Delta and JAL form a partnership in Japan – his silence is, well, deafening.

Today, American + JAL at Tokyo, Northwest/Delta at Tokyo and Delta + Korean at Seoul are competing for U.S. – Asia traffic.  There are 413 city pair markets in that region that involve 19 overlapping Asian markets served by each Tokyo and Seoul that have at least 5 passengers per day each way.  Currently, 83 percent of those 413 city pair markets either originate in or are destined to points behind a U.S. gateway to one of those 19 points beyond the two Asia gateways. 

It is these markets that represent a competitive disadvantage to the non-immunized alliances today – chief among them  American’s oneworld.  These markets also represent true opportunity for the immunized alliances of tomorrow – those, that is, that would now be permitted by the U.S. – Japan Open Skies Accord – and that’s what has the incumbent airlines looking nervously over their shoulders at the prospect of new competition.

Today both STAR and oneworld are limited in their ability to compete for this traffic by a lack of immunity with their Japanese partners.  Northwest/Delta, on the other hand, can coordinate schedules and set fares for traffic connecting over Tokyo Narita (as a result of the agreement negotiated with Japan in 1952) and for traffic connecting over Seoul with its Korean Airlines partner.

In fact, on 98 percent of the 413 city pairs we’re discussing, either Delta/Korean or Northwest/Delta or both “immunized” combinations have a larger share of this critical connecting traffic than does American + JAL. 

This ability to generate traffic and offer passengers a choice of carrier and gateway is just one of the important benefits that accrue to airlines and consumers as a result of a relationship that allows immunized alliance airlines to coordinate schedules and set fares.

Today Delta’s U.S. domestic network is roughly 2.5 share points larger than American’s, yet it is able to connect disproportionately more traffic from the U.S. to Asia.  Network economics suggests that this relationship does not make sense unless one considers the power of immunity.

The Threat of Competition

Today, both oneworld and STAR compete for the same traffic against SkyTeam.  Today there is certain symmetry among the three global alliances for U.S. – Japan traffic and U.S. – Asia traffic.

In the U.S. – Japan market, STAR’s share is 31%; oneworld w/JAL is 38%; and SkyTeam w/o JAL is 30%.  In the U.S. – Asia market: STAR’s share is 34%; oneworld w/JAL, 22%; and SkyTeam w/o JAL, 28%. 

Based on MIDT data American commissioned from Compass Lexicon and analyzed by me, if JAL were to be lured away by SkyTeam, the numbers would look very different.  In the U.S. – Japan market:  STAR, 31%; oneworld w/o JAL, 6%; and SkyTeam w/JAL, 61%.  In the U.S. – Asia market:  STAR, 34%; oneworld w/o JAL, 10%; and SkyTeam w/JAL, 30%.

Delta will likely challenge that analysis, claiming that it should not include traffic between Japan and the U.S. “beach markets” of Hawaii and Guam. I will leave that argument to the lawyers.  But last I checked, one was a U.S. state and the other a U.S. territory and each are therefore governed by the U.S. – Japan bilateral.

In simple terms, the real threat of liberalization in the U.S. – Japan market is the overnight competition Delta/SkyTeam will face from oneworld and STAR for the nearly 10 million U.S. - Asia passengers.  Do the math: If Delta is successful at luring JAL away from oneworld, then SkyTeam and STAR will have a 92% share of the U.S. – Japan market.  In most economic analyses, that share represents a duopoly.  And that should not be the result of market liberalization. But then again, do we have a duopoly on the Atlantic given that oneworld is not immunized there either?

Oberstar and the Fear Mongers have already protested the prospect of limited competition in three alliances hell bent on “gouging” air travelers.  So where are they when it comes to the prospect of just two alliances controlling so significant a share of the Asian market?

Duplicitous Delta and the Source of My Confusion

In late 2006, while Delta was in bankruptcy, U.S. Airways made a hostile offer to take control of the company.  Delta rejected U.S. Airways’ overtures vehemently and was ultimately successful in fending them off. “US Airways’ principle goal in its hostile takeover attempt is to eliminate its key competition,” Delta(Grinstein) said at the time. “In a pro-competitive merger, the two airlines’ routes do not overlap excessively; they are complementary. Joining complementary networks can enhance competition and create consumer benefits that result in lower prices and increased service option.”

Then in late 2007, Delta, on its own terms, began to pursue a merger with Northwest. Anderson argued time and again that the two airlines had “complementary instead of overlapping route systems” that would maximize synergies.

With the two airlines already connected through alliance relationships, Anderson said:  “Alliance relationships are valuable and very difficult to extract yourself from.”  He noted that neither Delta nor Northwest needed to pull out of its existing alliance, which would have “disrupted revenues and required tearing out significant infrastructure and then rebuilding someplace else.” 

Given regulatory restrictions regarding cross border mergers, an immunized alliance is a defacto merger in the sense that it gives the combination the ability to act as one airline in determining service levels, pricing, marketing.

On the surface, the size of Northwest/Delta’s North American network is slightly larger than American’s.  However, the fit of the network is more important than size.  The ability to leverage one network against the other in order to create new city pairs to sell is critical to any network’s success.  American and JAL would make for a true “end to end” combination whereas Delta and JAL possess significant overlap with each other – the very combination it suggested results in an anti-competitive combination.

On the surface, the solution is crystal clear - at least to me: Three alliances across the Atlantic and the Pacific that each benefit from anti-trust immunity and equally competitive tools.  Even if JAL ultimately restructures through bankruptcy, a partnership with American would still provide a true end-to-end partner that Delta itself contends is the very best way to maximize the synergies of a commercial combination.

But the more I study the data, a different picture emerges. Delta’s play for JAL is not about JAL at all.  It is about preserving Delta’s dual flag status in Japan.  For 58 years Northwest/Delta has been tweaking its US network to sync with its Japan-based network – and they have done it well.  Under Open Skies, Delta will realize new and more vigorous competition on many routes where it enjoys little to no competition today.  Self preservation is a strong instinct and I am all for consolidation in this industry.  But I am also for open and fair competition, particularly where all three alliances are concerned. 

Either way, Delta wins.  It wins by delaying anti-trust immunity for each American and United and thus preserving its legacy competitive position.  And it wins by potentially eliminating a competitor (JAL) where redundant flying can be removed. 

Competition loses.  If Delta lures JAL away from oneworld and the U.S. grants the Delta/JAL combination anti-trust immunity, then perhaps Oberstar finally has a position he can defend. Three way alliance competition is robust.  Institutionalizing duopolies in Open Skies markets is something else.

Thursday
Jul092009

Are Some US Airlines Too Big to Fail? Hell No!

Holman W. Jenkins Jr., writing in the July 8 Wall Street Journal gets it right: "The new administration seemingly won't let companies fail, and won't let them succeed either," Jenkins wrote of Justice Department opposition to antitrust immunity for Continental Airlines and the Star Alliance. Such alliances, he argues, are the industry's "self-help solution" for companies looking "to share losses and preserve capacity in a downturn." By denying that option to struggling carriers, Obama may soon be forced to "add the airlines to the collection of failed industries being run out of the White House."

 

Sadly, What is Good for One is Not Good for the Other Two

Congress, of course, has a long-held penchant for meddling in the affairs of industries and organizations. This week, the Senate Judiciary Committee Subcommittee on Antitrust, Competition Policy and Consumer Rights spent taxpayer money to hold hearings on college football’s selection process for placing teams in its Bowl Championship Series. So we should not be surprised to see a growing government role in an industry that has managed to lose more than $30 billion over the past nine years.

If government oversight of the airline industry is going to stand in the way of corporate success, then there is no airline too big to fail. So why not let them fail? Airlines are criticized for not being innovative. True - and for the most part their innovations over the past 10 years amount to little more than finding ways to maximize revenue within a system of constraints.

Delta/Northwest is the largest carrier in the world, and even it commands less than a 5 percent share of the global airline market. No other U.S. airline claims more than a 3 percent share. Yet the government continues to treat the U.S. airline industry as if it is a threat to competition and slap the hands of airlines that attempt to improve/augment their business models through partnerships and alliances with foreign carriers.

Antitrust laws are designed to protect consumers from corporate power. Does a well-established trend line of fares falling at rates greater than inflation for three decades demonstrate corporate or industry pricing power? A passenger traveling from Greenville/Spartanburg to Los Angeles has a choice between more than 20 flight combinations to get from California and back.  Does that demonstrate corporate or industry power? Does an industry that makes the price of its product fully transparent to the buyer sound like an abuse of the consumer?

The fact is that most U.S. air travelers still have plenty of choices when it comes to flying – albeit in an industry that still carries more capacity than it needs.

 

Southwest: The Wolf in Sheep’s Clothing

Let the record show that I have not joined the chorus of analysts and observers who predict rising fares by Fall. The recession holds. Many consumers are tapped out. Enter: Southwest Airlines.

Southwest has a long history of leveraging difficult financial times -- profiting at the expense of competing airlines because it could. It profited because of the chasm in its CASM versus it competitors; it profited because of the chasm in the RASM charged by competitors; it profited because it smartly used its balance sheet to make a wildly successful bet on the future of fuel prices . . . Southwest profited because it could. So this week’s fare sale in which the airline is selling tickets at $30, $60 and $90 says one of two things: either Southwest is struggling mightily with the forward booking curve, or the airline smells blood. I think the answer is both, but more the latter.

Southwest is now the big dog in the US domestic market and a player that must be reckoned with in any discussion of domestic market competition. If the nation’s lawmakers and policymakers continue to equate low fares with sufficient competition and consumer benefit, then deregulation has clearly come full circle.

Southwest is not now the big dog to those in Greenville/Spartanburg, Knoxville or Duluth. But most travelers can get in a car and drive less than a few hours to fly Southwest from these markets or more than 280 others not now served by LUV.

If this is what the regulators and policymakers really want, then that’s what they’ll get. Therefore, there is no reason to think that any airline flying today is too big to fail.

With Southwest adding the dots of the largest population centers where it did not previously fly to its route map, the industry could be at a tipping point. These markets also represent large sources of feed revenue to many legacy carrier hubs, and with Southwest offering fares too low for some legacies to match, this fall and winter may be a long, cold one for the traditional carriers.

Will the government continue to stand in the way of airlines that are desperately seeking new revenues? If so, no bailout will save an airline – not until U.S. airlines are allowed to act like other multinational industries serving a global economy. There already is enough taxpayer money bailing out other industries with similarly troubled attributes – adding airline rescues to the mix would only throw more good money after bad.

 

Union Rhetoric

What’s behind Congressional opposition to these common-sense alliances? The loudest voice in the room is labor. Even at this financially treacherous time, the industry is split from within, the result in part of union leaders that refuse to recognize economic trends and realities when they don’t serve the union’s objectives. When are the unions going to recognize that the transfer of domestic market wealth from the incumbent carriers at the time of deregulation to the new wave of carriers that followed is largely complete? And that tomorrow’s opportunities do not reside inside the 48 contiguous states?

Now, in the years since airlines sought and won aggressive cuts in labor costs during restructuring, it is increasingly clear to me that continual change/modification to outdated collective bargaining agreements cannot overcome the structural seniority chasms that exist between the legacy carriers and their lower-cost, younger competitors – at least in the domestic market. For decades, as the network carriers have been forced to compete for ways to average down labor costs through protracted bargaining, the low-cost carriers simply use seniority arbitrage to facilitate their growth. And I think we are about to see another run of growth by the LCC sector.

When it comes to the airlines seeking immunity to maximize revenue and, in the case of United/Continental/Air Canada, address certain cost efficiencies as well, the strategy is to maintain as much of the current operation as is financially feasible. Unlike the US steel industry that lost nearly 400,000 jobs because producers in other countries could do it significantly cheaper, blame for the next round of airline job cuts most go in part to the airline unions that have been busy trying to convince the dinosaurs at the Department of Justice and on Capitol Hill that alliances will result in job loss and a further deterioration of wages and working conditions.

Between the time Eastern Airlines and Pan Am died and 2000, the industry’s high-water mark for employment, U.S. airlines added nearly 100,000 jobs. Since 2000, the industry has lost nearly 140,000 jobs - and it should have been more -  mostly because nearly all the airlines and virtually all the existing hubs have been protected in one way or another by patrons on Washington. Indeed, many of the jobs lost from a failure of one or two of today’s carriers likely will be replaced as market positions in the largest cities are filled by new and more efficient carriers.

 

Let Some Airlines Die – And Then Let DOJ and Congress Rethink

At this point no one US airline is too big to die. Competition remains plentiful whether that competition comes from another ticket counter at the same airport or cheap fares at a nearby airport. Either way, the industry is still too big – with too many network carriers, too many regional carriers and too many hubs.

And, except for a few “up cycles” along the way, revenue has not supported the industry’s growth or size. The time is right for lawmakers to hear the new reality in the industry – one focused not on a false threat of monopolies and price gouging, but the very real threat in an industry so bloated, burdened and inefficient that it fails to provide the very thing a business must: a reliable return for investors and real job security for employees.

Thursday
May282009

Aboard UA #2: Reading Captain Wallach’s Latest Half Truths

I have a long institutional history at United, primarily working on behalf of the Association of Flight Attendants. In this role, I worked with the flight attendants through every concessionary period, the ESOP attempts, and Phase One of bankruptcy -- a long association that ended when I spoke my mind in a media interview on the vulnerability of defined benefit pension plans and, in doing so, angered some in the union leadership with my candor. .

All by way of saying that there is very little in United’s recent history, at least between 1985 and 2003, that I did not witness up front and personal.

 

The Recent Spat

The latest static at UAL involves a war of words surrounding United, Continental, Air Canada and Lufthansa in their application for anti-trust immunity to operate an international alliance. This debate is creating much more noise in Chicago than it is in either Washington or Brussels and that’s for one reason: the noise comes from a desperate union leader who waited ten months to voice concern about any potential impact on United workers.

This is the very same union leader who sits on United’s Board of Directors. His administration was subject to a federal court injunction to end what Judge Joan H. Lefkow ruled was a job action in clear violation of federal law. This, in fact, is a union leader who fancies himself as the second coming of ALPA boss Rick Dubinsky – the legendary golden goose hunter that worked more than 15 years to create many of the problems that still plague United. But, Mr. Wallach, you are no Rick Dubinisky.

Sometime after Wallach’s anti-trust immunity concerns were made known via the press, United COO John Tague, sent a letter to employees explaining United’s successful alliances with ten airlines over the course of the past ten years – none of which had led to problems or complaints with the carrier’s unions. A day later, Wallach responded with an open letter to Tague and copied all United employees – a tirade he then shared with the media as demonstrated by this submission to Forbes.com.

 

Wallach’s Letter

Wallach opens citing what he calls blatant mischaracterizations and outright falsehoods contained in Tague’s letter. But after reading Wallach’s letter, I am of the mind that it is he who is guilty of blatant mischaracterizations and outright falsehoods.

In building his case, Wallach attempts to blame United’s role in the STAR Alliance for the airline’s trouble today . . . a dubious case he makes by comparing the size of United in 1997 when it first joined STAR to the carrier’s size today. That argument conveniently fails to note that 1997 marked the middle of the greatest up cycle in US airline history, and then neglects to account for all the industry trouble that has transpired since. But that’s what the industry has come to expect from unions that spend more time and capital attacking companies through half truths and blatant misinterpretations rather than working to address the economic and competitive realities at the root of the industry’s struggles.

A more honest analysis would take into account the full breadth of events that have had a profound impact on the airline industry since 1997, including but not limited to SARS

  1. SARS
  2. The growth of the US low cost carriers
  3. The rapid deflation of the IPO bubble
  4. The puncture of the stock market bubble
  5. The advent of internet distribution and pricing (transparency that contributes to lower ticket prices
  6. The Summer of 2000 (where actions by UA pilots to “work to rule” impacted service)
  7. Ratification of a new pilot contract with rates far higher than the rest of the industry
  8. September 11, 2001
  9. US Airways bankruptcy filing that led to significant reductions in labor rates
  10. United bankruptcy filing
  11. Oil prices begin increase to historic levels; crack spreads depart from historic norms
  12. Delta and Northwest bankruptcy filings
  13. Oil reaches $147 per barrel, driving run up of other commodity prices
  14. New rash of airline industry oil hedges in anticipation of further price spikes,
  15. Followed by plummeting prices that put many hedge contracts underwater
  16. Credit crisis takes hold
  17. Consumer confidence falls
  18. Economy enters recession in late 2007
  19. Recession deepens to become worst on record since 1930’s with global reach into Asia and Europe
  20. Pandemic flu outbreak with hardest initial impact in Mexico.
  21. United pilots in negotiations over new contract for first time since bankruptcy agreement.

The real lesson is in the extent to which the entire industry has changed over the past 12 years with a permanent impact on the legacy carriers. Wallach weakens his own case by suggesting that alliances have hurt US airline employment without identifying the many factors in the equation.

In fact, I would argue that without the alliance partners United works with today, the airline would be even smaller.

Has the management at United made some mistakes along the way? Of course. The current UAL leadership has no compunction about forgetting the past other than to recognize that the carrier’s past was largely a dysfunctional disaster. But that recognition led to many of the changes to United’s structure and operations in place today. As CEO Glenn Tilton often makes the case, the industry has to earn its cost of capital – something the global industry has rarely achieved over its long history.

 

Corporate Campaigns and Organized Pilot Labor

The airline unions – particularly those now in contract negotiations, have not shied away from full-barrel attacks on the carriers as one method of soliciting support during labor talks. Ginning up opposition to airline alliances seems to have become the latest tactic in this long-running campaign. But it should not be lost on any industry watcher that the loudest rhetoric comes from the union halls of the pilots at United and American. Ironically, the least noise is coming from the most successful US legacy carriers – Continental and Delta. I’ll leave it to the readers to weigh in as to whether there’s a connection.

But outside the rhetoric there’s a pretty clear case for the benefits of these alliances, particularly for an industry that needs desperately to hold on to its customer base. Maintaining and expanding the current alliance structure is one sure way to do so.

 

Concluding Thoughts

It is important to filter the daily missives fired from the labor bunker with the understanding that many in the industry are understandably frustrated by the changes and challenges in the airline industry. At some level, the best labor leaders recognize that the industry will not return to the unsustainable bargaining patterns and demands of yesteryear. Captain Wallach should take a very careful look at his union’s history at United and role in contributing to the precarious position the airline now finds itself in.  In other words, make yourself relevant in shaping United's tomorrow.

That history lesson should begin with the pilot-led majority purchase of the company in 1994, a process that began following a strike in 1985. With that purchase, the unions had unprecedented power in the governance structure and influence so strong it included hiring and firing power. But as the ESOP sunset, there was no transformation – no new culture or structure that prepared the airline to weather the trials to come. Instead, the transformation has come as the result of seismic economic factors that are redrawing the global airline industry map. And that map includes alliances – a necessary partnership in an industry in which US airlines aren’t permitted to act like other global businesses and merge.

There is not one legacy carrier in the US today that could stand alone and compete on a global scale. To stand in the way of market evolution is to stand on a dangerous path.

Thursday
Mar262009

The United – Aer Lingus Venture: The Chicago Tribune Perpetuating the Past

Since starting this blog and taking advantage of opportunities to be “media trained” over the years, I was told that I would never read the news the same again. How true.

I am a little late in weighing in on a March 16 story by Julie Johnnson in the Chicago Tribune: Clipping Union’s Wings; United – Aer Lingus Plan to Outsource Pilots on Overseas Flights, which I believe errs in just about every aspect in understanding what is really going on in the airline industry.

In the article, Johnnson suggests that the arrangement between United and Aer Lingus will spark an uproar as pilot contract negotiations begin next month. But what the author fails to mention is that the Airline Pilots Association (ALPA) knew of this deal long ago. And while I am not in the business of selling newspapers as the Chicago Tribune is, I do believe that negotiations that already stoke emotional fires do not benefit from stories that throw fuel on those fires.

I’ll start with the article’s assertion that the United-Aer Lingus deal would allow the airlines to “outsource” pilots and, in the process, clip the union’s wings. But this argument ignores the fact that the UA – AE venture is permitted by the UAL pilots’ collective bargaining agreement.

Indeed, there is no evidence to suggest that the collaboration between the airlines is equivalent to outsourcing or in any way a violation of the pilot agreement. Worse, the story goes further by suggesting that these flights would be flown by under qualified pilots.

The article also raises questions – unfairly in my view -- about safety, noting that it is unclear who would regulate an airline not based in the home country of a parent carrier. U.S. limits on foreign ownership would not apply because the partnership would be based overseas. The author’s raising of the safety issue is specious as established carriers like United and Aer Lingus would not put their reputations at stake by knowingly engaging in unsafe practices.

But the story does underscore a common slant of some newspapers that key challenges can all be distilled into labor issues. It is, perhaps, no coincidence that the story implies that the company is working against the best interests of it pilots, while failing to mention that United has begun paying bonuses to its employees for operational performance.

So let me say what the newspaper article didn’t. The real story is network economics.

In this alliance, United is considering Washington Dulles to Madrid for the initial route. Keep in mind that Madrid is a hub for Iberia, which is part of the oneworld alliance. And so the plot thickens, as industry observers know that several oneworld carriers (American, British Airways, Iberia, Royal Jordanian and Finnair) have applied for anti-trust immunity to fly between the US and Europe. United, meanwhile, is part of the STAR alliance. The majority of its transatlantic flying is gateway-to-gateway flying between North American carrier gateways and gateways of European partners.

The advantages of gateway-to-gateway flying are many. Foremost is the ability to sell not just traffic in the local market; but also traffic behind the US gateway to the European hub. And not just traffic from the US local market to points beyond the European gateway; but also bridge traffic traveling from points behind the US gateway to points beyond the European gateway.

The STAR alliance is not now well positioned geographically to serve Madrid and Lisbon and even some points in the UK and France because its primary gateways are located much deeper into the European market. So for United to make Washington – Madrid work by itself requires the carrier to rely only on local Washington – Madrid traffic and feed traffic to Madrid from cities connected to the Washington gateway. The route therefore has a limited pool of traffic and revenue as compared to Washington – Frankfurt or Washington – Munich. Moreover, the Washington – Madrid route is much different from Washington – London where the local market itself can support multiple daily flights.

Iberia currently serves Washington Dulles - Madrid. My guess is that United, and STAR, have identified this as a strategically important flight to its network. But as a stand-alone UA route -- with its inherent cost structure (labor or otherwise) – I would be surprised if United could turn a profit. All of which demonstrates how important it is for United and STAR to establish a presence in a strategically important city pair at a cost structure that will improve the economics of the route.

The United Pilot Collective Bargaining Agreement

Under the terms negotiated between United and its pilot union, Section 1 of the collective bargaining agreement explicitly states that, prior to entering into code sharing agreements with foreign carriers, UA will confer with ALPA.

The agreement further obligates United to negotiate with the prospective partner any labor protections that it deems appropriate to the circumstances consistent with its business judgment, including a commitment to negotiate as much reciprocal code share as possible taking into account limitations that are beyond the company's control.

In my read, there is nothing in the scope section of the UAL-ALPA contract that prohibits revenue sharing, cost sharing or branding, as long as the code share tests are met. The agreement also stipulates that the company cannot remove a scheduled non-stop flight from a joint international non-stop market unless it can demonstrate that the flight fails to pass what is known as “base rate of return” test – in other words a route must achieve pre-ordained financial results. Moreover, the pilots’ contract permits United or one of its affiliates to acquire as much as 50 percent of the equity of a STAR alliance carrier, contingent upon certain details.

 

Concluding Thoughts

Finally, the story concludes with predictable comments from the unions representing pilots at both United and American – the two carriers expected to face the toughest contract negotiations and where the unions are most openly antagonistic toward management. These negotiations capture some of the most difficult issues facing domestic airlines, where in many cases labor leaders have failed to acknowledge or address some of the core structural economic factors changing the industry. But the story, and its take on this development, would be greatly strengthened by providing more context regarding the global airline environment and the pressures on US airlines to build a truly global network and route structure.

The question, quite simply, is whether the US airline industry can compete with lower-cost and better capitalized carriers from around the world, particularly in this challenging global economy?

The reality is that United is doing nothing more than what it is permitted under its agreement with its pilots. Yes, there may be union leaders and airline employees who simply resent that the era of US dominance in global aviation is on the wane, but to ignore this reality does nothing to position any airline for a new global marketplace.

Perhaps the Tribune erred mostly by painting the challenges and opportunities facing United in the time-worn management-labor construct, rather than with the complexity the situation demands. The industry will change and change dramatically. And companies that fail to find new ways to create value through branding and revenue sharing and cost sharing could fail to exist.