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Prioritizing US Airline Industry Needs for 2009

With news being made on every move the President-elect makes during his first days in Washington, I think it appropriate to prioritize airline issues that Swelbar sees as important for 2009. I do not make resolutions. If I did, many of this year’s items would be nothing more than broken promises from years past. However, we have an incoming administration that promises change. Until proven otherwise, I will take Obama at his word.

This week, we began to get some insight into his ideas behind a stimulus plan. Infrastructure remains a key component. It is nice to see tax cuts comprising a significant component of his plan which promise immediate benefit; conversely, investments in infrastructure likely will serve the goal of long-term stimulus. Of course the Supply-siders will be quick to remind us that tax rebates are nothing more than borrowing from tomorrow to pay for potential benefit today. Isn’t this all that we have been doing over the past month or so anyway? And I digress yet again . . .

In setting airline industry priorities for the new year, my ranking criterion is based on my belief of what benefits the most industry stakeholders. These are airline employees, travelers, manufacturers, airport operators and their vendors and, of course, shareholders. Theoretically, the interests of these varied stakeholder groups combine to create a virtuous circle of prosperity. But it’s safe to say we have had a disconnect in that circle going back as far as 2001, if not before.

Few industries are as vital to the overall economic strength and vitality of the economy as the airlines. It is an industry in the headlines every day, and in its role in moving people, goods and services is one critical to America’s financial recovery as grease on the economic wheel. So Mr. President-elect, without a stimulus package that serves the airline industry there is no velocity in the new administration’s economic policies.

While some of the stimulus ideas may be nothing more than good money chasing a bad idea, the chief goal must be to reinvigorate the velocity of the money supply. It’s about speed. The airline industry sells speed. And the industry needs a visionary push to operate at its maximum potential speed.

Priority #1: The Air Traffic Control System

With flight activity expected to triple by 2025, there are few issues that impact stakeholders as much as our ability to achieve a robust, scalable and more efficient air traffic system. Mr. Obama has promised to review each and every line item in the federal budget. When it comes to the Federal Aviation Administration (FAA), there should be more than enough fodder to make a significant down payment on the estimated $40 billion necessary to implement the new air traffic control technology that does not rely on a 1950’s era cathode-ray tube.

Yes, there is more to making the system efficient than technology alone. It requires ridding the system of inefficiencies that have plagued the industry for much of the past 50 years. In this case the miracle of compounding does not produce a good result. We’ve already seen that play out in the auto industry. And it’s not unlike what the airlines have been (un)doing since 2002 in their efforts to improve operational productivity and efficiency– all the while fighting a grossly inefficient infrastructure.

There is not one major stakeholder group that would not benefit from a permanent fix to the aviation infrastructure.

Priority #2: Aligning Labor Interests with Other Stakeholder Interests

For decades, the industry giveth at the pinnacle of an up cycle only to taketh away on the way down. This repeated practice has not served any stakeholder group well. I am not suggesting ESOP-like arrangements that were negotiated in the early days of deregulation. But I do believe that performance-based pay structures that include some component of risk for failure to perform will prove essential to strengthening the industry in the future. It could come in the form of stock grants, warrants, or liquidating preferred stock plans that are paid down with earnings, each in conjunction with meaningful profit and gain sharing.

The first goal of airline contract negotiations should be to begin the process of realigning the interests of management and labor in a compensation system that works for the long term and escapes the volatility that has resulted from pattern bargaining. All executive compensation plans are based on designs that reward performance. If at-risk pay is good for executives, then so, too, should metrics be used to institute variable pay that will reward performance throughout the organization.

What makes this a very difficult task is that management will always have more total compensation at risk. That is the nature of the beast. One example of a plan that had some success was Eastern Air Lines Variable Earnings Plan (VEP) that was put in place in the late 1970s. Depending on Eastern’s level of profitability, earnings were adjusted between 96.5% and 103.5%. In a Time Magazine article in February 1977 (‘Moon Man’ Turns Eastern Around), Eastern CEO Frank Borman credited the plan as one way to break "the almost blind acceptance that annual raises are expected regardless of company performance."

Thirty-one years later, the industry has still not figured it out. Therefore it should be a top priority to break this pattern. Volatile prices are unsettling in commodity industries – and the US airline industry has become a commodity industry. Beginning in late 2000, volatility came in the form of decreasing fares. Today, volatility comes in the form of oil prices. In the future, continued volatility in labor prices could prove disastrous because there are no other areas on the income statement that can cross-subsidize labor costs that are above what the market will bear.

Stable and predictable labor costs benefit all stakeholders – even employees. Employees continually focus on downside protections. They should also be thinking about upside protections as well.

Priority #3: An Energy and Environmental Policy

I fear the oil story is far from over. An amazing ride up the curve and a hair-raising ride down in the span of five months time leads me to believe that this story’s final chapter has yet to be written. Oil’s stark and rapid increase made it very clear that the world has changed and will continue to change. Worldwide, new forces drawing from a finite oil supply led to a fundamental alteration of the demand for oil – one that is not yet fully understood.

Historically, a rapid drop in oil prices is at least partially explained by an increase in either the supply of oil or a meaningful increase in refining capacity. Neither explains the plummeting drop in the past few months. While capacity levels are increasing, refiners continue to operate in hurricane alley, vulnerable to political unrest and violent weather. We sit one storm away from spiking prices again. Consider the last two weeks alone, when the price of WTI crude oil increased from $30 on December 23 to nearly $49 per barrel on January 6.

Clearly, there are many other benefits to addressing our energy needs -- national security high among them. The President-elect has put new energy policies on the priority list for his administration. I only hope that he gives it the necessary focus so that the U.S. begins to be more self reliant for its fuel needs, through increased exploration and production and through developing alternatives that will help dampen the volatility that has characterized the oil market since 2004.

Obviously, improved fuel efficiency also promises significant environmental benefits -- an increasingly important issue in commercial aviation. Modernizing the air traffic control system will help, as will creating a durable and sustainable financial model that permits airlines and manufacturers to invest in “green” technology and more environmentally-friendly aircraft.

Priority #4: The Customer

To date, the consumer has been the only clear winner in the deregulation experiment, which lowered fares to the point of making air travel accessible to the masses. But in most cases, the customer’s travel experience has suffered over the last few years.

With the key to a healthy industry beginning with a healthy demand, airline customers stand to gain from the reforms I advocate. Clearly, travelers benefit from better dependability and reliability that ATC modernization will promote, as well as more stable pricing that would result from a continued focus on cost controls, efficiency and fuel savings. The intangible benefit, in my view, comes from the real prospect of a better travel experience for passengers that will only be possible when the airlines have the financial ability to invest in the improved planes, cabins, amenities and services demanding customers want.

That said, the industry sure as hell does not need the so-called “Passenger Bill of Rights.” The last thing the airlines need is another layer of legislation and regulation. Investments in infrastructure will go far to solve air travel problems associated with overcrowded airspace and inefficient controls. But only then, if then, should the government consider further burdening airlines with legislative “fixes” – many of them addressing problems outside the airlines’ control.

But as fares increase; customers pay more for the services they want through “unbundling,” and fuel surcharges become the norm, it is incumbent on the industry to make the customer a focus . . . a very sharp focus.

Priority #5: Foreign Ownership and Consolidation

As the new administration takes its seat, negotiations are underway on Phase II of the US – EU Open Skies Agreement, which could permit foreign carriers to take a larger ownership stake in US airlines than the current statutory limit of 25 percent. Look at virtually any industry that is forced to compete in the global marketplace, and foreign ownership is nowhere near the issue it is in the US – or Europe - or Asia for that matter. Hell, Anheuser Busch, a company with a much stronger US brand than any airline flying today, was sold lock, stock and barrel to Belgian-Brazilian brewer InBev.

Alliances are nothing more than Band-aid fix to a problem that requires a more lasting solution. The global airline industry is amalgam of regional brands. In truth, the global airline industry is an amalgam of sub-regional brands, because anti-trust laws have largely prevented the creation of true regional brands. Now, with the world’s geographic regions already harboring more carriers than the market can support – all in the name of competition – the industry is pursuing these alliances as a makeshift to do what market forces require.

Europe is quickly becoming a three-carrier continent with a couple of LCCs in support. The US is consolidating more through shrinkage than by sub-regional brands joining hands. Delta-Northwest was just the beginning -- and provided a damn good blueprint on how to deal with the thorniest issues from past mergers. The question remains, which combination comes next?

A Concluding Thought

The US airline industry is not asking the government for a handout or a bailout. But the industry must work with the government on the problems and priorities unresolved from years gone by. It will take a commitment to get it done, and the effort will only succeed by addressing each of the issues this short list of priorities outlines. Only then will the US airline industry be in the position to benefit each and every stakeholder – for the long term.

And Mr. President-elect, until the ATC and other aviation infrastructure issues are fixed to the industry’s satisfaction, you might want to relieve the airline industry of its disproportionate tax burden -- as long as you are printing money for others of course.


Now This Is A Little More About What I Have Been Talkin' About

Reuters reports today on US position as Phase II of US-EU liberalization talks set to begin in Slovenia later this week: UPDATE 2-US suprises EU with global airline ownership plan.

More to come.


“A Flying Pig”

Eric Reguly of the globeandmail.com writes a cutting and provocative piece on the situation at Alitalia. I have been looking for an excuse to write about the Alitalia story as it provides a bit of a reflection of US airline industry tendencies. Particularly when politics and labor stand in the way of economic forces that demand change. Fighting an industry’s evolution seems to ultimately result in the failure of the very entity the entrenched believe somehow will flourish in its status quo state.

Whatever date will decide Alitalia’s fate is nearing. Mr. Reguly writes: “Alitalia, with some 18,000 employees (far too many) and 174 aircraft (far too old and fuel inefficient), has been a flying pig for as long as anyone can remember. It was plastered with bandages when radical surgery was required. Between 1999 and 2005, it lost €2.6-billion. In 2002, it was kept alive only by the emergency injection of €1.4-billion from the government. The bleeding still continued. The airline lost €605-million in 2006 and another €364-million last year. The politically motivated strategy of flying from two hubs - Milan's white-elephant Malpensa airport and Rome's Fiumicino - unnecessarily deepened the losses. Alitalia is too small for a two-hub operation (to its credit, the airline was slowly downgrading Malpensa in favour of Fiumicino)”.

The US airline industry is fast approaching a date where something is going to have to give as well with high oil and an economy in recession on a collision course. Whether consolidation or liquidation, the next 12-18 months promises to be the most challenging period in the industry’s deregulated life cycle. The barriers to exit that have historically existed will be challenged. My guess is that they will not provide the same safety net that has been experienced in the past.

Today, Alitalia is Europe’s sixth largest carrier in terms of revenue. The Big 3 in Europe (Air France/KLM, Lufthansa/Swiss and British Airways) are beginning to dwarf numbers 4-6 in terms of size. It would certainly seem that for Alitalia, being part of the world’s largest airline group is its best case scenario. But when parochial interests get in the way, somehow it becomes an all or nothing game rather than to preserve as much of the legacy as possible.

The US airline industry seems poised to experience some similar scenarios. Maybe the best path for the US is consolidation through liquidation? A path of lesser resistance? Some will say to me in various ways: Swelbar, this will only happen when pigs fly. What we are seeing in Altialia is that pigs can’t stay airborne forever – even in Open Skies.

Pigs don’t fly and neither will an industry that refuses to adapt.


Putting a Few Packages (of Airline Industry Issues) Under the Tree for Readers to Unwrap


In an industry that is associated with 3-letter identifier codes and with labor’s expectations that “concession recovery” is right around the corner, we should start to think about replacing NMB with PEB. Oh I know that a PEB requires time with the NMB, but …… I never remember a time where neither labor nor management has any meaningful leverage entering a negotiating cycle. I open with this one because trains and Christmas trees are synonymous.

Along those same lines, and with labor’s “one trick pony” leverage point being executive compensation, maybe we should be questioning whether the seniority system really works for airline labor and management. Imagine a real free market where individual airlines actually bid for individual labor's services? Would this type of a "free market" cause airlines to rethink their individual approach to invest in product similar to that provided by the global elite carriers? Free agency has generally been good for compensation levels – average and otherwise.

Isn’t it interesting to see AMFA being challenged on multiple fronts? Most observers expect them to lose their challenge from the Teamsters at United. It seems to me that this is nothing more than a story coming full circle. Just as AMFA challenged the IAM and won at each United and Northwest, by making promises it could not keep while exploiting situations where concessions could not be avoided. It is most interesting to note that by early 2008 AMFA could be gone from its two largest properties. OverPromise and UnderDeliver will be a term discussed more and more over the coming 3 years.

US Economy

With nearly $1 trillion in mortgage resets coming in 2008, doesn’t consumer spending have to be affected at some point?

It has been a long time since I remember reading so many stories and analysis which offer the mixed signals du jour on the direction of the US economy. From recession to inflation, the gamut is covered. The job market and manufacturing have each cooled which suggest a slowdown. Yet the consumer continues to lead the way as retail sales remain strong. But profit margins are less suggesting costs are exceeding the ability to price. Go figure. There is always demand at some price – the US airline business sure captures that concept.

US Government

With New York JFK and Newark operations capped by the US government, and the industry applauding the actions, which major US market will be affected next? What exactly does “new and real” capacity mean when considering a leasing of capacity program?

Remember when jetBlue was lauded as the best capitalized startup in US history? If something were to result in jetBlue failing, what would happen to those JFK slots “given” to the carrier?

Was Virgin America late to the party, or is their timing right? I am intrigued by their recent city pair market choices.

Is it really possible that Singapore Airlines will be serving the New York – London market and the Houston – Moscow – Singapore market in addition to New York – Frankfurt, Los Angeles – Taipei, Los Angeles – Tokyo, San Francisco – Hong Kong and San Francisco – Seoul by the end of 2008? Yes -- the signs of what lies ahead. Where is the home country?


Wouldn’t it have been ironic if the New England Patriots went 19-0 and won the Super Bowl, when in the same year the Miami Dolphins went 0-16? Well we know half of the story.

Aren’t you just tired of the same voices making statements that it just cannot be done because it hasn’t worked in the past?

Happy Holidays,



Is It True, Lufthansa to Buy Stake in jetBlue?

From the New York Times Deal Book, blog: click here. Before we write or say anything, let’s wait and see if there is something to this story. But based on our writing here for the past month, these are precisely the type of transactions that we should expect.

And Reuters offers this story click here.


Transforming the Transatlantic Market Into a Transcon Market?

Saturdays can be such dull news days unless of course the story is about the 2007 wacky world of college football. But this story popped up on my radar screen as having intrigue click here. Intrigue, or a sign of things to come as the largest transatlantic carriers explore strategies to best exploit the new US – EU Open Skies deal? Clearly British Airways is (re)evaluating the best use of its capital as the current architecture of the transatlantic market is being (re)examined. This story comes on the heels of reports that BA is considering a major expansion of new services into the US market.

Another interesting aspect to consider is whether the best use of capital is to consolidate at home or with an international partner?