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Entries in variable compensation in the airline industry (2)

Monday
Jun132011

Autos, Airlines and the Question of Union Relevance

Last month I had the honor of being invited by Wolfe Trahan’s Hunter Keay to participate on a Labor and Policy Panel at the firm’s Global Transportation Conference.  I shared the dais with Dave Bates, President of the Allied Pilots Association; Lee Moak, President of the Air Line Pilots Association; and Sharon Pinkerton, Senior Vice President for Legislative and Regulatory Policy at the Air Transport Association. 

With Keay as our moderator, we had a lively discussion on a number of subjects including the always controversial topic of variable compensation for union workers.  Of course, I was the lucky panel member to be asked the first question, and as Swelblog readers know, I’ve been a longtime proponent of variable pay structures for airline industry workers.  Why? Because I believe that workers should benefit on the upside, just as companies should be able to hold costs stable on the downside.  History shows very clearly that each time labor concessions were made in this industry, management later overcompensated labor for those give backs in subsequent negotiations.  Ultimately the overpayment was not sustainable.

Swelblog readers also know that I like to write about the similarities between two legacy industries; autos and airlines.  The issue of variable compensation in the auto industry is coming to the fore as the United Auto Workers (UAW) made clear that it is open to exploring such pay in lieu of fixed wage increases as negotiations with Ford, General Motors and Chrysler begin in earnest in July.

But before we go there, an interesting editorial appeared in the Wall Street Journal on March 2, 2011.  In “Winds of Change in Unionland” (subtitle: “The end of the road for the UAW, except as an administrator of retiree health benefits”) the author talks about the UAW’s presence in union strongholds in the Midwest. But now, as public sector unions in the region are under attack and these states are less successful attracting new business, the UAW is shifting its strategy accordingly. The grand plan under new leader Bob King is to instead look outside the heartland states, instead focusing organizing efforts on Toyota and other auto factories in the largely right to work states in the South. The WSJ piece points to King’s success in organizing parts suppliers but attributed those victories to the union’s “politically-protected labor monopoly over the Big Three.”  In it, the author also points out that:

  1. The union had little to offer the suppliers’ employees but the false promise of job security, and the companies put up little resistance for fear of losing their Detroit contracts;
  2. The supplier campaign was a distraction from the fact that the Big Three's own workers were giving ground on jobs and job security; and
  3. Mr. King is blowing smoke about Toyota. The UAW has no card to play. The union's labor monopoly gives it no leverage over the transplant factories, and the union's current appeal to their nonunion workers is, realistically, less than zilch.

The article then points to the outsized labor concessions that have helped restructure Detroit’s auto industry and the UAW’s cooperation prior to bankruptcy as part of a deft political play in Washington to appease those politicians that protect the UAW’s monopoly hold on the U.S. auto industry.

The parallel with today’s airline industry negotiations, as the Wall Street Journal makes clear, is that every airline industry union complains that contract talks are taking too long and blames management. “Mr. King knows, in the current political atmosphere, he can't go back to playing his monopoly card to extract anticompetitive terms from the Big Three,” the author writes.

So, too, is the case with airline industry unions that seem to think that the world will revert to days past when companies continually “paid back” workers, plus, for prior concessions.  In each instance, anticompetitive terms contained in airline labor agreements remained or were augmented.

In a June 10, 2011 article the Wall Street Journal's Matthew Dolan and Sharon Terlep reported that the UAW had signaled that it is “open to discussing wider use of profit-sharing plans instead of fixed pay increases for its members, a key shift as the union nears contract talks with Detroit auto makers.”  Like airline unions in the past, “The UAW has historically resisted linking large portions of workers' pay to profits because its members would suffer in down years. Another fear: The auto makers were simply not making profits on a consistent basis.“

Why the UAW’s change of heart? The Journal report said King wants a “non-adversarial” relationship with management. Maybe that’s because the union doesn’t have much choice. As the newspaper asks: “What exactly has the UAW got to offer? Evidence is lacking that organized labor actually adds value, creating gains workers and stockholders can share. If it did, Toyota et al. would be clamoring to have the UAW in their factories. They're not.”

The Journal continues:  “Mr. King's dilemma is evident in his lukewarm response to the Big Three's opening gambit in this year's quadrennial contract talks, an offer of enlarged profit-sharing. Here's the problem: Incentive pay is earned pay; workers see profits as something businesses create, not something union bosses create. And the foreign transplants will only be too happy to compete on the basis of performance-related pay. If the industry is headed toward compensation based on success, what are workers getting for their UAW dues?”

Good question.

I certainly never looked at variable pay that way.  I see it clearly as a way to better align the interests of workers and management across an entire business cycle and as a way to avoid the crazy cycle of take/give/take and the resulting bad blood and mistrust between union leadership, employees and management. 

Think about this:  If variable compensation was in place following the concessionary period of 1993 – 1995, workers would have gained far more between 1996 – 2001, the most profitable period in airline history when U.S. airlines earned in excess of $40 billion.  Instead employees received nothing with few exceptions. 

Today, the goal of most airlines is to reach “responsible” contracts with union employees with costs sustainable over the term of the contract.  That’s a much better approach than the patterns of the past, when buying labor peace in one contract only forced airlines into asking for concessions before the amendable date because they could no longer afford the terms. And sustainability benefits employees, too, particularly if it avoids the need for concessionary bargaining in a downturn and provides protection on the upside to prevent companies from earning outsized profits on labor’s back. 

This is the area where unions have missed the boat in the past.  Too often, labor leaders spend too much time negotiating protections on the downside and ignore similar protections on the upside.  Think back to the more profitable periods in U.S. airline history during which, for many, employees were still in the middle of concessionary agreements. As industry fortunes improved, employees sat and watched because their unions did not negotiate protections on the upside that would have ensured their sharing in the profits – some of which were made possible from lower labor costs.

Of course, the industry has been anything but profitable over the past decade except for a brief blip of black ink in 2006-2007 and 2010.  So upside protections would have returned little if anything following restructuring, with some companies instead giving performance bonuses when they met stated operational goals.  But let’s suppose the U.S. industry now sits on the brink of a profit cycle.  If upside protections had been negotiated during the mid 1990s, employees would have shared in $40 billion of profits while new collective bargaining agreements were under negotiation. That would send a far stronger signal about the connection between productivity, competitive costs and profitability than has the long and painful cycle of give-some, take-some negotiations.

One thing is clear: carriers with relatively expensive labor rates today will need to adjust expectations at a time that industry economics, particularly domestic market economics, do not support above-market increases in rates.

Unions:  Irrelevant or Just In Need of a Total Overhaul?

Unlike some in the Wall Street Journal article that suggests unions are increasingly irrelevant because profits are earned by companies and not union bosses, I believe that unions are relevant but need to be totally restructured. 

Airline unions are just like the airline companies before restructuring; trying to be everything to everyone.   Unions have become too democratic.  Decision paralysis creeps in because an agreement must satisfy so many disparate interests – at least in the eyes of the leadership who may represent workers with a wide variety of skills, experience and education.  With few exceptions at the local levels, airline union leadership simply does not lead.  Rather they succumb to the pressures of the most vocal factions. 

Unions need to start relying on professionals at the negotiations table who have an ability to divorce themselves from the rhetoric and the politics and instead focus on reaching agreement. They need to lengthen the terms of their elected leaders so that leaders will be less likely to overpromise during their campaigns and be accountable to members for the hard work of negotiations. Anyone can make bold promises. Real leaders set realistic expectations and perform accordingly.

Longer terms for elected leaders might also help speed the course of contract talks. Unions would face less risk of elections distracting from their work at the bargaining table, and less time training members of the bargaining committees on the hugely complex set of issues, factors and finances that go into negotiations.

This type of internal chaos every two years can occur because the union, at least in collective bargaining, is a monopolist.  Monopolists have power.  But the days of union monopolies wielding power as in the past are quickly coming to an end as suggested by auto workers’ considering variable compensation as a significant component of this upcoming round of negotiations gets underway.  The automobile industry is a mature industry.  The U.S. airline industry is a mature industry.  Mature industries grow slower.  Mature industries tend to be more risk adverse than emerging or growth industries.  As a result, industries like autos and airlines need to look at alternative forms of compensating their people because mining new revenue takes time and often involves adding more risk than mature industries prefer. 

To remain relevant, U.S. airline unions need to begin a process of rethinking how they think.  Just as Ford, GM and Chrysler have unique needs in negotiations, so do individual airlines.  As author Susan Sontag once said:  “Existence is no more than the precarious attainment of relevance in an intensely mobile flux of past, present, and future.”  Unions exist because of the relevance attained in the past and the present.  What about the future? 

Thursday
Aug052010

Market Realignment: Labor, Mexico and the U.S. Regionals

Variable Compensation and “Upside Protections”

A commenter on my most recent post wrote:  “Variable compensation?? That implies that you think I trust airline executives to treat me fairly. Their behavior over the past decades clearly shows that they can't be trusted, and you want me to buy-off on a scheme where they CONTROL the data?”

Another commenter wrote quoting AMR CEO Gerard Arpey:  "And again, our hypothesis is that we’re going to continue to work in good faith, cut responsible agreements with our unions and that all of the network carriers in the next 24 months are going to go through the same funnel. And that when we all come out of that funnel, ultimately the market is going to be brought to bear on all of these companies and the market will determine wages and benefits in this industry just like it largely does other industries."

Just what is a responsible agreement? For one, a responsible agreement benefits both sides. It is one unlike those negotiated in the past where companies were forced to ask for concessions in a downturn because they cannot afford the terms of what had been agreed to previously. And for labor, it is one that is sustainable – one that won’t require concessionary bargaining in a downturn and provides protection on the upside to prevent companies from earning outsized profits on labor’s back. 

This is the area where unions have missed the boat in the past.  Too often, labor leaders spend too much time negotiating protections on the downside and ignore similar protections on the upside.  Think back to the period when this was most relevant - between 1995 and 2000 when the U.S. airline industry earned record profits.  Unions had just completed ratified concessionary agreements negotiated during the economic downturn begun in 1991.  As the industry’s fortunes turned, employees did not share in the most profitable period in U.S. airline history.  Rather employees sat and watched because their unions did not negotiate protections on the upside that would have ensured their sharing in the profits – some of which were made possible from lower labor costs.

The industry has been anything but profitable in the years since, so upside protections would have returned little if anything following the negotiations during restructuring.  Instead many employees got performance bonuses when their companies met stated operational goals.  But let’s suppose the U.S. industry now sits on the brink of a profit cycle.  If upside protections had been negotiated then, employees would share in the profits while new collective bargaining agreements are under negotiation. That would send a far stronger signal about the connection between productivity, competitive costs and profitability than has the long and painful cycle of give-some, take-some negotiations.

Can we expect realignment in labor during this round of airline negotiations?   And what will that mean for labor rates by the time every airline makes it through the funnel of negotiations? 

One thing is clear: carriers with relatively expensive labor rates today will need to adjust expectations at a time that industry economics, particularly domestic market economics, do not support outsized increases in flying rates, mechanic rates or most assuredly “below the wing” rates.

Mexicana

Two days ago, Mexico’s largest carrier filed for bankruptcy protection in the U.S. and insolvency proceedings at home.  Precipitating the filing, according to the carrier, was its inability to achieve significant wage and productivity concessions from its flight crews.  When negotiations did not produce the company's desired outcome, the employees were offered the keys to the company for one peso.  The employees said no thank you.  Like bankruptcy filings here in the U.S., the burden of proof will be on the company to make a case that deep concessions are necessary.

Like the U.S., the Mexican market is deregulated.  Like the U.S., low cost carriers (LCCs) fly in major markets throughout Mexico, driving down prices all the while the Mexican economy has suffered more than most around the world.  In fact, Mexicana holds two low cost carriers in its fold (neither of which will be affected by the bankruptcy filing of the larger legacy carrier).  Mexico is a microcosm of what occurred in the U.S. where LCCs grew at the expense of the network legacy carriers, driving prices down because they enjoyed cost advantages.  And like in the U.S., the Mexico domestic market does not produce sufficient revenue premiums for the legacy incumbents to offset their high and out-of-market cost structures.

Might Mexicana’s bankruptcy filing result in liquidation?  It could.  Already planes have been repossessed in anticipation of the filing.  Sounds like the U.S. industry immediately after deregulation but before Section 1110 protections became part of the bankruptcy code.  Today, unions in the U.S. are calling for changes to the bankruptcy code (Sections 1113 and 1114 specifically).  Ever wonder just how many U.S. airline jobs might have been lost if there were no Section 1110 protections?  I digress.

The Mexicana story causes me to reflect on the U.S. domestic market.  The realignment of the U.S. domestic industry is not done.  Mainline carrier presence in the domestic market will continue to shrink unless the labor economics change.  Network carrier presence in the domestic market is now more a function of moving a passenger from Lansing to Lagos than it is Lansing to Los Angeles. 

Since 2000, network carrier revenues are down 36 percent.  Since 2000, when mainline network carrier domestic Available Seat Miles (ASMs) reached their historic apex, capacity flown by the same carriers has been reduced by 30 percent.  Over the same period, domestic ASMs added by the U.S. LCCs increased by 134 percent.  ASMs flown by the regional sector have increased by 178 percent.

These trends are a function of the economics of flying today.  Labor contracts in the past were based on $30 “in the wing” jet fuel.  Today’s reality is $90.  With domestic revenue generated by the network carriers down more than capacity since 2000, it is uncertain what kind of contracts will come out of that funnel, and whether the U.S. airline industry as we know it today we be able to sustain higher costs.

SkyWest Subsidiary Atlantic Southeast Airlines to Purchase ExpressJet

Another story occurring within the industry that has labor ramifications is the consolidation taking place within the regional industry. One of the catalysts for consolidation within the regional sector is the unknown outcomes of scope negotiations between the mainline carriers and their managements as to what kind of flying will be done by the regional providers tomorrow.  Another catalyst is the known, but yet undetermined, push for new regulations governing how much regional pilots can fly.   

Readers at Swelblog.com know that we have been talking about consolidation and realignment of the regional industry since the beginning.  Does a consolidating network carrier sector need nine providers of regional capacity?  No.  

Given that new, expensive changes to regulations governing regional carriers and their relationships with mainline are expected this year, the network carriers would be wise to look carefully at their regional feed composition. With the merger of Continental and United and new regulation pending, it simply makes sense to realign regional relationships.  United is one of SkyWest’s two major partners and it does business with each Atlantic Southeast and ExpressJet (who is Continental’s primary regional partner).

The SkyWest/Atlantic Southeast announcement comes on the heels of Pinnacle buying Mesaba and expanding its presence under the Delta umbrella.  These types of realignments are now a trend and not one-off and ill conceived acquisitions.  Just like network carriers need scale economics, so do the regional partners in order to minimize labor and maintenance costs regardless of what type of flying they are permitted to perform tomorrow. 

This is healthy consolidation and the idea of scale economics may be what just makes American Eagle attractive.

More to come.