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Thinking About Three Headlines from January 24, 2008

So much of the current discussion surrounding US airline industry consolidation scenarios involves only the Network Legacy Carrier (NLC) sector. In an earlier post this week, I wrote about the catalysts for consolidation. In that post the importance of economies of scope, scale and density is discussed and how they are a most important ingredient to a healthy industry structure. These economies are critical to all players – even the LCCs.

Three headlines in yesterday’s news underscore the negative effects of a highly fragmented and hypercompetitive US domestic industry structure – and those negative effects are not limited to the sector of the industry that is forever blamed for the industry’s woes – the NLCs. Yes, there is even bad news emanating from the Low Cost Carrier (LCC) sector. The very sector that many policymakers believe is solely responsible for the consumer benefits that the entire industry delivers each and every day - NOT.

First off, Holly Hegeman writing in her blog Planebuzz reports the first credit downgrade of the period. No it is not one of the NLCs, it is Southwest Airlines. Not that this is anywhere near the end of the world for the carrier with the industry’s best credit rating – even after the downgrade – but noteworthy in my view.

Second, Terry Maxon in his Airline Biz blog writes about additional stock sales by David Neeleman, founder and non-executive Chairman of jetBlue. Whereas there are always multiple reasons for stock sales, Neeleman has sold nearly 30% of his holdings since May of 2007. This particular announcement comes just days after jetBlue finalized a stock sale to Lufthansa that was designed primarily to address some near term liquidity concerns.

Third, last night Reuters reported out on Frontier’s earnings. The short article was entitled: Frontier reports wider loss, to sell four jets. Enough said.

For government regulators generally: the bad news regarding the industry’s financial performance is not limited to one sector. If you were right, and I was wrong, that the LCCs were/are the sector that will keep the US industry in a global leadership position, then it is time to step back and recognize that even this sector is beginning to show signs of troubled economics. And given that this sector is largely confined to the 48 contiguous states, that would be a good place to start your analysis of the industry’s structure.

For government officials in smaller US communities: the bad news is that the LCC sector of the industry is not your answer. The bad news is that industry economics do not support all of the service currently being provided. The good news is there is an opportunity to look at the current industry structure and allow it to make necessary commercial changes. Scrutinize the proposed changes for sure. But, changes that keep your airport market connected to the US air transportation system is much better than being the subject of attrition from the airline map.

For government officials in cities that serve as corporate headquarters: keeping your city as a critical dot on the global airline and trading map is much more important than housing a few thousand workers. It is simple economic impact math.

Much more to come,

Comments

[cdvillani]

On the issue of consolidation Bill, I have a different perspective. With your previous post, Converging Catalysts Making a Case for Consolidation?, you mention the 1980's consolidation. Of all the carriers listed, all but one [American Airlines], is out of business or have declared bankruptcy. Given what I have personally witnessed at AA, I would argue that the resulting consolidation from our mergers/acquisitions has not helped in stabilizing the industry or improving labor relations either.

As you point out, even the LCC's are starting to feel the pressure of sustainable profitability. In my view, let the free market weed out those that can't compete rather than executives or politicians.

In regard to labor, history is littered with problems associated with integration of seniority lists. While the MEC's at Delta and Northwest may be talking a good game right now, history suggests real problems ahead.

There was also mention of foreign capital investment. While I believe some level of foreign investment is good, I also believe in the sovereignty of our nation. Too much dependence on foreign entities is not good for our country. Oil is a prime example.

In my view, we have a serious people issue in this industry. Solving that will not be achieved with consolidation but with leaders. In doing so, this industry can be a healthy one.

[Swelbar]

Carmen

Thanks much for taking to the time to write in. My guess is my perspective is not popular in many corners. I agree with you that merger history has not been kind -- depending on perspective of course.

But if not the deals done in the 1980s that helped to improve the economies of scale, scope and density of the surviving liveries as the industry was in the infancy of deregulation, my guess is that there would have been another spate of activity during the economic downturn that followed in the early 1990s. But we do not know and will not know that.

I would further agree that for AA, the Reno and TWA deals did not play out as envisioned.

But here we sit in 2008. Two years of profit following the deepest cost cutting period in history -- no matter how you measure it -- and the resulting performance is not anywhere near sufficient. Further the profit generated is not even close to the labor cost reductions let alone when you factor in all of the non labor cost cuts made on top of them.

Labor is not the answer for most of the larger carriers. Sure there is productivity that can be negotiated, but..... Fuel costs for industry have increased nearly $15 billion since the cost cutting began. Distribution costs have largely been wrung out of the system. So where does it all go?

Labor and the regulators need to learn from past mistakes. Given that there are fewer cost cutting opportunities, combinations should provide, by theory and proven in practice, better revenue generation while allowing the combined entity to wring duplicative costs from the resultant combination.

This will be a period of pain for some to be sure. But just because it did not work in the past is not the right answer either. This is no different than autos or steel or telecommunications. In each of those spaces there are some good stories and some obituaries.

I would rather try something than stand around with my hands folded because I can point to cases that did not work. I look at Air France and KLM and go wow. There is no wow in the US.

[cdvillani]

You touched on one very key issue Bill -- "labor and regulators need to learn from past mistakes." I would add airline executives to that list. On your MIT website, you illustrate total compensation packages along with a host of other good data. Southwest pilots are at the top. Their contract clearly demonstrates how competitive costs can be achieved while bringing value and job opportunities to pilots. Politicians should work aggressively to reduce foreign oil dependence. More oil drilling and refining in our country, nuclear power, and new technology for alternative power sources would help reduce in what has become an airline's highest cost -- fuel. They should also raise the bar for entry into this industry and lower it for exit. Executives need to redefine the performance metrics in determining bonuses. They should also put forth realistic contract proposals [APA take note] when negotiating with their most valuable asset -- the employee. Then continue in the relentless pursuit of generating more revenue.

In 5 years, this industry lost somewhere in the area of $35 billion dollars. As the saying goes, "Rome was not built in a day." The corner has been turned but it is going to take some more time. I think that we, as a society, have to learn to be a little more patient. We must also learn to constructively work thru our differences. The evil attacks of 9/11 should have taught us that. Unfortunately, I believe that lesson has been mostly forgotten.

All that I have suggested is not easy. Things that matter the most, such as freedom, do not come easy but they are sure worth the effort and sacrifice. The airline industry rose to that challenge following 9/11. Anyone associated with it should not let all the progress that has been made up until now be derailed because we refuse to learn from history.