American Airlines, Labor Leverage, US Airways and Chicken Little

Labor Leverage and Other Thoughts

Since American’s filing for bankruptcy protection last week, I’ve received many notes asking why I am not writing about American - about a potential combination with US Airways or what I expect the company to win from the unions.  I haven’t written because, frankly, I already talked about the potential consequences of bankruptcy for the airline, unions and the industry in my most recent piece.

On Monday, I intended to write about leverage and how the Allied Pilots Association was seriously misjudging the leverage it thought it had. Tuesday’s filing kind of made that point moot.   As the Sections 1113 and 1114 negotiating process wends its way through a court supervised restructuring, the pilots and all unionized employees will either reach consensual agreements with the company or the company will look to the court to terminate the existing agreements.  Whichever outcome, the new contracts will look nothing like the potential deals the unions could have negotiated at various times over the past five plus years.

I know, I know… “American could have reached a deal if it wanted.” It does take two to tango, but in this round of negotiations, American and its unions were listening to vastly different music. American’s offers provided cost benefits that would be realized over the long-term while still maintaining what can only be described as an industry-best benefits package. That wasn’t going to sit well with analysts and Wall Street types who fervently believed the airline needed immediate gains to remain viable.

The unions, seemingly, wanted everything to magically return to past patterns and routinely called for restoration of the pay and benefits they conceded in 2003 to stave off bankruptcy. A common refrain has been no union members have seen substantial increases in wages since 2001. Peers at other airlines did get raises, but American’s employees were – and are - still better off.  It’s a simple, provable truth and it meant there was no going back to 2003 or 1993. It’s a different industry and a different world.

That’s key to understanding there is no leverage for either side in this round of negotiations. (Are you listening, United pilots?) It’s also why this negotiations cycle has been so difficult. Few agreements have been struck. American will likely get deals well before we see contracts – or even tentative agreements - at United and US Airways.  As the bankruptcy process plays out, the American pilots and flight attendants will no longer have industry leading contracts among the network legacy carriers – Delta will.

And guess who comes up next for negotiation – the Delta pilots.  Like American’s management over the past five years, Delta’s management will have to negotiate improved terms and conditions on the highest cost labor contract in existence. All the while, the United/Continental pilots will spend more time asking who is on first than they will spend at a negotiation table.  Looks to me like all of that “leverage” being created by the United pilots alleging poor safety policies by management is NOT moving the parties quickly toward a deal.

While I expect the Delta pilot negotiations to be complicated and difficult for the company, at least the pilots enjoyed some benefit following the merger with Northwest and the bankruptcy agreements that preceded it.  Delta’s pilots will have the richest compensation package in the industry after American completes its bankruptcy negotiations. That means they won’t have any leverage over the company even as pilots squawk about the liberal scope clause in the current agreement. 

In this process, there is a different kind of “trickle down” theory. Case in point: The TWU employees at American. Talk about no leverage.  The more removed from the flight deck, the more leverage dwindles. American’s below-the-wing employees currently earn a total compensation package of roughly $25 per hour. That work can be outsourced for 40 cents on the dollar.   Add the fact  American outsources the least amount of maintenance work in the industry, and that it has more ground workers than any other airline, well, you get the feeling things are going to change. If you’re a TWU worker, that’s probably no comfort.  

All This Talk About A Merger With US Airways

I am surprised – no, blown away - by just how much attention the US Airways – American merger possibility is getting.  In the first 36 hours after AA filed for protection it seemed the world was suggesting a merger with US Airways was the only viable exit strategy.  I don’t believe it.  American will have the exclusive right to file a Plan of Reorganization (POR) for 180 days – a right that is typically extended multiple times by the presiding judge.

Keep in mind, all three of American’s unions were appointed to the unsecured creditors committee. Any plan of reorganization by a party other than AA will have to convince the committee their plan is better for all stakeholders.  Given the messy labor situation that remains at US – six years after its merger with America West – I sincerely doubt anyone would find a US bid credible… especially American’s unionized workforce.  

That’s why, at least right now, I simply don’t see a merger happening, despite industry analyst Vaughn Cordle’s contention that, “regardless of the ugly nature of merging two suboptimal business models and different unions, American's best option is to merge with US Airways.”  My first question is, why would you even think of merging two suboptimal business models in the first place?  So that you can compete directly against balance sheet and network rich United and Delta?

There is another option I don’t think many analysts have considered.  I could see a competing plan led by British Airways and other oneworld partners that would have the potential to win if the AA case gets to the point where outside parties are free to submit alternative PORs – even at today’s 25% foreign ownership limit.  If you believe AA will become a smaller entity over the coming months, the one sure thing is AA’s network will be optimized to maximize revenue generation with its new joint venture partners.  That’s precisely what STAR is doing through United and SkyTeam with Delta. 

The Sky Is Not Falling

Over at Terry Maxon’s AirlineBiz blog is a letter from TWU President Jim Little decrying American’s filing with $4.1 billion in cash and thus a near term ability to pay its current obligations.  I urge you to read the letter in full and the lack of reasoning throughout.  What did Little expect the company to do when he refused on numerous occasions to step-up and tell his TWU members the cold truth that something is better than nothing?  He has had a number of opportunities over the past five years to negotiate an agreement with American that the company could afford. 

The bottom line is bankruptcy is not a big deal.  This is not the industry’s first rodeo.  American’s problems are bigger than a check labor could write outside of bankruptcy, but sadly, the employees will pay much more inside of bankruptcy.   As APA President Dave Bates told The Wall Street Journal, "Sometimes in life it's easier to have something imposed upon a person than have them agree to it voluntarily."  Sad commentary indeed.

FORT WORTH, Texas: The Longer It Goes, The Worse It Will Get

Another Sunday in the Washington D.C. area means being forced to watch the Redskins if you want to watch some football.  I wanted to watch some football, but catching up on my reading was much more interesting.  As is typically the case, my starting point is Terry Maxon's Airline Biz Blog.  Three of Maxon’s last four posts pertain to the negotiations between American Airlines and the Allied Pilots Association.

Each of the parties issued a statement regarding the decision not to negotiate over the past weekend with both pointing fingers at each other.  The understanding, at least for those of us on the outside looking in, is the company is seeking to reach an agreement in principle with pilots before this week’s regularly scheduled AMR Board of Director’s Meeting. 

I have participated in numerous troubled negotiations between management and labor, and taking time off because someone is tired prior to a deadline just does not make any sense.   Maybe the APA doesn’t think it is negotiating against a deadline.  I am also someone who knows a little bit about Board of Directors meetings and fiduciary duty, so if I was the APA, I would be taking Wednesday’s meeting seriously.

After all of the news, reviews and Wall Street’s muse over American’s financial blues I am guessing that AMR’s Board of Directors is feeling under pressure.  And Boards under investor pressure often feel the need to act.  As I wrote in American: Limited Options, Pain Likely, something at the Fort Worth, Texas carrier likely needs to give if no labor deals are reached – particularly a pilot deal that could serve as a template for other work group agreements.  The potential scenarios are, of course, bankruptcy, getting significantly smaller outside of bankruptcy or getting smaller inside of court-assisted restructuring.

Some of the messages I received on that piece suggested bankruptcy is an acceptable solution for American’s situation, particularly when dealing with the current management.  I think all of American’s union groups, and especially the pilots, should be very careful what they wish for.  Never forget the truism that it is probably best to deal with the devil you know.

The fact is employees at American still have their benefits, including pensions, because CEO Gerard Arpey chose not to use bankruptcy proceedings to cut costs the way everyone else in the industry did. Whether the unions like or dislike Arpey, though, is moot. If American files Chapter 11, creditors and the courts probably won’t let Arpey guide the airline during its time in bankruptcy.  They’ll want a restructuring guy, possibly in the mold of United’s Glenn Tilton, who turned his back on company history and acted in the best interests of financial capital, not employees to reposition the enterprise. That caused some serious labor/management relationship wounds.

American can survive labor discord as it has since Robert Crandall was in charge. I’m not as sure American comes out of bankruptcy unscathed – at least, not the American Airlines that we’ve known for the last 85 years. A much different airline would likely emerge, if at all, so emotionally-charged employees might rue their actions today.

Let’s review a few facts about bankruptcy and North American airlines.  Since 1991 there have been 14 airline bankruptcies and only one carrier remains a stand-alone airline today – financially troubled Air Canada.  Eight of the airlines have been liquidated or ceased operations:  Pan Am, TWA, Aloha, ATA, Skybus, EOS, Arrow and Mexicana (Eastern filed for bankruptcy in March of 1989 and ceased flying in January of 1991).  The remaining five airlines have been merged:  US Airways, United, Delta, Northwest and Frontier.

While the merged companies are stronger, they lost most – if not all - of their individual identity.  A merger partner with American in its current financial and labor condition is unlikely.  Private equity would only be interested in American after a deep cleansing of labor contracts in bankruptcy.  After all, even private equity wants clean fingernails when the entity emerges from court protection.

Union groups need to think long and hard about what that means for them. For American’s flight attendants and ground workers, a Chapter 11 filing would be the end of the world as they know it.

American’s flight attendants fly the least of any cabin crew in the U.S. airline industry. They currently pay less for medical coverage than their peers and still have pensions and retiree medical that are but faded memories for flight attendants at other carriers.

There are roughly 25,000 TWU members employed at American – mechanics, baggage handlers, cabin cleaners. A bankrupt American would dramatically slash that number, outsourcing a majority of jobs as much of the industry already does. Pensions, retiree medical – all gone. The reverberations would shake big cities like Miami and communities like Tulsa where the American maintenance base is the largest private corporate taxpayer.

Pilots like to think they’re different, more crucial to the operation, more prepared to handle anything that arises. That’s their job, and most are very, very good at what they do. The members at the Allied Pilots Association, though, should use the same reasoning and spend some time rethinking their position.

As MIT’s Airline Data Project shows, on average, American’s pilots are already making about two-percent more than their peers. The thing that should make pilots uneasy, though, is when you look at their benefits, which are worth about 40+ percent more than what pilots at other network carriers make. There is not a bankruptcy judge in the country who won’t immediately allow the company to toss all of that out the window.  It is not the wages per se; it is the benefit package and relatively poor productivity that makes the American pilot agreement uneconomic when compared to peer carriers. 

I’m not privy to what’s being talked about at the table between pilots and American, but the company is posting all of its proposals on its public web site, AANegotiations.com. From what I’ve seen, American’s current offers don’t dramatically change pilot benefits… they would still be significantly better than other carriers. What hasn’t been posted is any item on scope, and I’m sure the pilots would vehemently oppose any changes, no matter how necessary or warranted they might be.

If anyone on the APA Board foolishly thinks bankruptcy wouldn’t be so bad, they should review those facts I mentioned earlier. Besides the loss of pensions and work rules, a post-bankruptcy American would either be much smaller – meaning fewer pilots needed-- or prey to other airlines circling its carcass. If it’s plucked as a weak-sister acquisition, those APA pilots would most likely lose their seniority taking a backseat – or right seat – to their new colleagues.  And that assumes that acquiring airlines would even want former American employees – particularly in seniority order.

I could absolutely envision a U.S. airline industry without American.  Think of the value of the Heathrow slots, the LaGuardia slots, the JFK slots, the Washington National slots, the related real estate at each of the former, a ready-made Deep South America operation in Miami and an opportunity for network and low-cost carriers alike to finally get necessary real estate at Chicago O’Hare to mount a competitive operation.  American’s parts could be worth more than its whole to creditors and other airlines.

From a Board of Directors perspective, there are some basic facts to contend with. You cannot restructure the price of jet fuel.  Most, if not all, of American’s assets are pledged as collateral so little might be achieved in the airplane area other than rejecting certain leases on the oldest and most inefficient narrowbody fleet in the industry.  The company faces significant loan repayments and pension contributions.  In other words, AMR has every reason to file.

The pilots and the APA can belay that. They can be the leaders they think they are; not just for themselves, but for every other employee at American. Negotiating a deal now sends a signal to Wall Street, creditors and even consumers that things really can change. It also lessens the pressure on AMR’s Board of Directors to take a more active role in the company’s day-to-day dealings. Without it, the only pragmatic course for the Board would be to seriously examine its next steps. It can’t wait on the promise of a labor deal, especially if the APA mistakenly believes it has leverage and wants to try and use it.  Even if an agreement were reached today, it will be sometime in the first quarter of 2012 before the voting on a new agreement is concluded - that is why time is not on the side of the pilots and why AMR's Board is likely to grow restless if something does not happen soon.

Should a Chapter 11 restructuring end in Chapter 7 for some reason (a probability greater than 0 given that the company may be forced to cede control of its right to file a plan of reorganization), one can envision U.S. air transport system without American Airlines.  History suggests that the capacity void left will be filled in short order by the remaining players.  If a profitable hub opportunity exists for a remaining airline, it will be filled.  Will there need to be a hub at DFW?  No.  But there is plenty of local traffic to fill new service from existing airlines as well as Southwest at Love Field.  American’s aircraft order will likely be absorbed by the remaining carriers over the coming years to help fill the void left.

I just wrote “An Unpleasant Situation That Continually Repeats” last week that focused on unions thinking they know what is best for the company at both Qantas and Air Canada.  Maybe American was the sequel I was thinking about when I wrote that piece.  If that sequel includes bankruptcy, I know the story ends badly for the working men and women at American.  The rest of the industry will applaud the demise.

“An Unpleasant Situation That Continually Repeats”

Remember the movie “Groundhog Day?” Well, Qantas is starring in the current airline version with Air Canada in the supporting cast. The basic plotline has unions pretending to know how to run companies while portraying management teams as the dastardly villains whose only aim is to run carriers into the ground, milk their pay and destroy organized labor.

If you’re thinking you’ve seen this one before, that’s because you have. Outside of Hollywood, there is no better industry at recycling the same old material than U.S. airlines and their workers.  Like any movie fan, I love a good sequel, but the all-knowing unions versus incompetent management is the same story run more times than a 1950s B Western.

Still, the version from Down Under is quite possibly the most intriguing adaptation in recent years. At the crux of the Qantas story is CEO Alan Joyce.  During the past several months, Joyce has faced numerous intermittent strikes by employees; received alleged death threats as he seeks to change the course of Qantas; threw his hands up, shut down the airline and locked out employees for a weekend (the same weekend the Australian government was hosting a major conference); took a lashing for doing so from the Prime Minister and other Australian lawmakers; and, in a move reminiscent of U.S. airline stories, tried to explain the business to a dysfunctional government lacking a complete understanding of air transportation.

Joyce recognizes very clearly that Qantas must change, otherwise the Flying Kangaroo will land in a gravesite alongside Pan Am and TWA and not on a runway in Sydney.  Joyce wants/needs to establish a low-cost presence in Asia.  It already has a low-cost alternative called JetStar in Australia.

Qantas is a geographically disadvantaged airline – its home market is an end point on the global airline map.  Airlines in the Middle East have targeted Qantas’ traffic base using their geographic advantage to route traffic to points in Europe, North America, Africa and the Middle East.  Because of their lower costs, Emirates, Etihad and Qatar can offer much lower fares.  Singapore, Malaysia and Air Asia can do the same thing for the same reasons.  Imagine what will happen if (or when) the Chinese carriers become formidable competitors.

The union response? Rolling, intermittent strikes by the Transport Workers Union, the Australian Licensed Engineers Union and the Australian and International Pilots Union. This destructive industrial action forced Qantas to cancel more than 600 flights affecting 70,000 passengers, creating uncertainty for businesses and damaging the tourism industry.

I know some regular readers will say I’m once again bashing unions and sticking-up for management, but that isn’t the case. I think labor has some legitimate beefs with Qantas, but the reaction by the unions simply isn’t rational. When an airline is struggling, you don’t plunge it further into economic turmoil, especially when the heart of the dispute is job security. All the Australian unions have to do is look at past versions of this story to see how that works out.   It just makes no sense.

What makes this round of bargaining different than past rounds in the U.S. is there are major, structural claims that management cannot accept without putting the enterprise at risk.  It is one of the reasons I write so often about scope.

Joyce very eloquently outlined Qantas’ position: “No responsible company would let a small number of unions dictate how the business is run.  What the unions are actually trying to do is secure a veto on change. They demand the retention of outdated work practices that do not reflect the realities of modern aviation. They want Jetstar pilots to be paid at the same rates as Qantas pilots, a move that would drive up ticket prices for leisure travellers. These are major, structural claims that we cannot accept.”

I applaud Joyce for standing up and saying enough is enough.  Some very smart people have said Joyce’s major error was not informing the government of his intended actions, thus embarrassing the current administration. Truth is, whatever decision Joyce made to combat the union’s actions, he was damned.  If he did nothing, he was left in charge of an airline that had no idea if it could deliver service to customers because the unions could strike at any time.  He was damned if he shut the airline down, inconveniencing those same customers as well as humiliating the government. And if he gave the unions even half of what they wanted, he’d forever be known as the man who doomed Australia’s national airline.  

Like it or not, decisions made in management suites and board rooms are all about preserving the enterprise - - even if it means making unpopular choices.  That’s what makes the airline business different today than in the past.  The irony is both management and the unions really want the same thing; to keep the airline a viable enterprise into the future, thus securing jobs. It’s about building the best job protector that can be built – a healthy company.

That’s why so many U.S. aviation workers really should be tuning in to what’s happening at Qantas and, to a lesser extent, at Air Canada. Pilots and flight attendants at United/Continental, the pilots and all other groups in negotiations at American as well as the pilots and flight attendants at US Airways don’t have to produce their version of “Groundhog Day.” They can recognize reality and start a new script that guarantees good paying jobs for their members and helps keep their respective airlines competitive. Think of it as an adaptation of the UAW play.

To be stuck in the same place, with the same unproductive mindset and doing the same things over and over isn’t going to be any more effective in the Qantas story – or any other version – than we’ve seen in the past.  

Bill Murray’s character in “Groundhog Day” has a telling line I don’t want to see as airline unions’ epitaph. After trying to break the repetitive cycle he’s stuck in, Murray’s Phil Connors says, “I’ve killed myself so many times, I don’t even exist anymore.”  If management and unions don’t change the script soon, that’s exactly what will happen.

The Ultimate Unintended Consequence: Government Proposals Will Kill Small Community Air Service

Ten Reasons Why

I’ve been on the road for six weeks, traveling to communities large and small to discuss the grim future of small community air service in the face of economic pressures on regional airlines.

Those pressures only begin with jet fuel at a price equivalent of $120 per barrel, but the factors are many. They include the reality that: 

2) There are no aircraft of 50 seats or less in the production pipeline

3) All regional flying contracts will come up for bid between now and 2017 and likely will not be renewed by the mainline carriers

4) Low Cost Carriers in a regional market’s catchment area are drawing traffic to larger airports at the expense of smaller airports

5)  A growing pilot shortage will hurt the regional carriers first as regional pilots will find work on the mainline

6) Proposed FAA flight time/duty time regulations that put new limits on pilot flying hours will force regional carriers to hire more pilots to do the same amount of flying the sector is doing today

7) Congress, in a questionable response to the Colgan crash, passed a law requiring 1500 hours of training time for a commercial pilot

8) Most manufacturers won’t produce commercial airplanes smaller than 100-seats as most airlines can’t afford to sustain many routes with smaller planes

9) Negotiations between mainline pilots and management over new scope language is as emotional and contentious as it has ever been.

10) Proposed tax increases certain to punish the smallest of markets.

The Administration’s 2012 budget proposal already levies a $100 fee for every airplane departure in controlled airspace, costing passengers and the industry more than a billion dollars a year.  It also seeks to double the “security tax” paid by passengers to $5 per one-way trip, and triple the tax to $7.50 by 2017.  The total price tag for that proposal: $25 billion – $15 billion of which would be diverted for deficit reduction. The proposals together will cost passengers and the industry $36 billion over the next 10 years.

Air Transport Association of America CEO Nicholas Calio said it best when he said Washington is treating the airline industry like it treats  alcohol and cigarettes – taxing the hell out of it  as it does with “sin taxes” as if Congress actually wanted to discourage flying.  While I assume that’s not the government’s intent, it may well be the result.”

I do find it ironic that the government is seeking to tax an industry an incremental $36 billion over the next ten years after it lost $65 billion over the past ten years.  But I digress.

Let’s not forget that the airline industry ranks as the third greatest producer of economic activity in the US.  In my view, there is no way the industry can absorb these financial and regulatory pressures imposed by Congress without negatively impacting airlines and their role in driving economic activity. And the industry’s first response would be to remove marginal capacity from the system of production.  Where will they look to trim capacity even further – San Francisco to New York or Cincinnati to Des Moines?

Of course, airlines might try to pass new costs onto passengers, just as most industries do when faced with higher costs and limited opportunities for expansion. In this market, however, it is hard enough to simply add a few bucks to the price of a ticket to cover the rising cost of oil.  Imagine the impact of trying to pass on costs that will total billions at a time business and leisure travelers are counting pennies.

Typically, excise taxes like sin taxes work best in industries that have more control over the pricing. That is not the case in the airline industry.  Sin taxes are most successful on industries that produce products with price inelastic attributes.  The airline industry can hardly be termed an industry that produces a product with inelastic characteristics.

The ATA estimates the proposed taxes would lead to a 2.3 percent reduction in capacity at a possible cost of 9,700 airline and related jobs – and that’s just the impact from a tax increase.  Still unknown is the cost of the other factors outlined above, which alone would inevitably lead to fewer flights and fewer routes flown.

The mainline will hurt some. With fewer regional jets feeding the big carriers, how many larger aircraft do we need?  Some traffic will be captured at airports that continue to receive service within the catchment area of an airport losing service - but not all.  Some traffic may find its way onto competitor aircraft. And some demand may fall out of the system entirely.  In any instance, overall demand will suffer over the long term as marginal supply is removed from the system.

But the brunt of the damage will be felt in the small communities that rely heavily on regional carriers.

One of the things that bothers me most about Washington’s view of the airline industry is the clear bias in favor of the so called low cost carriers.  These airlines have been brilliant in cherry-picking profitable routes and creating networks designed for profitable flying. But it was the legacy carriers, not the LCCs, who invested in the assets to serve the nation’s smallest airport markets and sustained routes that, were subsidized by other flying.  It is the network carriers that keep small markets connected to the global air transportation grid. 

Unfortunately, the economics serving all these small cities are fast eroding because of factors the airlines don’t control, oil costs at the top of the list. But the lawmakers and regulators should step back and fast and realize how their well-meaning proposals could result in a loss of service to small markets across the nation.  The politicians will probably find a way to blame the airlines for cutting service while the real blame falls with those proposing “easy” fixes now that will do far-reaching economic damage  in the future.

Update on 10.25.2011 by swelbar

The good folks at ATR remind me that the ATR42 comes standard at 48 seats.  The company believes that it is a replacement for the 50 seat jets.

The UAW Gets It; U.S. Pilot Unions Don’t

It is simply time to end the war of words between airline labor and airline management.  It’s time to respect the realities of a fragile global economy. It’s time to appreciate that increasing fixed costs can’t be part of collective bargaining agreements. It is time to realize that new competition does not include the iconic names of the past.  It’s time for airline pilot labor to stop blaming everyone but themselves for the slow pace of negotiations.  These sentiments apply in Chicago, Fort Worth and Phoenix.

Two of the Big 3 U.S. automakers filed for bankruptcy protection.  A significant amount of the cost relief won by management came from labor, much like what U.S. airlines won from labor at United, US Airways, Delta and Northwest several years ago.  The automakers are negotiating – successfully, mind you – their first agreements since gaining labor concessions. In my mind, there are few differences between these legacy industries except for the agreements being negotiated in Detroit reflect the realities of today’s marketplace while airline contracts still contain outdated provisions ladened with duct tape and chicken wire. 

In an odd twist, the auto industry and the UAW embraced the concept of global competition long before globe-trekking pilots recognized changing domestic competition and acknowledged the economic realities of a new century. U.S. airline pilot unions seem to forget, as the Harvard Business Review wrote: “that there will be no going home again… that the landscape of business has been forever altered.”

U.S. airline pilot unions blame everyone but themselves for the growth of today’s regional industry.  After all, it is the mainline pilot unions that negotiated the “productivity improvement” of shifting small aircraft flying to the regional sector.  The war of (useless) words has to end, and it’s also time to stop the blame game over scope and just who is going to do the flying of aircraft 77 seats and larger.  Today's regional carriers are. To accomplish that, U.S. pilot unions need to negotiate rates and work rules less than those in the current collective bargaining agreements in order to bring more flying in-house.  That means, yes, a two-tier wage scale…  like the UAW just negotiated.

The UAW agreed to continue the two-tiered system negotiated in bankruptcy in return for adding or keeping 6,400 jobs in the U.S. A central point in the agreement was leveraging the two-tier system to win buyouts for higher paid workers – up to $65,000.  I think that would work in the airline industry as well, a prudent use of cash by airlines to get higher paid workers off the payrolls.  Instead of pay increases, most GM workers will get $12,500 in profit sharing (more because of an improved profit sharing formula), bonuses and other payments over the four year contract.  Those at entry-level wages - roughly half the current work force - will receive hourly rate increases of 24 percent. 

Just like the regional industry cross-subsidizes mainline pilot wage and benefit packages today, the new two-tier system would do much the same, but also put an end to what pilots’ term “outsourcing.”  I am not saying the numbers above are the right amounts for pilots; I am suggesting the concept of a two-tier wage/benefit/work rule package for airplanes dedicated to flying in the revenue-poor domestic system need a downward adjustment and need to include at risk earnings.  Fixed rates of pay, particularly in the domestic system, should only be negotiated in return for hard and fast productivity improvements. 

As a bonus, the credit rating of General Motors was upgraded by Standard & Poor’s allowing the company to borrow at cheaper rates which also works to maximize profit sharing payments. 

I’m writing this after listening to speech by Capt. Wendy Morse at United in which she spoke openly about the dysfunction in her own ranks standing in the way an agreement.  Morse does suggest the company is also dragging its feet, but it certainly makes one question the internal union politics at United/Continental.  The same rhetoric has been heard at American and US Airways.

What absolutely befuddles me about the FUPM mentality by the boisterous minority at each of the pilot unions is the failure to recognize the past financial performance of this industry certainly doesn’t guarantee job security.  There is no more room for court-assisted restructuring.  What is absolutely amazing is the U.S. airline industry might just make a penny on the dollar of revenue in 2011 despite jet fuel prices that are higher than they were in 2008 when the industry lost 17 cents on a dollar.  A penny of profit is just north of $1 billion for the entire industry.  Some will do better, some will do worse, but either way, there is not a lot to go around.

There have been times in the history of the U.S. airline industry where union pilot leadership has, well led.  This is an opportunity for those heading the pilot unions at United, American and US Airways (and, to an extent, Continental) to do so again. Leadership is needed to understand domestic flying economics do not support collective bargaining terms for aircraft sized between 100 and 140 seats. Someone needs to step-up, otherwise the industry squanders yet another opportunity to remove emotion from the bargaining table and untangle the morass called scope. 

Just like the UAW is negotiating terms and conditions not previously considered in order to maintain and create jobs in the U.S., mainline pilot leaders must figure out how to return flying to its members. The U.S. airline industry is going to see its fortunes turn.  It just won’t be today or even 2012 based on current economic trends.  Therein lays the opportunity. Like the auto industry, airline pilots and other workers should share in increased profits. It’s an upside protection that pays off for members and they “get theirs” when the headwinds change. It’s also a catalyst to get something done now and provide cost-certainty to companies desperately trying to staunch the red ink.  

If pilot group “asks” continue to follow the same old, tired, predictable pattern of fixed-wage increases and blind allegiance to obsolete scope clauses, more than likely, one carrier will face liquidation and tens of thousands of jobs will be lost.

I think of these negotiations as “transition” agreements.   They must be evolutionary because past “gives” cannot be repaid. The industry, the economy, has dramatically changed and we can’t go back.  To be evolutionary requires leadership willing to be revolutionary in their thinking.  It might be cliché to say the world is getting smaller, but it’s a truism for the networks that comprise domestic U.S. airline systems today.  Larger markets will always have airline service; it’s the small and mid-tier markets airlines struggle to serve profitably. As the network continues evolving, the underlying economics of the domestic system simply do not work if flown at today’s outdated and trumped up wage and benefit packages at the mainline.

No more whipsawing.  No more arbitrage.  Just reality.  Pilot leadership and airline management must get it right this time and create a template other work groups mired in their own false hopes that historical patterns will reemerge can follow. 

Pilots are a sophisticated group in their education, reasoning and their ability to react in times of trouble.  The UAW probably isn’t as sophisticated, but currently, they’re smarter than pilots.

This is a case where the ends really do justify the means.

Scope Yet Again; Commenting to a Commenter

There is often some very good reading over at www.airliners.net inside their civil aviation forum with some very good commenters and very interesting threads to follow.  This week, one asked:  “United/Continental Conceding Domestic Market?”  Another speculated about the future of the Air Line Pilots Association (ALPA).  Another asked which is the next US carrier to file for bankruptcy? That speculation is rightfully focused on the regional sector of the industry.  But much of the discussion fails to recognize the tangled web called the domestic network business, which includes mainline carriers, regional carriers and the unions. The players in this web are inextricably intertwined - but too often discussed in silos. 

United-Continental Holdings’ CEO Jeff Smisek once said something I now quote in every presentation I make. Of the world’s now largest airline, he said:  “We’ll have the domestic operations sized solely to feed the international traffic.”  That quote and its derivatives are sprinkled throughout the airliners.net thread focusing on whether United/Continental is conceding the domestic market.

In my view, the US domestic business is at a crossroads.  Do iconic names like United, Delta, American and US Airways continue to make pure domestic flying a significant portion of their route portfolio, or do they continue to attrite pure domestic operations away because cost structures can no longer support mainline flying in what has become an ultra low fare market?

Some in the thread note that Smisek’s words worry some pilots, as they should. And those concerns shouldn’t be limited to the flight deck.  In a ‘be careful what you ask’ for scenario, there are forces at work that ensure the regional sector of the business as we know it today will be smaller tomorrow.

There is a virtuous circle of events at play:  with in the wing oil in excess of $100 per barrel; no 50 seat and less replacement aircraft in the pipeline; regional flying under contract that won’t be renewed because of economics; the prevalence of low cost carriers in the primary and secondary catchment areas of small and non hub airport markets; a pilot shortage that will impact the regional sector; flight time/duty time regulations that will require more regional pilots to perform the same level of flying being performed today; a new law requiring 1500 hours of flying for new pilots; and the fact that the smallest aircraft coming to market will be at least 100 seats. 

And so the circle spirals downward for the regional sector of the business.

I think scope is a cancer because it has been used as a bargaining chip.  It has been, and is, a Ponzi scheme as I wrote in US Pilot Unions’ Dirty Little Secrets.  There has been a B-Scale in place supporting the rich mainline contracts since 1984 when new hires were offered positions at lower rates of pay.  When it was deemed wrong for unions to do such a thing, regional airline code sharing relationships were formed.  This “outsourcing” was agreed to by the union in return for higher wages and benefits for incumbent mainline pilots.   

After my last two posts on scope I expected, and received a lot of interesting mail.  Much of it emotional but some as ugly as the commentator who suggested “a certain poetic irony to the image of you[Swelbar] in a smokin' hole and another Captain Renslow at the controls.  Be careful what you ask for.”

Now it is my turn to say:  Be careful what you ask for.  If no B-Scale for domestic flying is possible and a phasing out of regional jobs is the goal in this round of negotiations, then what is going to cross-subsidize the wages, benefits and work rules at the mainline? By my calculation then, there is even less money to go around to for mainline pilots to win in a new contract.  And with the loss of feed traffic from a smaller regional sector, the real question is just how many mainline narrowbody aircraft does a carrier need?  In a point-to-point world, the answer is a whole lot less. If 14,000 mainline pilot jobs were lost in a decade of downsizing then more job losses are on the way from a loss of feed.  And the effects of a pilot shortage are even less.

And so the virtuous circle spirals downward for the mainline sector of the business.

Commenting on a Commenter

I received the following private email from John, which encompasses the views of many other commenters (public and private). He writes:

I read your blog because I know management does, I’m not your biggest fan.  However, I would like to see your opinion on the consolidation of regional carriers.  To me, scope is synonymous with outsourcing, which you say allows for flexibility.  But the real advantage of outsourcing is the low cost entry into markets (and exit). 

Things have changed, wouldn’t you agree?  Cash strapped regional airline are a thing of the past because consolidation has honed the market down to three: Republic, Skywest, and Pinnacle.  With size came assets, more loan opportunities, and market dominance.  In my opinion, I believe that regional airlines have reached a size where they have serious power over code sharing agreements or have the option to go many markets alone, Skywest is already considered a major airline with a MC of $6B.

I know you love to blame labor, because your audience isn’t.  I understand you have to make a living, and the ATA may not want to hear this, but they are screwing up.  The majors better start thinking of in-sourcing or face another round of upstart airlines entering the market with low cost structure and plenty of established routes thanks to the majors giving them business.

After all, outsourcing worked so well on the 787 it aught to do equally well for the airlines…right?

For the record, I do not see scope as outsourcing as it was agreed by both parties that a certain number of smaller jets can be used within the domestic system carrying a certain airline code.  After all, the mainline pilots did not want to be bothered with those little jets.  As for John, the real advantage of deploying small jets under the airline code is to maintain presence in feed markets that the mainline cost structure could no longer support.  Mainline aircraft in markets like Charleston, WV is a thing of the bygone years that immediately followed deregulation, yet they unfortunately still comprise a disproportionate size of the memory bank called entitlement. 

Yes, things have changed and are changing.  There are haves and have nots within the regional industry today as there were in mainline industry of yesterday.  There is one airline, SkyWest, which stands alone in the industry because of stellar management that understands the carrier’s place in the industry and their role in building a balance sheet that ensures Skywest will be part of the discussion for years to come. While I am sure that SkyWest would love to have a market capitalization of $6 billion that you make fact – on Friday the market capitalization of SkyWest was less than $650 million.

To make a valid argument, John would need to produce economics at the mainline that allow the company to serve Ft. Wayne, Indiana with non-regional (77 seats and more) equipment.  And my guess is that he could not. How many of those 737s/A320s/MD80s are filled with traffic coming from 50 and 70 seat jets?  How could he produce the same economics on the flying without having to make wholesale changes to his existing collective bargaining agreement in order to keep the flying in house? 

I get this argument often from other commenters that look back before looking ahead. Yes you can bring the flying in house - but not until the terms of the collective bargaining agreement reflect the B-Scale terms and conditions the mainline pilots found, and find, appropriate for their regional brothers and sisters.

Many claim I am too quick to blame labor.  In this case, it is the unions that create this purported “outsourcing” to support bloated mainline salaries, benefits and work rules.

John is right in his comment that “the majors better start thinking of in-sourcing or face another round of upstart airlines entering the market with low cost structure and plenty of established routes thanks to the majors giving them business”  -- at least on one front.  Today, the use of the regional industry is a defensive weapon used by networks to curb encroachment into mainline markets.  By forcing regional carriers to fly fewer 76-seat aircraft and less as well as limit their ability to fly anything bigger (again assuming the pilot unions would not change their collective bargaining agreements to meet or exceed the terms available from the regional provider), any airline network will begin to vacate certain markets that may then become an opportunity for a start up or an inroad for an incumbent like Southwest or jetBlue. 

Scope is as much as regulator of the business as is government at a time this industry does not need any more regulation.  Regulation often results in unintended consequences, one of which will be to create market vacuums that an upstart might willingly fill. Nature abhors a vacuum.

And John and many of his fellow mainline pilots end up over-regulating the business of feeding the aircraft they fly.  No feed – assuming that airlines cannot get to the right economics to fly certain routes – will likely result in significantly less mainline narrowbody flying – perhaps just enough to support the international operation.  And that may not be the consequence that mainline pilots have intended.

American: Limited Options, Pain Likely

Many readers have let me know that they are not as encouraged about the financial prospects of American Airlines with its massive aircraft order as I was in this piece. After all, the folks at AMR have problems beyond an ancient fleet, including an anemic revenue performance relative to the industry, high labor costs and all the other economic misery inflicted on many airlines in the past ten years.

I believe that AA’s aging fleet contributes some to the competitive disadvantage it suffers, and bright, shiny, fuel-efficient new planes will help impress customers and cut fuel and maintenance costs.  But what comes next?

Anxious analysts point to the fact that the price of oil impacts everyone, yet AA’s performance lags quarter after quarter. And there’s seemingly no significant movement yet in the airline’s labor negotiations, despite years at the bargaining table. With contract costs higher than anyone else in the industry, the company wants more productivity and smarter work rules in exchange for enhancements. All the while the unions have dug in either thinking or pretending that their righteous indignation will somehow turn the global economy and thus the industry around and recoup for labor all of losses in recent years.

American is one of the few carriers out there that didn’t turn to bankruptcy to shed some of these costs. In bankruptcy you cannot restructure the price of oil, but you can shed the leases of the least desirable aircraft, work with creditors to reduce debt and make changes to the labor agreements. But bankruptcy is probably not a realistic option now.

This is not 2002 with the shadow of 9/11 cast over the proceedings. This is not 2005 when the price of oil began its march upward and served as a catalyst for the bankruptcy filings of Northwest and Delta on the same day. 

No it is 2011, 10 years past the date that the country would like to forget.  Now, many airlines are flush with cash and don’t have the liquidity scares that were present when others filed. Many U.S. airlines are making money or at the very least are cash positive, despite jet fuel prices at the equivalent of a barrel of oil at $130. 

American, however, is on the wrong end of the industry today and some smart people question whether it will survive to see it’s much talked about long-term plans take wing.

So, let’s assume that Avondale Partners’ airline analyst Bob McAdoo was right in his May 16, 2011 analysis that American simply needs to shed capacity.  McAdoo cited US Airways as an example, where new management culled 20 percent of jet capacity.  But what he did not figure in is the likely relief American would need from its pilots union to make that kind of correction possible. More on that later.

American still relies on its regional partners to fly 37 and 44 seat jets because they are part of the pilot contract’s “scope” equation that determines the number of larger regional jets American can fly.  A 20 percent reduction in flying, much of it on long haul wide body routes flown by senior crews, would likely result in a furlough of up to another 1,500 pilots.  But American can’t do that either because of the same contract provisions that say American cannot drop below 7,200 pilots on the active roster.  And that doesn’t even take into consideration what the other union groups may have in their contracts that prevent the company from making the kind of changes that may be necessary to save the airline.

So what choice does American Airlines have?  Cutting that much capacity will be extremely painful for employees, and could put at least an additional 11,000 other American Airlines workers on the furlough list and in the unemployment line.  Cutting that much capacity would also redraw American’s network and route structure as we know it, giving its competitors greater strength in some cities and markets where American’s presence would dwindle or disappear.

McAdoo’s analysis calls for American to pull down certain Chicago to London flying; cut flights to Buenos Aires from multiple AA gateways; eliminate service to India;  reduce by half the flights from Chicago to China; and trim transcon service between JFK, Los Angeles and San Francisco.

McAdoo also challenges American’s “Cornerstone Strategy.”  In addition to flying a money-losing route between London Heathrow and Los Angeles, American is building its LAX presence using those inefficient, small regional jet aircraft. The same is true at Chicago and New York JFK.  In McAdoo’s view, Chicago is too dependent on connecting traffic at fares that are not compensatory.  Further he claims that in many instances, Chicago and Dallas/Ft Worth compete for many of same passengers connecting to points east and west and internationally and therefore are redundant service. 

Maybe it is time to de-emphasize LAX because the mix of traffic makes profitability difficult.  Maybe it is time to pull out of O’Hare because de-leveraging a hub is tricky particularly with an aggressive United hubbing in the same market.  Honestly, the only real big bang [removing fixed costs] American may have left is to massacre a hub like Chicago the way US Airways did to Pittsburgh and Delta did to Dallas/Ft. Worth.  The bigger the hub takedown, the bigger the fixed cost savings.

As for New York, American is now third in the market behind Continental at Newark and Delta at JFK and offers less connecting service than does Delta at JFK.  American’s relationship with jetBlue was supposed to address some of these competitive disadvantages but, as McAdoo points out, one can look a long time before finding many jetBlue to American connections in the various distribution systems. 

In the local New York market, AMR’s revenue per seat mile is underperforming when compared to peers at JFK and Newark.  Maybe it is time for American to pull out of JFK except for some select Trans-Atlantic flying, select transcon flying, and turn the rest of the region’s feed over the jetBlue.  But oneworld is depending on American to make New York the best market it can be for the alliance so this would be harder to do.  In fact with more 70-seat aircraft American could actually become more competitive there.  That would, again, depend on the pilot union’s willingness to do the right thing.

There is no doubt that a 20 percent cut in capacity would cause significant pain at American, even if it might be absolutely necessary to address the airline’s structural problems. But what if the cuts go even deeper?  What will be the impact on necessary American Eagle capacity that American has contracted for in the new Air Services Agreement?  If there is no Eagle feed, then there is no need for many mainline aircraft now dependent on the flow from points of all sizes behind and beyond the hub.  The virtuous circle spirals downward. 

At that point, American’s Cornerstone Strategy will be more about Dallas/Ft Worth, Miami and a little New York JFK and Los Angeles.  And the labor savings will come simply by cutting headcount.

To be clear, McAdoo says very clearly that labor costs are not the main driver of American’s weak results.  “Stopping the long haul bleeding has more direct leverage than trying to offset the losses by squeezing labor,” he said.  But in this scenario, labor is a large component of the fixed costs shed.

And on a strict profitability analysis, McAdoo may be right.  But contractual restrictions like pilot scope clauses – and American’s pilot scope clause is the most restrictive of network carriers – hamstring the company from making necessary tactical and strategic decisions. It is pretty clear that that American would not be flying as many mainline 136-seat aircraft today if it were able to utilize 70 seat aircraft like its competitors.  If that were the case, we may not be having this discussion.  And American Eagle would certainly not be flying 37 and 44 seat configurations in today’s fuel environment if not for the mainline pilot scope clause.

These small aircraft, “scope busters” to their critics, are used for many reasons and in this case they are used to average down the seat size of the regional fleet so that larger aircraft can be flown.  By the way, the competition flies 70-seat aircraft at will, primarily with the borders of the contiguous United States.  They can compete on frequency because they have right sized aircraft.  American does not.  Remember CALite?

Those who suggest that there is no labor problem at American should look no farther than the pilot agreement.  Among other common-sense adjustments, either American needs relief from that scope agreement in order that it can compete on equal footing with its domestic peers and provide the U.S. network feed to its oneworld partners that they demand, or the Allied Pilots Association needs to negotiate a regional-like contract for domestic flying as the A319s are delivered.  I wrote about these two options in March 2010 when I asked:  Mainline Pilot Scope: Will Regional Carriers Be Permitted to Fly 90+ Seat Aircraft?

It is unlikely that management at other airlines are going to make any deals that drive up their own labor costs only to have to go back and ask for relief later.

So there is not likely going to be the kind of labor cost convergence American hopes for in this round of negotiations; therefore, American may still have a labor cost disadvantage relative to the industry, particularly on productivity and benefits and scope.  This coupled with continuing economic challenges and pressure from investors and analysts will necessarily limit the extent to which American can sweeten its contract proposals to buy labor peace.  Purchasing labor peace only exacerbates the Ft. Worth carrier’s problems.

By all appearances, even the National Mediation Board recognizes that American does not have the money to satisfy the inflated demands of the unions that seem unwilling to discuss anything that smacks of a concession.

The upshot is that the unions at American may want to think hard about a draw-a-line-in-the-sand strategy that has done nothing but contribute to the airline’s under-performance. The contracts have to be part of an overall plan to get American out of the financial doldrums if the company is going to be able to execute the kind of financial and operational maneuvering that is absolutely necessary to win back the hearts and minds of the investment community – let alone customers and alliance partners.

A failure to make strategic, forward-looking agreements at the negotiations table now could have ramifications well beyond the individual contracts.  And there’s not a lot of time to waste in the process.  With limited options, the structural changes will prove painful.  

It Shouldn’t Be About Scope This Time – Rather Benefiting More Than One Stakeholder Is Key

It is Friday, August 26, 2011 and I am aboard United flight #701 bound for Albuquerque to participate in the 16^th Annual Boyd Group International Aviation Forecast Summit.  Many third rail issues get addressed at this widely attended conference and this year promises to be no exception.  The conference will address what Boyd refers to as futurist issues that will ultimately result in structural change to the architecture of the industry.  And I have been asked to help Mike open the conference along with Captain Michael Baiada.  I cannot wait.

What is significant about United flight #701? Seven years ago, a significant part of my career was assisting communities to attract airlines to begin new service. I was working with a talented air service development team at the Metropolitan Washington Airports Authority and my former firm, Eclat, and at the time there was very little domestic service to relevant markets that Washington Dulles did not have, whether regionally, mid-con or trans-con. 

But there were unserved markets like San Antonio and Albuquerque that were made interesting with regional aircraft service.  We approached United about a regional service from Dulles to the Land of Enchantment starting with a regional jet.  United agreed that the market could support a 50-seat aircraft on that route.  Over time, that route could support a 70-seat plane. Tonight I sit aboard a United mainline A-319 flown by a United mainline crew. 

If not for the ability to initiate a route that had fledgling demand with a right-sized aircraft, there would not be a mainline flight today that would get passengers from Washington Dulles to New Mexico in three hours and nineteen minutes. And this is but one example of many similar stories.

Today's pilot unions might look at this through a different lens.  How can we talk about any positive development stemming from the relationship between a mainline carrier and a regional partner?  In the view of many, any flight flown under the flagship name should be flown by mainline pilots. That's why unions negotiate scope clauses. That's job protection.

Or is it?

Ahh -- the law of unintended consequences rears its head in union halls.  Scope language is negotiated – in the mind of the pilot unions - to protect jobs.  But it does not.  Just note the loss of more than 800 mainline narrowbody shells and nearly 15,000 mainline flight crew members over the past decade and ask how successful the pilot unions have been at protecting jobs. 

More cuts will come if management negotiates the wrong scope language this time – language that limits their ability to remain agile when responding to competitive threats.  Domestic mainline network attrition will occur by 300-400 additional paper cuts per airline if done otherwise.  Nothing can artificially alter market forces.  Airlines have found ways around regulations governing international air transport and they have found ways around the biggest regulator of all – unions and scope language.

All I hear from negotiations at United/Continental, American and a renegade wannabe union challenging ALPA at Delta is that this round is about Scope, Scope and more Scope.  And I smile and wonder where the magic will come this time as lower cost competition remains keen to take full advantage of its labor and other cost advantages to find future growth opportunities.

Jeff Smisek, President and CEO of United Continental Holdings, recently lambasted the federal government - the other regulator - in a presentation at the Global Business Travel Association Convention in Denver.  Where might the U.S. look for a model of more effective air policy? Dubai, Smisek said, according to an article by Fred Gebhart in Travel Market Report.

“Emirates is a good example of an airline with a government that has good aviation policy,” Smisek said.
“Dubai recognizes the importance of air. It has an intelligent policy with a government that cares about the success of the air sector. It doesn’t throw up roadblocks, doesn’t over-tax it, and doesn’t beat it down at every opportunity. The U.S. government does all those things every day.”

 As usual, Smisek is spot on.

He talked of wanting to make United an airline that customers want to fly and investors want to invest in.  But while he spoke, Gebhart reports, nearly three dozen pilots and staffers picketed Smisek outside the conference, claiming that the company was "outsourcing jobs while creating unsafe working and flying conditions for employees and passengers.”

Nothing, and I mean nothing, disgusts me more than the actions of the US Airways and United/Continental pilots playing the safety card to create leverage in negotiating a collective bargaining agreement.  Is it really useful to try to frighten passengers? The vast majority of employees recognize that the best job security is a successful company and successful companies need customers to provide the revenue and shareholders to provide the capital.

Keep in mind that the pilots doing the picketing agreed to the language that allows the outsourcing of certain flying.  If not for the regional partners as a lower cost alternative, United, Continental, Delta and US Airways mainline operations would be but a shadow of the shadow they are today.

The United/Continental and US Airways pilot groups should get out of the court room and the arbitration tribunal business and get back to the bargaining table and negotiate an agreement that takes into account their companies' unique strengths and weaknesses.

Scope is not their problem.  Global competition is the challenge, and no scope language is going to protect them from that.  Any attempt to hamstring the airlines from making decisions that are in the best interests of all employees/stakeholders will only weaken the companies down the line. When it comes to United/Continental and US Airways ability to survive, Smisek and Parker are not the enemy; Emirates and Southwest/AirTran and Air Asia are.

Qantas Compared to the US Network Carriers

Speaking of being hamstrung by labor - the Qantas story playing out has strong parallels to the US network carriers that used the bankruptcy process to remake their operations during the 2002 – 2007 period.  The only real difference is that Qantas is quickly losing its competitive advantages to the emerging international “low cost” network carriers whereas the US network carriers lost their competitive advantage to the emerging domestic low cost carriers.

Last week Qantas outlined for the world the initial phase of an intended restructuring in its international operations designed to get its operating costs down – beginning with a new, high end, narrowbody intra-Asia operation with 11 Airbus aircraft.  Needless to say, Qantas CEO Alan Joyce’s decision to embark on such a strategy only poured more fuel on the fire burning between the kangaroo and its unionized pilots. 

Joyce is one tough leader.  Last week, Qantas announced that its profits doubled.  You know if you are making money why would you need to possibly embark on a radical, non-Australia based operation?  Because the international operation is under fire from Emirates and Air Asia and Virgin Australia and . . . Qantas announced that the mainline domestic and international – not subsidiary JetStar - made AUD 228 million, an improvement of 240 percent over the prior year period.  So what’s the problem?  The international operation lost AUD 200 million, meaning a very small domestic operation made a staggering AUD 428 million.  Therein lays the problem.  A money losing international operation, given the large fixed investment made, could quickly land a smallish carrier like Qantas in the memory bank.

Not only does Qantas suffer a structural geographic disadvantage of being at the end of a network system easily making its markets captive by the competition, it also suffers from a labor cost disadvantage, particularly in its international operations.  With successful competitors springing up in all sectors of Asian commercial aviation, the Qantas brand is potentially isolated and damned for extinction unless the network procreates outside of Australia.

This is why Joyce is making his move and doing so before it is too late.  And that is what the unions do not understand.  Scope is only as valuable as a met condition makes it.  Scope is negotiated before the future landscape is fully known and understood.  Airlines overpay for scope because the opportunity costs to shareholders are disregarded.  And this must come to an end because it only hurts the bottom line and job protection in the future.

Smisek, Anderson, Parker and Arpey (and maybe even Kelly as his airline gets more complicated) should take a long hard look at the history of scope.  Has it produced the desired consequences for employees, shareholders and the company?  Has it produced the kind of goodwill a company might expect from negotiating job protection measures in collective bargaining agreements?  Has it stopped unions from using the "safety card" to attack their own airlines by making customers leery of flying?

I challenge each of the US CEOs to resist caving into union demands for scope language in negotiations with the unions. There is no job security for any employee if the company is made weaker because management tried to buy labor peace with short-sided, limiting "job protection" clauses designed to make one employee group feel better.  In today's airline industry, the root of job security is the ability to fly profitably and with the flexibility to fly the right aircraft with the right costs on the right routes for the network.

More to come later this week.

Global Distribution Systems and the Pretense of Consumer Protection?

This past weekend, I found myself immersed in the messy divorce between airlines and the Global Distribution Systems (GDS) that used to be their “partners”.

In this case, I was looking at complaints filed by American Airlines and US Airways against Sabre and related companies, and then Sabre’s and Travelport’s complaints against American Airlines.  Readers know that I believe this is one of the more transformational events in the industry and I finally found the time to read in detail each party’s take on an increasingly tense situation.

In coming weeks, this fight is likely to again come to the fore.  The story is about monopolies and not market power. 

There is no elevator speech on this topic.  Within the industry, it’s all inside baseball. To the outsider, it’s incredibly obscure. But here’s the crux of the matter:  American, US Airways and other airlines are trying to retake their inventory from the GDSs that have for years listed their flights and taken a piece of the ticket price. 

What the airline’s want, in other words, is broader competition through an alternative mechanism to sell airplane seats and other travel related products – not to eliminate the GDSs.  

After all, airlines understand competition. Airlines understand fragmented markets.  Airlines understand pricing dictated by competition and macro economics, and monopolies and duopolies of vendor industries.  There is no global airline company with more than a 7 percent market share.  Even the top 10 airlines in the world together have less than a 40 percent share of global capacity. 

But when it comes to the GDSs, it is a different story.  Sixty percent of airline tickets are sold through travel agents and it is this sector of the industry that is ripe for competition.  According to MIDT data today, three players dominate the field in the U.S.: Sabre with 58% of the market; Travelport with 33%; and Amadeus with 10%. 

Travel agents make money by using the GDSs. The contracts between the vendor and the agent impose such significant switching costs that the financial penalty is too steep for most agents to consider an alternative booking channel.

As US Airways wrote in its complaint, the American Society of Travel Agents confirms the industry’s dependence on the legacy GDSs.  As of the end of 2009, 85.7 percent of travel agencies use only one GDS.  94.9 percent of travel agents using a GDS have not changed their GDS provider in the last two years and a remarkable 86.7 percent of agents are using the same primary GDS that they were seven years ago when the GDS industry was deregulated.    

As a business model, the GDSs are more about suppressing competition than spurring innovation.  Seven years after deregulation, barriers to entry in the GDS space have blocked all new competition. Contrast that with the domestic aviation market where low cost carriers now fly more than 31 percent of ASMs flown.

Market power is a seller's ability to exercise some control over the price it charges. In our economy, few firms see perfectly elastic demand. All products have a differentiation, whether due to consumer tastes, seller reputation, or location, as with airlines that convey upon a seller some degree of pricing power. Thus, a small degree of market power is common and understood not to warrant antitrust intervention.

Market power and monopoly power are related but not the same. The Supreme Court has defined market power as "the ability to raise prices above those that would be charged in a competitive market," and monopoly power as "the power to control prices or exclude competition."  In many markets, but not all, airlines do have market power in that they are able to set revenue in excess of marginal cost.  The last thing they are is monopolists as they have no ability to control prices or exclude competition.

In its complaint against American, Sabre makes a feeble and even laughable attempt to point to American’s monopoly power over certain routes at Dallas/Ft. Worth, Chicago O’Hare and Miami.  Sabre goes so far as to name non-hub cities like Abilene,TX; Augusta, GA; Brownsville, TX; Champaign, IL; and Dubuque, IA as city pair markets where American has monopoly power.  But it is simply wrong to suggest these cities are examples of monopolies, when each is blessed (given their population and underlying demographics) to have entry into the nation’s air transportation grid and each faces some direct or indirect competition. It is just as wrong to suggest that American has no competition on its Augusta GA to Dallas/Ft. Worth route when Delta flies those skies multiple times a day. 

This is a network business and American Airlines holds a 15.2 percent share and US Airways 9.6 percent of capacity in the domestic network market. In fact, the top five airline competitors hold an 80 percent market share in the U.S. domestic market, with the largest carrier, Delta, garnering a 20.1 percent share of ASMs.  This is a far cry from Sabre’s 58 percent share of the U.S. GDS market and that three firms have 100 percent of the U.S. domestic market.

To read the GDS’ complaints, you would think that we’re back in 1978 when schedule and price were the only consumer consideration. Thirty-three years later the GDSs still force the airlines to compete only on two factors; schedule and price. By limiting how airlines compete, the product is the definition of a pure commodity.  

After all, Southwest does not turn its inventory over to the GDSs. How can you have a discussion on price and service without Southwest – which now competes in markets that account for 95% of domestic demand – as part of the dialogue?

GDS advocate Kevin Mitchell, Chairman of the Business Travel Coalition (BTC) has a questionable take on the issue.  In Sabre’s complaint, Mitchell says: “The stakes in this conflict are clear: either an improved airline industry and distribution marketplace centered around the consumer, or one that subordinates consumer interests to the self-serving motivations of individual airlines endeavoring to shift costs and impose their wills on consumers and the other participants in the travel industry.”

He’s right on one point: the stakes are clear.  This is a battle about an improved airline industry – one that is sustainable over the long term; and a distribution marketplace centered on the consumer. But that’s only going to happen when the airlines have control over their own inventory.  Only when airlines have the ability to package their product based on their knowledge of consumer behavior will it become all about the consumer.  To protect and advocate for the GDSs in fact subordinates consumer interests because this legacy distribution vehicle does nothing but thwart competition and stifle innovation. 

Perhaps it is OK with the GDSs and the BTC that shifting (cutting) labor costs in bankruptcy was an appropriate strategy as long as the annuity from the airlines to the GDSs to the travel agents was not affected.  But that assumes an annuity in perpetuity, and fewer and fewer of those exist in today’s airline business. The business of the GDSs can be done cheaper and better by those with technology younger than 1960.  What the GDSs and the BTC claim is an entitlement is anti-competitive at its core.

Mitchell also proclaims to be a consumer advocate.  Remember it was he and Kate Hanni who teamed to advocate for the three hour tarmac delay rule which, with the help of the gullible Secretary of Transportation Ray LaHood, purported to “protect the rights” of some fraction of one percent of all passengers.  Today he supports a monopoly making its money off of 60 percent of air travel consumers.  Now it is Mitchell who rails against what he calls “Hidden Fees” like seat upgrades, baggage fees, and charges for pillows and blankets to name a few of the 16 specific revenue items the Department of Transportation wants the airlines to report.

This, keep in mind, is an industry that earned a scant two cents on every dollar in 2010 and yet the government wants to dig further into the file cabinets of every airline in the country in a misguided attempt to account for the money those fees are bringing in. In case you have been living under a rock, the genesis of ancillary fees has been among the most covered and scrutinized stories since 2008.  In 2010, US airlines generated $3.4 billion in baggage fees and another $2.3 billion in reservation change fees for a total of $5.7 billion.  What about the fact that the industry’s fuel bill in 2010 was $6.5 billion higher than in 2009?  The Air Transport Association forecasts that the industry’s fuel bill in 2011 will be $14 billion more in 2011 than it was in 2010.  Remember, it was the rising cost of fuel in 2008 that served as the catalyst to unbundle the airline product in the first place.

The airline industry already pays more than its share of taxes and fees.  But if it is transparency of “hidden fees” that the regulators (and Mitchell) want, then I as a passenger also want to know how much of my ticket price goes to the GDSs just as I want to know how taxes on my airline ticket are disseminated to various government agencies. 

To me GDS fees and taxes are similar as they both support legacy interests/ideals – some might argue outmoded models -- without any meaningful return to the airlines. That said, there remains an ongoing need for GDSs, particularly with respect to the support they provide to the thousands of travel agencies worldwide and to their international reach.

Today, the GDS industry earns $7 billion in revenue with no product other than the airlines own schedules and prices.  Is that innovation?  Some estimate that the work of the legacy GDSs could be done for 20 cents on the dollar.  That’s a lot of money spent on something that belies innovation.

The GDS role was relevant until about 2002 when market share was the name of the game.  Now the industry is focused on profits.  In fact, this is an industry that would have lost money in 2010 if not for the fees that Mitchell decries.  The GDSs need time to develop the software necessary for it to “up sell” better seats on US Airways.  Imagine how long it will take for the legacy GDS systems to account for 16 fee buckets as defined by the Department of Transportation (a potential new regulatory requirement).

But Mitchell bangs the consumer drum while advocating for an industry serving the airline industry that has monopoly powers over the very companies it calls customers.  

Concluding Thoughts

According to the U.S. Department of Justice (DOJ), “U.S. antitrust laws reflect a national commitment to the use of free markets to allocate resources efficiently and to spur the innovation that is the principal source of economic growth.”  Today’s GDS industry, circa 1960, represents anything but free markets or innovation.  Rather is about protecting a monopoly revenue stream at the expense of allowing the consumer to customize the travel experience depending on their wants and needs.

According to the US Airways complaint, the DOT made four assumptions when the GDS industry was deregulated: 

1) Airline divestiture of their interests in the GDSs made it less likely that a GDS would favor one airline over another;

2) Forthcoming technological changes – including online, direct-to-consumer ticket sales – would operate as a check on the market power of the GDSs;

3) Airlines’ ability to control access to their own content, including webfares and other discounts offered through an airline’s own website or select distribution channels – would reduce the GDSs market power; and

4) Vigorous anti-trust enforcement would help ensure competitive markets.

No matter how well-meaning those assumptions, they haven’t held water largely because of the power of the legacy GDS industry. So perhaps it is high time that the DOJ file suit against the GDS industry.  Why is it OK that Amazon.com is able to offer recommended products to consumers based on past purchase behavior and the airlines cannot?  Why can the consumer pick from a variety of offerings when picking a cable television or cellular phone plan but is so limited in options for air travel purchases?   

Today, all the consumer can do when buying from a travel agent is to make the purchase decision based on service and price.  Limiting indeed.

We desperately need an industry correction that allows a natural evolution in business practices so the free market can work.  A DOJ suit may achieve that.  Free competition will spur the innovation that anti-trust laws are designed to promote.  A DOJ suit may do that.  When competition wins, the consumer wins.  When innovation is allowed, the consumer wins.  Don’t be fooled by the GDS industry and its supporters hiding behind hidden fees; the consumer has no idea how much it already pays to an industry that stifles competition each and every day.   The biggest thing hidden there is the opportunity cost imposed by the GDS industry that would rather direct consumer’s attention elsewhere.

Thinking About American’s Contrarian Path to Transformation

The list is long of those kicking American Airlines for not producing near-term results because that is, after all, what Wall Street wants and needs.  Wall Street’s lead striker and headline maker has been Jamie Baker, airline equity analyst at JP Morgan Chase.  Baker was quoted in a Wall Street Journal story last week saying AMR's poor financial results and worsening margin deficit raises questions about the wisdom of a giant aircraft purchase. He said,  “We cannot reconcile spending incremental capital while failing to earn returns on [the] existing capital base.”

It was Baker who, on a company earnings call that outlined some near-term strategies to address American’s underperformance, first asked AMR executives, “Is that all you got?”  In the WSJ story referenced above, Baker stated “we think the best thing AMR can do is figure out a way to generate more profitable flying with the current fleet." 

Jamie, is that all you got?

Baker and much of Wall Street’s short-sightedness is perplexing, even for a group that has a hard time seeing six months ahead.  I agree American’s quarterly revenue performance relative to peers was disappointing and concerning, as pointed out by Bank of America/Merrill Lynch analyst Glenn Engel. The point I think the Street is missing is American’s re-fleeting isn’t about six months from now or even next year. It’s about transforming a Robert Crandall vintage 1983 airline spending nary a dime. 

American’s MD80 fleet has basically been around since the earth cooled.  And it shows.  American flies more small narrowbody aircraft (150 seats and less) than any network carrier except for Southwest.  In 2009 (2010 data incomplete/incorrect) it’s the fuel guzzling, maintenance intense 140 seat per aircraft fleet flies about 9.7 hours per day (less than its peers); with an average stage length of 870 miles (about the same as its peers); and less than 4 departures per day (less than its peers).  More importantly, on those missions, the fleet burns 957 gallons of jet fuel per block hour – the same amount of burn as in 1995 when jet fuel was 56 cents per gallon – not $3.00+ per gallon.  No airline, except for maybe portions of Delta’s fleet, has to keep more spares available to maintain some sort of schedule integrity and thus have the potential for more operating leverage than American from a re-fleeting order.

And yet Baker and Wall Street want American to do more with less than its industry peers?  Maybe – and this isn’t a stretch - that aging fleet contributes to some to the airline’s under performance?  I’d say yes even though it’s difficult to quantify and I like my numbers cold and hard.  Perhaps most puzzling is the Street never offers a better time to re-fleet. When was it supposed to take place?  When it was too late and even more spares would have been required to maintain some semblance of a schedule?  That might have slaked some analysts’ thirst for capacity cuts, but that type of cutting is eerily close to shuttering an airline… and more expensive than marginal revenue improvements might lead you to believe.

Let’s Think About This Aircraft Order

American is not alone.  All of the industry, especially the more mature United, US Airways, Delta and Southwest – yes Southwest - all face some sort of replacement order.  It is just that American has a more real-time issue than do those that effectively used bankruptcy – not Southwest - and other means to get rid of aircraft with poor operating economics.  I am not being self-righteous… bankruptcy was necessary to address many legacy issues that would have buried others in the airline graveyard.  Fleet replacement is not like going to the store and grabbing something off the shelf.  Long lead times define aircraft purchases. 

What is wrong with placing an order at the bottom of the cycle versus the top of the cycle? It's a long-standing industry practice to do the opposite. It’s been a proven recipe for bad economics by adding capacity during a weakening economy that only leads to even poorer results. This quarter was less about writing down results than communicating a contrarian message – a re-fleeting announcement.  The rest of the industry, along with American, has been engaged in balance sheet repair over the past two years. 

The Street immediately pointed to the increased financial leverage associated with the new order and the fact that even though American will finance the first 230 aircraft with operating leases there will be a need to adjust upward the Fort Worth carrier’s debt by seven times the lease cost to reflect the long term commitment stemming from the lease financing negotiated with Boeing and Airbus. American’s hard won terms with the manufacturers does little to nothing to impact the company’s near term liquidity.  There is nothing to stop American from further balance sheet repair should operating results improve over the next five years as the first 230 aircraft are delivered.

Keep in mind, this order isn’t just about American. It’s also very much about Boeing and Airbus. They’ve thrown their balance sheets on the table as well, betting on American’s strategy and willing to take on the cost of building planes with no cash up front. That doesn’t normally happen in the airline industry. That’s serious backing and just how much of a deal both manufacturers gave American could very well be a game changer.

This Order Is About Both Finance and Competitive Positioning

When comparing American’s small narrowbody economics with Continental’s, American burns 262 more gallons per block hour than does the newly Chicago-based carrier.  I use Continental because its fleet is the most modern among the network carriers. Let’s not forget Continental began its re-fleeting project at the bottom of a profit cycle beginning in 1995 upon exiting bankruptcy #2. At 10 hours per day per month and with fuel assumed to be $3 per gallon, American’s new planes would immediately save $236,000 per month per airplane in fuel costs versus its MD80 fleet.  For every 10 cent increase in the cost of jet fuel, American would save an additional $8,000 per month per aircraft.

Few fleets have realized maintenance cost increases like American’s narrowbodies over the past decade.  I appreciate there are many ways to pay for maintenance expenses across the life of an aircraft, but during the honeymoon period of 5-10 years, American will, at least, not be paying $600 per block hour just to keep its MD80s in the air.  Instead it will likely save about $400-450 per hour.  Using the same calculus as in fuel savings, that saves the company another $135,000 per month per aircraft.

Yes, American still has to pay for the airplanes. As a general rule, the lease cost of an airplane is one percent of the sticker price.  If the retail cost of the various airplanes is $40 million per copy, then the lease cost is somewhere around $400,000 per month.  The fuel and maintenance savings are estimated at $370,000 per airplane per month. 

But wait a minute. We know that American did not pay retail for the airplanes.  Reuters reported American will only pay 70 percent of the list price on the Airbus equipment.  Airbus disputes that and I normally don’t believe numbers bantered around in the press, so let’s split the difference. Assume American is paying 85 percent of sticker price.  That brings the operating lease cost of the first 230 airplanes to $340,000 per month.  Even Wall Street can do this math.  If the planes cost $340,000 per month and the potential exists to save $370,000 per plane per month (and we haven’t talked about ancillary revenue possibilities from IFE, crew cost efficiencies from a simpler fleet once complexity costs are addressed, crew cost savings from a more reliable fleet, new passenger acceptance of a modern fleet etc), all of a sudden, American’s income statement and thus its balance sheet looks much different.

Is The Fleet Order Itself Transformational?

In a word, no.  Or maybe, sort of. The fleet is transformed, but that alone doesn’t necessarily transform the way American works today.  What would make this order even more exciting is to see a pilot agreement that really is transformational and recognizes the sub optimum economics of the U.S. domestic market.  What if the pilots were to negotiate pay banding, training language that does not create a bubble and benefit packages better resembling what corporate America provides its employees?  That would really make things interesting.  Problem is, those are all long-term realizations, which makes no one in New York any happier than they are today.

Another benefit from a pilot deal that could be labor transformational is to break the current regional – mainline mold.  If the economics of the smaller mainline airplanes (pilots, flight attendants and airplane) just ordered can match the economics of the largest regional jet airplanes out there, then much of the discussion over scope just might be over.  American needs access to more 76 seat aircraft (existing scope relief) with two class service, but the ask of the mainline pilots would not be further relief into the 90 and 120 seat range – unless of course there is no headway with APA making necessary changes.

Another thing to consider is, if some of the new planes are less efficient than even newer models or the price of oil goes significantly higher, the leasing options let American re-fleet the re-fleet.

Odds and Ends

Some say that American’s transatlantic partners are not the same airlines today as they were in yesteryear – namely British Airways.  That may be true in some respects, but either way, 1 + 1 is greater than 1 and that addresses those that believe American and their London counterpart are but half of their previous selves.  It was nice to read BA’s earnings release Wednesday morning citing improved traffic flows from American.  That will only continue to get better.  Realizing the full benefits of the joint business agreements is transformational for American as it evolves from a single entity into a much broader network.

But the most important fight taking place to transform American – and the industry for that matter – is the fight with the Global Distribution Systems.  Imagine the revenue benefits that will accrue to American in addition to just passenger revenue if they are able to package the product for the individual consumer.  If they are successful in breaking the monopolistic practices and reclaim their inventory – now that is transformational.

Taken together, there are some interesting possibilities taking shape in Fort Worth, Texas.  What needs to take shape immediately are the unit revenue benefits supposedly coming from the cornerstone strategy.  As analysts have correctly pointed out, that hasn't happened yet, which might explain the Street’s shortsightedness about other things American.

Look, I’ve been teasingly picking on Baker, Keay (indirectly) and Wall Street types. I realize their job is gauging the near-term forecast for clients.  But we’ve gotten so wrapped-up in Street predictions and instant opinions we’ve forgotten long-term, especially in the airline industry, like January 2015. American is resetting itself with a bold move that, honestly, shocked competitors and analysts. It deserves credit for making an astounding and first comer economic deal. Whether it works won’t be known 24 months (or five years given the jet fuel price) from now or even possibly 72 months.

But I doubt anyone is going to be asking if that’s all American’s got anytime soon.

Congress Considering More Taxes On The Airline Industry Is A Sin

ATA President and CEO Nicholas E. Calio, comparing taxes on airline travel to sin taxes:  “The industry already pays more than its fair share of taxes – more than alcohol and tobacco, products that are taxed at levels to discourage their use. Today on a typical $300 round-trip ticket, passengers already pay $63 in taxes and fees.”

The U.S. airline industry pays 17 different federal taxes totaling nearly $17 billion.  Or, put another way, the U.S. airline industry pays more in federal taxes than the combined market capitalizations of American Airlines, Delta Air Lines, United Airlines and US Airways.

Note the point Calio makes:  heavy taxes are usually levied to discourage their use.   Are the White House and Congress looking to discourage air travel?  I would hope not, but let’s again revisit the law of unintended consequences. 

In the Concise Encyclopedia of Economics, Rob Norton says, “The law of unintended consequences, often cited but rarely defined, is that actions of people—and especially of government—always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it.”

The government is apparently considering imposing $1.5 to $2 billion in new taxes on the airline industry.  That would be bad enough for a healthy industry, but could be potentially disastrous for one that is barely emerging from one of the worst decades in its history, during which it lost $55 billion and bankruptcies, failures and service cuts were common place.

The White House and Congress won’t believe this, but their “easy” fix comes with a simple, unintended consequence:  MORE TAXES = LESS FLYING. 

Oh, I know the argument is going to be if airlines can charge for baggage and ticketing changes and other ancillary fees then a few more dollars in taxes will have little to no effect on the industry.  Problem is, those ancillary fees have kept carriers flying, covering the difference in the base fare charged and the total cost of the trip and helped staunch the gush of red ink caused by volatile fuel prices. (Usually caused by unregulated fuel speculation, but that’s an entirely different topic.)

Let’s not forget about fuel. Ancillary fees and fuel surcharges have helped airlines offset – but not completely make up for – the high cost of Jet A. Tacking on dollars to the base ticket price in taxes probably means carriers won’t be able to curb fuel price effects by passing some of the cost on to the consumer. We’re back to unintended consequences as those additional taxes could cost the airline revenue and, if airlines aren’t careful, keep passengers from flying.

Worse, new airline taxes won’t put a dent in the national deficit.  Rather than do the job they were sent to Washington to do and make difficult spending cuts, the politicians would rather nickel and dime their way to some sort of feel good fix while inflicting damage on an industry that helps propel the economy each hour of every day.

It will be interesting to see if service cuts similar to what Delta announced last week don’t increase if new taxes are imposed.  Certainly some profitable flights will become unprofitable.  Some breakeven flights will become unprofitable.  Reading the lips of today’s CEO’s, unprofitable flying must be culled from the system.  How will that sit with 535 representatives that call Congress home for at least two years?  If members of Congress are frustrated by service cutbacks as a result of high oil prices and weak economies, then what might they tell their constituents when more tax on the industry results in even more lost service. 

Communities are being disenfranchised from the air transportation grid.  The highway will increasingly become the first access point.  Service cutbacks triggered by new taxes won’t only force more communities to the road, but they’ll also strangle their economic opportunities. Yes, another unintended consequence.  

The White House and Congress should be thinking about the airline industry as a facilitator of economic activity.  To dismiss it as a make work project or generator of marginal tax revenue only undermines the United States global leadership position.  As I have said before, it is less about Altoona and more about Auckland. If you make it so people can’t get here from there, they simply won’t bother.

There’s another consequence the White House should be very sensitive to. The airline industry still offers high-paying jobs. Killing it with a thousand paper cuts – a little tax here, a little tax there – and, all of a sudden, carriers are cutting even more capacity. More employees are furloughed. More carriers head to bankruptcy and those jobs disappear.  Completely opposite of what the administration has been promising. 

The increased taxes under consideration are not industry killers by themselves.  They just pile on top of taxes and fees that really do impact the overall demand of an industry – an industry vital to the velocity of economy every day.

Congress and the White House should really think about what their intent is… and the consequences it might have. Picking the pocket of an industry that has little to give, costing not just businesses, but communities and employees isn’t smart government. In fact, it might be a sin.

LaHood Protecting Consumers? Pretending To Protect Consumers?

Some time ago, I asked this question to an audience of airport executives:  If the airline industry is consolidating, shouldn’t the infrastructure supporting the industry consolidate as well?  The converse action of consolidation is fragmentation.  Fragmentation of markets has long been a practice of the US airline industry that has attempted to be everything to everybody.  Fragmented industries earn poor returns.

For example, the LA Basin is served by five airports:  Los Angeles (LAX), Ontario (ONT), Orange County (SNA), Burbank (BUR) and Long Beach (LGB).  Not every airline serves all five of the Basin’s airports.  But in every case the core traffic is Los Angeles traffic and by serving different airports the industry is fragmenting the Basin’s traffic.  Now Los Angeles may not be the best example given its huge population base and underlying wealth.  Nevertheless, the concept is as prevalent in Indianapolis as it is in Atlanta as it is in Washington, DC.

Between 1980 and 2010, LAX has accounted for increasingly less of the region’s domestic traffic.  To compound the problem of intra-regional competition, nominal domestic air fares at each of the five Los Angeles airports were lower in 2010 than they were in 1980.  This is but one reason why the infrastructure needs to consolidate.  Fragmentation produces unsatisfactory and unsustainable financial results.  As individual carriers increasingly realize, airlines cannot be everything to everyone.  Just last week, the following news story hit the wires:  Delta to Adjust Service to Smaller, Underperforming Markets.

As Jad Mouawad wrote in his recent New York Times article Air Service Cutbacks Hit Hardest Where Recession Did:  “. . . the [air service] cutbacks are redrawing the nation’s air service map to reflect the industry’s new priorities and changed economics. As recently as a decade ago, the airlines put a premium on growth, competed on every possible route and sought to connect to even the farthest outposts. Now, they are emphasizing fiscal discipline, which means paring back service to many cities and forgoing unprofitable destinations altogether as higher fuel prices weigh on their bottom line.”

I’ve weighed on this topic before:  Regional Airline and Small Community Air Service: It’s Time to Regionalize, Not Marginalize, the System.  As has analyst Mike Boyd of Boyd Group International whose thoughts in his weekly Hot Flash make clear the topic also will be discussed in depth at The Boyd Group International’s 16th Annual International Aviation Forecast Summit, August 28-30, in Albuquerque, NM.  As with many things Mike, the conference is a no-holds-barred discussion of third rail issues that affect the entire industry, whether airports, airlines, vendors, media, manufacturers and government, to name a few.

Under structural consolidation, a number of airports will ultimately lose direct air service, and more Americans will have to drive farther to get to an airport.  No doubt that for many communities this will come as a shock.  But as is the case with even urban areas, travelers already often bypass the local airport to take advantage of lower fares at another airport a bit farther away.

Unfortunately, the Obama Administration isn’t doing much to help an industry already burdened by regulations, battered by the economy, squeezed by oil prices and constantly beset by competition. Consider the response of U.S. Transportation Secretary Ray LaHood who, in the classic tradition of “I’m from the government and I’m here to help” last week unveiled a new proposed federal rule to force airlines to report more data on fees, baggage and mishandled wheelchairs..

This is an industry that earned a scant two cents on every dollar in 2010 and yet the government wants to dig further into the file cabinets of every airline in the country in a misguided attempt to account for the money those fees are bringing in. In case you have been living under a rock, the genesis of ancillary fees has been among the most covered and scrutinized stories since 2008.  In 2010, US airlines generated $3.4 billion in baggage fees and another $2.3 billion in reservation change fees for a total of $5.7 billion.  What about the fact that the industry’s fuel bill in 2010 was $6.5 billion higher than in 2009?  The Air Transport Association forecasts that the industry’s fuel bill in 2011 will be $14 billion more in 2011 than it was in 2010.  Remember, it was the rising cost of fuel in 2008 that served as the catalyst to unbundle the airline product.

This latest proposed rulemaking coming out of LaHood’s agency under the guise of consumer protection is anything but.  Today fees are not taxed.  The government wants to get its paws on any new revenue it can find and of course the airline industry is targeted.  LaHood’s proposed rule would require airlines to report 16 additional categories of fee revenue in addition to the baggage and reservation change fees.  Outrageous.

Let’s turn the tables.  As a consumer and a taxpayer, I’d like to see a complete breakout of the special aviation fees and taxes collected by the government.  All I get on my ticket is a total: an amount that includes what the ATA counts as 10 categories of special aviation fees and taxes. 

I want to know how much the passenger facility charge is on my ticket.  I want to know how much is going to the Department of Homeland Security for the September 11 fee, immigration fee, the customs fee, the Aviation Security Infrastructure Fee (ASIF) and APHIS Passenger and Aircraft fees.  I want to know how much is going to the FAA in the form of domestic and international passenger taxes, jet fuel tax and the cargo waybill tax.  If the airlines are to report out on 16 incremental items in the name of consumer protection then I want to know where each dollar of taxes and special aviation fees goes.

So as the industry struggles to earn a meaningful profit, LaHood grandstands.  As he states in the DoT press release: “Our goal is to improve the quality of data we collect from airlines and make airline pricing more transparent. In an era of rising fees, passengers deserve better information about how airlines are performing, particularly when it comes to fees, baggage and accommodating passengers in wheelchairs.” 

Meanwhile communities are losing air service.  Maybe if some or all of the tax and fee revenue were returned to the airlines, then fewer markets would be underperforming and thus avoid service cuts.

The conversation about regionalizing air service should begin with a sober assessment of the market and clarity from the Secretary of Transportation on this administration’s vision of what constitutes the right air transportation market. 

This difficult discussion already is underway in some markets, including in Kansas where Dodge City and Garden City are discussing whether or not to form a regional airport. 

The article notes new urgency on the issue in Kansas because Congress may decide to eliminate the Essential Air Service program.

"The EAS program has come under attack in the past, but never really did we feel that the program was in jeopardy," Dodge City Manager Ken Strobel is quoted. "This year, however, there's more concern that the program may be phased out or funding cut substantially.”

The EAS program is but one reason for communities with marginal air service to consider “regionalizing.”  A stark example of another market is Pittsburgh and its catchment area.   There is one strong airport in that catchment area that includes Akron/Canton.  Latrobe, Morgantown, Franklin, Johnstown, Clarksburg, DuBois, Altoona, Parkersburg, Cleveland, Youngstown and Erie.  All have realized decreases in traffic or a total loss of service since 2000.  But demand within this area is the same as it was in 1990, signaling that fact that some areas have far weaker economies than others.

As the industry’s route map is redrawn maybe the Department of Transportation should be thinking about bigger picture things than wheelchairs, data reporting and fee transparency.  Rather than threatening the existing Essential Air Service Program, begin to define what is tomorrow’s essential.  Work with industry to identify the airports of tomorrow (airports serving a region that can fill either a large regional jet or turboprop or mainline with sufficient local traffic) and ensure that money is being spent wisely (as opposed, for example, to building air traffic control towers in Johnstown, PA.)  If it is determined that certain airports are closed to commercial air traffic, then each of those airports should remain closed to that traffic to ensure that regionalization produces positive results for an industry that desperately needs to be run like a business as opposed to a make work project.

Maybe the Department of Transportation turns out to be the agency that behaves the way former Congressman Oberstar behaved toward the industry – standing in the way of progress in building a sustainable system.  But I certainly hope not.