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Entries from March 1, 2011 - March 31, 2011

Tuesday
Mar292011

To The GDS's: Either Evolve Or Dissolve -- It's That Simple

In the March 12 Economics column of The New York Times, University of Chicago economist Richard Thaler correctly titles his piece as it pertains to the airline industry:  “This Data Isn’t Dull. It Improves Lives.” The column then goes on to distort the intentions of the airline industry. 

At the heart of the matter is the relationship of the airline industry to the Global Distribution Systems (GDS).  Every time an air travel consumer works with a travel agency, the information being supplied by the agent is likely provided by a GDS.  The data necessary to enable the agent is supplied by the airlines to the GDS.   

In the early years following deregulation of the airline industry, GDS were largely owned by airlines and used to provide information to intermediaries to sell tickets on particular carriers.  The systems were biased toward the airline(s) providing the technology to the travel industry community.  These massive networks were built using the technology prevalent at the time – prior to the advent of the internet – and GDS were compensated for providing and maintaining vast private networks and for acting as gatekeepers between agents and airlines.

In fairly short order, the government stepped in to regulate the bias.  As a result, the GDS were no longer a distribution tool aiding the airline(s) that invested in the technology directly; rather they became a tool of the travel industry to sell a service.  Today, the airlines pay an intermediary to distribute their product – and they are paying a price much higher than the prevalent transaction costs. The airlines’ costs reflect an outdated model replete with older and more expensive technology as the GDS fight to sustain their large networks and maintain their role as gatekeeper.

But the intermediaries don’t pay the airlines for the airline-created content they use to lure customers to their respective websites so they can sell hotel stays and rental cars.  It makes no sense.

Name a financially successful industry that turns over control of its inventory to an intermediary. I can’t think of one either.

Airline travel is now available for purchase on multiple channels via the internet, including through the airlines’ own websites. Those sites typically provide carriers with the most control over the shopping experience while also being the lowest cost channel for the transaction. It is simply much cheaper and more efficient to use newer, internet –based technology to distribute tickets without the need for a “gatekeeper” between airlines and agents.   

Now the airlines also want to be able to go directly to their customers via their own channel.  Not that the airlines do not value the higher yield business that comes from agencies.  The motive is not, as some detractors have said, because airlines want you only to shop at their sites or not reveal what the cost of a trip is if you check two bags.  Rather, airlines are looking for ways to differentiate themselves by offering additional products and services to their customers that enhance the travel experience. This information is something the GDS cannot provide today without a significant investment in their systems.

Duopolists are typically reluctant to invest new capital unless it is absolutely essential to protect its cash cow

The airlines don’t necessarily want - or need – to drive all transactions to their sites and there is still a role GDS can play in this process. GDS could be content aggregators, allowing customers to easily compare fares. Right now, though, that’s a role GDS seems unwilling to take on perhaps worried about risking their fees.  

There are other factors at play here as well. First, airlines know their particular customers better than the government or the GDS. Plus; the GDS haven’t evolved as the industry has dramatically changed.  

Today’s GDS force the airlines to compete only on two factors; service and price. By limiting areas how airlines compete, the product offered is the definition of pure commodity. This was true in 1983 just as it is today. 

Despite the airline industry’s efforts to remove more than $20 billion in expenses over the past decade, the price of another commodity essential to its business increased more than fourfold – oil.  The airline industry is left with little choice, if it is to ever be a sustainable business, but to begin the process of de-commoditizing its product and finding new revenue sources.  To do so, means fundamentally altering its legacy relationship with the GDS and recapturing control over its inventory.

The airline industry has found new ways to generate revenue by offering customers products they value and are willing to pay for, including seat upgrades, passing through security faster or day passes to airport clubs. Bag fees, now charged by the majority of U.S. carriers, reflect a more accurate way to pay for what you use. In other words, customers that don’t check bags no longer subsidize the cost of those who do.  

Yet the GDS and supporters claim airlines aren’t being “transparent” in their pricing that they do not want to reveal the total cost of trip to a passenger.  Few industries have price transparency like the airline industry – compare it to cell phone contracts – and the majority of customers know exactly what they’re paying for when they travel.

Thaler is right; the data supplied to the GDS is anything but dull and service and price competition have benefited many by making air travel affordable to the masses. This will certainly continue as the competition is as hungry today as ever.

This is not a fight about defending the purity of data or somehow withholding it from those whose only aim is to presumably help customers. No one, including the GDS, can really dispute that this information comes from the airlines.

Despite the rhetoric, it’s also not about protecting customers from an industry desperate to reach more. This is about protecting an outdated mode of operation and stifling innovation.  The GDS duopoly cannot move fast enough for an industry that sells “time saved”.  The GDS doesn’t want its revenue tap turned off. It’s time the GDS recognizes it can’t support interests other than their ultimate customer – the airlines.  The airlines are simply looking to adapt to new economic realities and help their ultimate customer – the person who actually buys a ticket.

Duopolist.  Monopolist.  Neither is accepted in the airline business.  Now the airline business says it is time that vendors servicing the airline industry cannot be duopolists or monopolists either.  It is all part of the evolution of the business that began in 2002. 

Tuesday
Mar082011

Jet Fuel and Labor Part II: Commenting on the Comments

The message of this blog as it pertains to the current round of industry-wide negotiations can be boiled down into six words:  Doing More With Less For More.  Honestly, I have not heard management teams say they are seeking concessionary contracts.  I have not heard anything suggesting W2 wage reductions are being sought.  What I have heard is productivity is needed in return for an increase in W2 compensation.  So Doing More (flying/working more productive/smarter time) With Less (fewer headcount needed to staff some level of flying) For More (increase in wage and salary compensation).

When I posted my last blog item, Oil and Water; Jet Fuel and Labor, I expected colorful comments from readers.  And I wasn’t disappointed.  You can’t have had my career and not ruffle some feathers.  And I did.  The comments were also instructive, showing sections of my blog that needed additional explanation and clarification.

Yesterday, I had a private exchange with a thoughtful pilot leader.  After some initial back and forth over the merits [or lack thereof] of my blog piece, he wrote, “My pilots and I have been living under a concessionary contract for X years now.  Our work rules were gutted down to the FAA Minimum....the CEO and the officers seem to be doing quite well though, aren't they?  Nobody is looking to break the bank.  I don't begrudge what anyone else makes. I just get tired of the excuses that there is no more left for the working guys after everyone at the top has already skimmed off all the cream!”

I lead with this exchange because it captures the essence of many of the comments made.  It’s pertinent for its truths and its misconceptions, just as many of the other comments were. For instance:

  1. $100+ oil may be the new reality, but you cannot expect any workforce to accept wages from 2001.  SWELBAR:  The industry has drastically changed since the heyday of 2000 and oil prices in 2008 and now in 2011 are but part of the catalyst.  For instance, according to MIT's Airline Data Project in 2001, U.S. airlines employed 89,349 flight attendants.  In the nine years since, nearly a quarter of those jobs - more than 25,000 - have disappeared.  No one likes to be told that they're not as in demand or cannot command the wages they once did.  Millions of U.S. workers - union, non-union, auto workers in Detroit to tech nerds in Seattle - face the same dilemma airline workers must come to grips with.
  2. Unions need to wake up to the new reality and give up the long lost dream from the regulated era and the flying public needs to acknowledge that good service from a safe airline might actually cost something more than the bus fare they want to pay.  SWELBAR: I agree up to a point, but what about the price elasticity of demand?  At some point consumers (and I mean the all important business and premium passengers) will simply decide it's not worth the expense and simply stop flying.  The acknowledgment needs to come from management and employees that they're providing a consumer-driven commodity.  That's all.  You price consumers out of the market and you price yourself out of a job.
  3. Continually beating the "it's the union's fault" drum is old, hollow, and doesn't reflect the reality of the situation.  SWELBAR: When it comes to oil prices, I'm certainly not blaming the unions.  The unions have the same control over oil prices as management - NONE.  What I said, and have said, was the history of pattern bargaining in the airline industry was created when oil prices were not a factor.  They are now.  To make the U.S. aviation model work, everyone needs to realize, and accept, that things are not the same and there is no going back.  If you want a relevant example, look no further than the auto industry.  Fuel is a factor for automakers too and they have been been forced to shrink the workforce all the while ensuring that the smaller workforce is efficient - ways to escape the burden of unsustainable contracts yet still turn out a safe, reliable product consumers want while facing increased competition from domestic and global competitors.
  4. Regardless, to try to base employee costs on the cost of oil is absurd.  They are unrelated, just as is the cost of airframes, engines or catering is to oil.  SWELBAR:  In a word, wrong.  Every cost affects the bottom line through its consumption of the revenue pool; it's just a matter of by what factor?  When jet fuel remained at the equivalent of $29 per barrel for 25 years, it had little impact on the bottom line for most airlines and, thus, employees.  That's obviously changed, as it would with any cost where a penny increase can mean tens of millions of dollars in increased expense.  If engine prices suddenly rose 100 percent, don't you think airlines would have to drastically rethink their consumption of engines?  This is about controllable costs, which oil isn't.  Something has to give.
  5. Keep this up and Air India will have continuing service to OMA because the only ones who will have labor cost that is acceptable to your masters will be third world countries who will be laying over in East LA at the Days Inn with the entire crew sharing two rooms and thinking this is a great layover.  SWELBAR:  This actually raises a good point.  Increased competition is a factor for the U.S. aviation industry no matter the cost of Jet A.  The shape and makeup of the industry will continue to evolve and will further embrace multi-national carriers.  Oil could accelerate that process by culling some carriers or impede it by slowing international growth.  If U.S. airlines - management and unions - don't rethink the business model, accounting for oil - then it really does not matter what "acceptable labor costs" might be.  Does it?  A major message in this blog is instead of fighting tooth and nail for what once was, maybe it is time to think of what has to be. 

Going back to my exchange with the learned pilot leader, this is how I responded, “I have been around a long time like you, and if someone can say the past volatility in labor’s earnings worked nicely for them then ….. there is just not much to say.  Many of the business practices in this industry are built on a model of growth.  When there is no growth, then something has to be done to those costs that are controllable.  There is no more need to file for bankruptcy because oil is not controllable.  [Inserted today:  The price of oil cannot be restructured].  Not a damn thing that can done.”

I went on to say if people would take the time to move beyond their visceral reactions and think about my arguments, they’d see I believe  flight crews are less an issue than “below the wing employees” where differentials have grown significantly at some carriers. “I want you to have yours too.  But the zealots saying ”I am going to get it all back and more” when the environment is diametrically different – as it is –  then someone in a (labor)  leadership role is not doing their job.” 

“There is enough to go around, as I will write later in the week.  But [pilots] and flight attendants working 40 hard hours per month are not an answer.  Too much headcount for the amount of flying to be done.  Ground workers at an all in rate of $25 when it can be outsourced for a fraction, which is what many of the LCCs do, is simply not good business.  The restructuring is not done.  Doing More With Less For More needs to be a mantra.  If oil keeps going, and my dart board is as good as anyone’s, then capacity will again get cut in the fall.  2008 all over again – just not as deep.”

“As for management doing nothing, this is the first time in 30+ years where capacity actually reflects a business environment where costs can be passed through.  Even Southwest is a participant.  That is but one change that had to happen.“

Final Thoughts

There is no question the key to success for this industry going forward is raising fares.  And that’s happening, thanks to Southwest now taking a lead versus being the carrier always fighting the industry on pushing through an increase.  Since December 2010, Southwest has been part of five – read five – fare increases.  No longer does the lower cost carrier enjoy a unit fuel cost advantage either - Southwest isn’t hedged like it was between 2004 – 2008.

As one commenter said, “This notion that airlines cannot control domestic pricing is absurd.”  Then the same person actually outlines how airlines are finding new revenue streams from unbundling attempts.  Here’s the catch: The unbundling was done in response to high oil prices in 2008 because there was no industry consensus on increasing base fares. If one carrier doesn’t raise fares like everyone else, the attempt to increase ticket prices typically fails.  To say that management has done nothing to address a poor revenue environment is simply wrong.

Any discussion of management compensation on this blog is a non-starter - as I have learned.  The comment section is not big enough to house the emotions that spew forth over the subject.  Few things at the Board of Directors level are more difficult than management compensation plans; especially with the level of scrutiny those plans now receive.  Because of the outcry, the chairperson of the Compensation Committee might be even more important than the chairperson of the Audit Committee. That’s just not right.  Management has their contracts.  Organized labor has theirs.  Given the volatility in costs and the push to see pay-for-performance as the rule and not the exception, labor should be making it a part of their overall compensation as well.

That I’m somehow tying labor costs to oil costs is absurd.  I suggested volatile - and increasing - fuel prices consume more of a finite revenue pie.  I should have explained that better.  The pie is finite when base fares are considered because the industry has to agree.  The unbundling strategy being employed is designed to increase the size of that pie.  It is working.  But when an industry is profitable primarily because of fees collected, one can easily read that as a negative simply because it’s not sustainable.

A long-time critic of the message of this blog stated, “Even Wall Street says there is no blood left to squeeze out of the employees yet you still beat that drum over and over and over........ Get some new material.  You being a shill for the ATA I assume the always lower labor cost mantra will continue until everyone is working for free.”

I challenge anyone to read this blog and find where I said airline workers should work for free.  Further, I dare anyone to find where I suggest contracts in this round need to be concessionary (less total cost than the previous contract).  I have said time and again expectations that the industry can afford to repeat its past patterns of repaying concessions, plus more, have to stop.  I have also said productivity improvements are paramount in the industry as it is still operating with too much headcount.  This is where the business of unions needs to look in the mirror and ask, “Is it better to negotiate a great agreement for fewer people or an OK agreement for many people”?

This is about Doing More With Less For More – that’s the reality. While I understand the emotions that can be triggered when talking about people’s livelihoods, it doesn’t change the reality. My hope is the sooner a truculent industry embraces what it is, the better off every ground worker, pilot, flight attendant, shareholder and, yes, even management will be.

Thursday
Mar032011

Oil and Water; Jet Fuel and Labor

On June 25, 2008 I blogged asking the question:  Is Oil A Cancer Or A Cure?  At that time, the price of a barrel of oil had not yet reached its apex of $147 per barrel, but was well on its way.  Based on findings by the Air Transport Association’s superb economic analysis team led by chief economist John Heimlich, the U.S. airline industry paid the equivalent of $174.64 per barrel [price of a barrel of oil plus the equivalent cost to refine crude into jet fuel (the crack spread)] on July 11, 2008.  By December 23, 2008 the price of a barrel of West Texas Intermediate had fallen to $30.28 per barrel.  So far in 2011, we’ve seen a similar surge in oil prices, but based on current geopolitical events, I am not expecting another $117 drop in the price of a barrel of oil like we witnessed in 2008.

I’m actually wondering what happens if the wave of Mideast political upheaval washes over Algeria? Or Saudi Arabia? Some economic experts say the price of oil could rocket past the $200 threshold.

In 2011, the industry has paid an average of $89.15 per barrel of crude and another $25.80 in the crack spread for a total cost of “in the wing” jet fuel of nearly $115 per barrel.  Since February 22, 2011 the industry has paid more than the equivalent of $120 per barrel for jet fuel.  On March 1, 2011 the industry paid the equivalent of $132.17 per barrel for jet fuel including the crack spread of $32.54.  For all of 2008, the industry paid the equivalent of $25 per barrel to refine crude into jet fuel.  In the last five days of trading the crack spread paid by the industry is nearly $30 per barrel. 

That’s a lot of numbers, so let me put this in a way that might shock even the most ardent follower of the airline industry: Today’s cost of just refining oil into jet fuel is roughly equal to the total jet fuel price per barrel paid by the industry every year between 1978 and 2001.

1978 – 2001

The mindset of many airline stakeholders - and particularly labor - is based on the period between 1978 and 2001.  Deregulation began in 1978 and 2001 marks the beginning of wholesale industry restructuring. .. which actually should have started 24 years earlier.  To put this period into an oil perspective, over the first 25 years of a deregulated industry, the equivalent per barrel price of jet fuel was $28.93.  Oil was cheap (more than four times cheaper than in 2011) and it was the basis for the industry to grow too big, too fast.   After all, the biggest “uncontrollable cost” was a blip.  There was little change in either the price of a barrel of crude or the crack spread.

Based on analysis at MIT's Airline Data Project, between 1978 and 2001, the industry grew nearly 2.5 times in terms of available seat miles.  Traffic grew faster than capacity.  The great enabler in the growth in addition to the cost of jet fuel was the fact industry yields, or the amount the customer pays per mile, declined by 39% when adjusted for inflation.  Domestic yields fell by an inflation-adjusted 41 percent over the same period.  In other words, cheap seats. The price of an airline ticket was one of the great consumer bargains.  This fact ultimately led the network carriers to refocus their operations on international flying because their high cost structures struggled to conform to the realities of the domestic market economics.

As the industry added capacity, employment grew by nearly 220,000 full-time equivalents.  During the same period, the total cost of an employee to the industry declined by eight percent in real terms.  I can hear it now, ”no way – my salary is significantly less.”  Yes, it is true salary costs when adjusted for inflation have decreased. On the other hand, the cost of pension and benefits paid to airline workers has grown at a rate faster than inflation.  The cost of an employee to a company is not based on salary alone.

Over the 24 year period being discussed here, it is true that employee productivity in terms of available seat miles per employee and enplanements per employee increased 44 percent and 30 percent respectively.  Much of that is again driven by cutthroat competition driving prices downward in order to stimulate demand.  Here is the kicker.  The number of available seat miles produced per dollar spent on labor fell by 42 percent.  Or, labor is producing more output but the cost of that output is increasingly expensive.  This fact alone was unsustainable and the restructuring process was used to address the underlying economics.

Many areas of the income statement were addressed by managements over the period with the most noteworthy being the decision to stop paying legacy commission rates to travel agents.  This action alone saves the industry nearly $6 billion dollars per year although we can also say that the savings are largely competed away in the form of lower fares.  Food and advertising expenses were also reduced.  Each of these cost areas, like labor, is considered controllable costs.  Oil is not.  What the industry did realize over the period was a 30 percent efficiency improvement in the consumption of fuel.

2002 – Today

As 2001 came to a close, unit costs at the network carriers in the face of free falling unit revenue became the story.  US Airways was the first carrier to file for bankruptcy.  United was second.  And American followed with an out of court restructuring.  Each carrier had extremely high overall unit costs relative to the industry as shown by the MIT Airline Data Project.  The ADP also shows the three carriers were out-of-market with respect to unit labor costs relative to the industry.  The network carriers mentioned simply had costs so high, there was no choice but to seek some sort of a consensual restructuring either through bankruptcy or out of court if they were to live and fight another day.  The scary part is, oil was still reasonable during this time. The industry jet fuel price per barrel equivalent as restructuring commenced was $30.07.

While jet fuel prices are uncontrollable, so too is airline pricing, particularly in the U.S. domestic market.  Since 2001, the industry has only increased capacity by 2.5 percent as capacity discipline became the mantra.  Again traffic grew faster than capacity as inflation adjusted yields fell another 12.5 percent.  The nominal level of capacity growth can be attributed to the growth in regional carrier and low cost carrier flying.  Since 2001, mainline carriers have shed nearly 24 percent of their previous domestic capacity with nearly one-third of that capacity removed since the 2008 fuel spike.

Capacity cutting was all that was left in the face of high oil prices.  When carriers delete capacity, they also eliminate jobs.  Since 2001 the industry has shed nearly 155,000 jobs – a period when the jet fuel equivalent price per barrel averaged $73.08.  Labor productivity has improved significantly as the network carriers restructured.  But as I’ve talked about before, the problem with a seniority-based system is that average costs increase as the less expensive employees are the first to be let go.  In 2002, when the restructuring began, the average cost of a full time equivalent airline employee was $74,910.  Today, the average cost of a full-time equivalent employee is $83,869.  More troubling is the benefit and pension package for full- time employees in 2001 cost $11,560.  Today, the cost of that package is $18,195 reflecting seniority as well the country’s inability to reign in medical costs. 

So Here We Sit

The history of pattern bargaining - and resultant expectations - between labor and management was created on a basis of $30 per barrel for jet fuel.  Today, the cost of jet fuel is the equivalent of $132+ per barrel.  Yet labor doesn’t seem to acknowledge the fact that times – and oil prices – have changed.  There are 52 airline cases under the auspices of the National Mediation Board and I will wager few, if any, of the labor negotiating teams consider oil a major factor in a future contract. It’s “management’s problem.”

Well, it’s also labor’s. While the industry has been creative in finding new revenue to address the reality of fuel costs, consumer pass-throughs generally lag behind the rise in the price of fuel. The bigger issue, the one labor has trouble admitting, is the size of the revenue pie is finite.

Oil is uncontrollable and therefore difficult to predict how much of the revenue pie it will consume.  Cost reductions in many areas of the operation have already been largely realized.  And that’s where oil prices become labor’s problem.  Employees – rightfully - want their share of the pie, and they’d like to make-up the concessions of the past.  The problem is the pre-restructuring high water mark, when oil was around $30, is what labor wants to return to. That’s not possible and it’s certainly not sustainable.   

I have heard it said many times, "labor is not going to subsidize the price of oil again".  Well, truthfully, labor didn’t the first time. When restructuring began and adjustments to labor costs were realized the price of jet fuel was not the issue.  It was declining revenue.  After much pain inflicted on virtually every stakeholder group over the past decade, $100 per barrel jet fuel is the new reality.  Expectations of returning to the past should be forgotten.  I like to use history, but history is useless in evaluating this industry because the fundamentals that now govern the industry’s structure like oil and the economies of China and Germany and Brazil are new and rapidly evolving.

I had someone say to me the other day that shouldn’t we throw away the past and just start again making this apex the new reality?  The simple answer is yes.