Mumblin’, Bumblin’ and Stumblin’ for Something to Write

It’s pretty sad when . . .

. . . the reports that US Airways will discontinue charging for water and soft drinks is the best news out there. Not just in the airline industry, but in any industry for that matter. Water for nothin’ and cokes for free.My guess is Southwest was more than happy to have US Airways charging for water and soft drinks. And that is the nature of a competitive market– what is good for someone in this industry may not be good for another.

For me, the best news out there are reports that the government is telling the automotive industry that its turnaround plans do not go far enough in addressing the structural problems of Detroit’s automakers. The Big 3 is about to become the Big 1.75.

What will that mean for the airline industry which already is suffering from a sharp decline in business travel?For one, it will probably throw a klieg light on the fact that U.S. airlines have too many hubs in the middle part of the country. That might provide incentive for the industry to actually rid itself of marginal hubs that have outlived their useful lives. And that could portend well for the underlying economics of the industry once the toxins are extinguished from the macro economy.

In other news, Delta flight attendants have come up with a seniority list they say embraces the important tenets of equity and fairness for the former Northwest flight attendants who joined their ranks following the merger. The problem is that the Association of Flight Attendants, which represents the former Northwest cabin crews, does not yet recognize the combined airlines as a single carrier. It is no surprise that the AFA is digging in its heels – after all, Delta flight attendants are not unionized and in fact twice voted down the union’s organizing efforts -- in 2008 and in 2002. Merging workforces is never easy and anxiety over relative seniority will only grow if further capacity reductions become necessary. Expect a tough battle when the AFA goes back for yet another unionization vote.

Speaking of capacity, we are now seeing more impact from the transfer of industry capacity from domestic markets to international that began in 2004. All trends point to a very tough international environment, particularly for transatlantic services. Deteriorating fundamentals at British Airways have been in the news off and on for the past year. Now even Air France and KLM are cutting capacity. Lufthansa just keeps shopping but being the smart carrier it is – a deal is a deal and they will not pay too much.

Pacific region fundamentals are holding up, but China could change that equation. At a time that the West really needs China to increase consumption, that trend now is on hold as the Chinese economy continues to sicken. Economic problems in India that took route last fall continue to grow. Now the economic weakness is beginning to impact airlines throughout the region. Japan Air Lines is looking to its government for a $2+ billion dollar handout and economic ills already are beginning to hurt financial performance at Singapore and Qantas and Cathay Pacific.

The Middle East is perhaps the only economic bright spot for the airline industry, where both fledgling and well-financed carriers continue to grow and take delivery of new equipment, although not without occasional talk of potential mergers. And while Latin America shows pockets of strength, don’t forget that more than half of that region’s demand is focused on Mexico and Brazil.

In the US, we actually have some labor deals getting done. Earlier this year, Southwest ratified an agreement with its mechanics and announced an agreement in principle with its pilots. This month, Alaska Airlines announced a tentative agreement with its flight attendants with a vote scheduled for March. In each case, the contracts demonstrate the difficult state of labor negotiations in the industry. A prime example is the Southwest pilot agreement that attempts a delicate mix of pay increases, productivity measures and new scope restrictions.

Finally stock prices seem to be suggesting that another round of bankruptcy filings might just be around the corner. It is hard to totally discount what market values seem to tell us. Air Canada finds itself back in the news as a bankruptcy possibility following the financial engineering done in the prior bankruptcy that leaves the airline with nothing to fall back on this time around. At this point it looks like the only potential safety net is the Canadian government, which seems intent on increasing the ownership limit to 49 percent, but it is too soon to say how that will ultimately play.

Maybe the current economic Armageddon will generate interests in increasing the ownership limit for U.S. airlines– which could provide them a source of new capital and the opportunity to minimize expenses and leverage economies of scale. Most important, such a change would force recognition that competition for competition’s sake at home does not make for an industry structure that can grow and prosper.

Last week I had the opportunity to speak to the Aero Club of Washington and addressed the legislation limiting airline alliances that sponsors -- visionary Rep. James Oberstar among them – support based on misguided arguments of anti-trust issues. To make the point, I quoted economist Henry George who said:“What protectionism teaches us is to do to ourslves in time of peace what enemies seek to do to us in time of war”. George is absolutely right when it comes to those regulating the U.S. airline industry, which in their protectionist views have largely done what George suggests.

This time is different. Very different. The past is less prologue. Those companies that revise history will be best served because simply, you cannot do business today with yesterday’s mindset and practices and hope to be in business tomorrow. This will prove to be true in the airline industry over the next 18 months.

Dear Richard: You Are Not a Virgin Anymore

One of the more amusing bumper stickers I have ever seen/read occurred at an intersection of Woodland Avenue and Jean Duluth Road in Duluth, Minnesota. I was a senior in high school and had been driving for a year and a half or so. The bumper sticker read: Virgins: Thanks for Nothin’.

Last week, Terry Maxon of the Dallas Morning News Airline Biz blog wrote a piece discussing the data analysis that Virgin Atlantic is using to frame the antitrust immunity application recently filed by American, British Airways and Iberia. We will touch on a few of those issues later and in future posts. But first, I have held a late August 2008 interview with Branson done by Karl West of the UK's Daily Mail that I would like to speak to.

West writes that “he [Branson] believes an alliance of the two giant airlines, plus BA merger partner Iberia, would allow them to dictate the market, charging higher prices between Europe and America." This makes no sense to me whatsoever because if it is high prices you are worried about, then who better than your own Virgin Atlantic, to offer lower prices and show the air travel consumer that you are the answer to their high air fare plight.

Your business model takes you to only the largest metropolitan areas, so your pricing actions will benefit the lion’s share of US – London Heathrow (LHR) demand. Because of your “network’s presence” in these large markets, you have, and will continue to have, a strong voice in attracting these customers because your product offering is very good and even different.

Whether it is the US domestic market or the transatlantic market, mature/maturing airline markets have demonstrated time and time again that where competition is vulnerable, a new entrant will exploit that vulnerability. Where there are market opportunities, there will be a carrier to leverage that opportunity. Where there is insufficient capacity, capacity will be sure to find the insufficiency. Simply, if the US - LHR market shows signs of “price gouging” by BA/AA, then surely Virgin Atlantic is among the best positioned to discipline the behavior.

West’s interview was the first one done with Branson following the BA/AA announcement that they would try for an immunized alliance for the third time. Branson believes the 'monster monopoly' will be bad for passengers, bad for competition, and will result in higher ticket prices. “It patently does not make sense,” he fumes. “Monopolies are good for companies, but they are never good for the consumer.” Branson adds: “BA has improved as an airline as a result of Virgin Atlantic keeping them honest.”

First of all where is the monopoly?

To answer that, I turned to Wikipedia for a definition. In Economics, a monopoly exists when a specific individual or enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it. Monopolies are thus characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods. Monopoly through integration: A monopoly may be created through vertical integration or horizontal integration. The situation in which a company takes over another in the same business, thus eliminating a competitor (competition) describes a horizontal monopoly (and that is what you are talking about I believe).

Surely no one believes that a monopoly would exist, or even be created, by granting Anti-Trust Immunity (ATI) to BA/AA/IB between the US and LHR. Branson’s arguments are LHR-centric and totally ignore the fact that the airline industry is a network business today and not the cozy structure protected by Bermuda II when Virgin Atlantic first flew in 1984. Yes, LHR is coveted, and is served, by nearly every major carrier of substance from around the world. Those US carriers that were not permitted to serve LHR are now allowed to serve the market and provide Bermuda II incumbents with significant new competition.

But fundamentally, today’s airline industry is about networks and not city pairs. It is a simple fact that oneworld cannot sit and watch STAR and SkyTeam grow anymore. Air France/KLM and Lufthansa/Swiss have grown into the world’s largest revenue producing airlines. Delta and Northwest will alter the ranking once their merger is approved but that will probably only last as long as it takes Lufthansa to get its hands on SAS and/or Austrian. Branson mentions his thirst for British Midland (BMI) and its extensive LHR slot holdings, but what about Lufthansa’s option on those LHR slots? Surely Richard you are not implying that with meaningful STAR alliance presence at LHR a oneworld monopoly would exist?

Branson talks in the interview about how AA and BA are using the current difficult economic and operating environment to accomplish what they have not been able to accomplish in two prior attempts. Quite honestly Richard, the entire world is being forced to transform their business models to adapt to the new realities.

US carriers are using this time to make difficult decisions on capacity cuts in order to diversify their route structures away from an over-weighted position in the US domestic market. Maybe you should be questioning whether Virgin Atlantic should be considering something other than LHR. Oh you have with Virgin Blue, Virgin Nigeria (and you might sell your stake in that Virgin) and Virgin America.

Or maybe you should be putting more energy into changing the ownership laws in order that Virgin Atlantic can realize all possible synergies from your family of Virgins. Abstinence from industry realities might be safe in the short-term but potentially lonely over the long term. You talk about the AA/BA/IB’s ability to strong arm travel agents and corporate customers. You are a branding genius and now you are saying that you cannot differentiate your product from AA/BA?

At what point do we take you serious?

Your data arguments are weak as well. It is about the local US – London/LHR market and that does need to be studied just as it is done on other deals. At least AA and BA have performed the best analysis to date using the best data source available to make that assessment. The competition authorities will make the same informed analysis and draw the distinction between local and connecting traffic as well.

So go paint your airplanes and while doing so recognize that Willie Walsh is right. He said broken record and I will not take a shot at another of your brands. What I will say is that your arguments are not virgins anymore and maybe you should be writing letters to Oberstar rather than McCain and Obama. If you write to McCain and Obama, the subject should be about changing the ownership laws that stand in the way of allowing the industry to become the global industry that rewards world class competitors like Virgin Atlantic. Because the large and small can cohabitate and as you say, make competitors even better competitors.

Oh and while you are thinking about some new arguments, take a look above London. On a clear day, at 40,000 feet, you will see liveries like Emirates, Ethiad, Qatar and others that do not necessarily believe that a network industry requires London to be the center of the airline universe.

Unless you recognize that 1997's arguments need to change the third time around, thanks for nothin’.

Back to the Future?

In a comment to my most recent, and only, post thus far in May a reader asked if I was suffering from Airline Fatigue Syndrome? I am thinking yes. I look at the news today and I see that Frontier is going to start flying to Fargo. WOW. And Virgin America is going to start flying to Chicago. WOW again. And Sun Country did Mother’s Day with flowers. Double WOW.

I admit I am hung up on wanting a real transformation of the industry – or at least a sense that one is underway. I want the UPS guy to redraw the lines without labor or political interference and present us with a way to work toward making each of those stakeholders more secure in tomorrow’s rendering of the US and global airline architecture.

I do not remember a time when more balance sheet risk presented itself. In the past there was typically a carrier or group of carriers that you were sure would emerge from the trials of a particular period. This time you give a nod to Southwest given the health of their balance sheet and their current hedge positions. After that, it is clear as mud.

I lectured today on issues confronting the industry and its evolution. We talked about the current actions being undertaken that feel like recycled ideas. We talked about Phase I of the US-EU deal and its lack of transformational attributes – unless Phase II is successfully negotiated. We talked about Delta – Northwest and the revenue synergy concept that they are employing -- and how it looks and feels a bit like the combinations of Air France/KLM and Lufthansa/Swiss. We talked about a potential United – US Airways deal and asked if the third time might be a charm?

We talked about the fragility of networks. At some point, the downsizing of a network collapses under its own weight. We talked about the dollar versus foreign currencies and the competitive advantage currently being enjoyed by our non-US competitors in reinvestment, growth and in the purchase of fuel. We talked about the need to raise fares, cover input costs and the need to emerge from the long-term value destruction cycle that has described this industry. We talked about the drive to find the inelastic demand component.

We talked about the difficulty of placing meaningful raises into the pockets of labor given all of the externalities impacting the industry – and we barely talked about the infrastructure. We talked about politics and their impact on the current industry structure. We talked about how the US does not have a strong bearer of the flag in foreign markets. We talked……..

Back to the Future

Maybe we do need to look back before we can go forward. Remember when we talked about yield and not RASM? Remember when we had turboprops with limited range that married them to a geographically centered hub market? Remember when we actually talked more about operating profits than EBITDAR? Remember when load factor was a data point and not the mantra?

Not that there was ever structural stability during these points in time either, but fuel is the real deal. It just might be that catalyst for change that has been missing during the deregulation experiment. And if the change causes an industry to be disciplined enough to charge the passenger "all-in plus some return on capital", then we just might look back and call this time the best thing that happened to the US airline industry.

Let's get smaller (whether by commercial choice or by market forces); focus on yield and not RASM; get rid of duplicative hub feed (whether by commercial choice or by market forces); and forget about load factor that is won largely by not charging anywhere near enough for those final 10, 20, 30 or even 40 seats. Surely these actions would lead us to some capacity level less than today and approaches an economic level.

As cp5000 commented on the previous post: “And assuming the industry is successful in raising fares (which they must), what alternatives will benefit? More teleconferencing, more driving, more conference calls? I don’t know. That question at least is new and fresh. Better than the same old, same old”.

“The market place is working. It is not pretty, nor should it be. More change has to come – hard to say what it is going to be. Stay tuned”.

“A Flying Pig”

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

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

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

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

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

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