If History Is A Lesson – American’s Labor Cuts Will Be Large

There is much anticipation regarding when American will file its petitions for labor relief under Sections 1113 and 1114 of the US Bankruptcy Code.  The clock is ticking in terms of the airline’s ability to get its network and costs in line generally and its labor costs specifically.  This needs to be done without undue rancor and in time to implement a workable plan. 

Further, the bankruptcy road has many unknown twists and turns as experienced by US Airways (not one filing but two), United (a three year stay and multiple approaches for concessions from labor) and Delta (an unsolicited offer to buy the company from US Airways).  American will face surprises along the way as well.

Let’s consider some facts.   Today United/Continental fly 39 percent more ASMs than American, yet its payroll is only 17 percent higher.  Delta flies 27 percent more ASMs than American, yet its payroll is only 7 percent higher.  US Airways is 53 percent smaller than American in terms of ASMs but its payroll is nearly 1/3 the size of American’s.  Any way you consider it, American pays significantly more for labor to fly its schedule than its network carrier peers.

I concluded a recent blog noting that American’s problems are bigger than any check labor could write outside of bankruptcy, but that employees will pay a much higher cost inside bankruptcy.   And that’s a painful situation that might have been avoided if all of the employee groups had the will and found a way to negotiate cost savings the airline requires to survive and prosper.

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." 

UNITED

The same story played out at United in 2002 and, sure enough, the toll on employees was much higher in bankruptcy than what the company originally sought in direct negotiations. Early that year, the company proposed a package of concessions totaling $9 billion over six years – or $1.5 billion per year.  The unions went back and forth for months and ultimately proposed a give of $5.8 billion over 5.5 years as a package they said employees could live with.  But as with the American negotiations, deadlines kept slipping as the unions sought more time to ratify the agreements. 

United, losing millions of dollars a day at a time the carrier was trying desperately to win a loan guarantee from the Air Transportation Stabilization Board (ATSB).  As it was, the ATSB was about the only potential source of capital then available to a company hemorrhaging cash and seemingly unable to control its labor and other costs.

As the clock ticked, the unions finally agreed to the $5.8 billion package, only to have the International Association of Machinists and Aerospace Workers (IAMAW) vote the deal down.  With the ATSB loan imperiled as a result, United filed for court protection 11 days later, on December 9, 2002.

US AIRWAYS

Four months earlier, inside of court protection, US Airways in its first filing asked for $950 million in labor relief per year on a total labor bill of $4 billion.  This was US Airways’ first bite at the labor apple as the company quickly emerged from bankruptcy number one and filed again in 2004 where a subsequent $800 million in concessions were granted.  By the time US Airways emerged from its second bankruptcy and was being merged with America West, the company was half its size in terms of employees and its payroll was 58 percent smaller.

DELTA

On September 14, 2005 Delta Air Lines filed for bankruptcy reorganization.  In the year before Delta’s filing, its payroll was $5.8 billion and it employed nearly 58,000 employees (down from 71,000 in 2000).  Through the bankruptcy stay, Delta shed nearly $2 billion in payroll and reduced the number of employees by an additional 11,000.

WHAT IS THE LESSON FOR AMERICAN?

First, the bankruptcy court proved to be a more effective means to achieving the cost savings than any airline is able to accomplish through traditional collective bargaining.  Remember, United asked for $1.5 billion per year from its labor groups prior to bankruptcy and the unions would agree to about two-thirds of that. Under Section 1113, United asked for, and received, $2.4 billion dollars of an annual labor cost savings over 6 years – for a total of $14 billion in concessions.  And this would only be United’s first of three bites at the labor apple.

The second bite occurred in early 2004 when United filed for relief from paying contractual retiree medical benefits under Section 1114 of the US Bankruptcy Code.  The third bite came in late 2004, with fuel prices beginning their march to $147 per barrel and clear recognition that the company had not cut enough while in bankruptcy, United went back and asked for an additional $725 million per year that would include the employees’ defined benefit pension plans.  These two additional bites at the labor apple cause American to stand out as having benefit packages significantly more rich than the industry and productivity constraints dictated by terms in the existing collective bargaining agreements more onerous.

According to the MIT Airline Data Project, if American’s contract with its pilots union allowed it to match the productivity of Continental’s pilot workforce, American would need 800 fewer pilots to fly its current schedule.  That amounts to $400 million in costs mostly attributable to a labor contract that puts artificially low limits on the amount to hours an American pilot can fly.

If American were to achieve the same flight attendant productivity as Delta, it would require 1,500 fewer flight attendants than it now carries to fly the schedule.

And had American relied even partly as much on outsourcing as does every one of its competitors, American’s maintenance operation, represented by the TWU, would be a fraction of its current size. American today outsources only 24 percent of its maintenance and related work, compared to an average of 40 percent outsourcing among all other carriers.  When United began its restructuring, it outsourced 17% of its maintenance.  By 2007, that had grown to 46 percent.  So it’s not unreasonable to expect something similar when all is said and done in American’s trip through the restructuring process, particularly as its maintenance-heavy Super 80 fleet is retired.

According to AMR, American’s labor cost disadvantage versus the industry now tops $800 million a year.  One of the he main questions outstanding is where the airline cuts, resizes and reconfigures its network to get to a place that it can compete and earn sustained profits.

That plan could, and probably should, contemplate significant outsourcing in the aircraft and traffic servicing department, particularly “under the wing” work in small stations with limited flight activity.

And as the airline rethinks its overall fleet and flight schedule under the watchful eye of its creditors, every position from the flight crews to ground workers to airport agents will be examined to determine how many employees will be necessary to support a resized operation.

How much power do the unions have to “protect” these jobs? If history is any guide, very little. Ultimately, the bankruptcy court will determine the viability of the company’s operating plan based on its ability to balance costs and revenues and return a profit. And if that means fewer jobs, then that’s the reality the court will consider.

This is an admittedly harsh portrait, particularly in light of the $1.8 billion in concessions granted in 2003 by American’s unions – alongside another $2+ billion in non-labor cost reductions that affected employees across the company. 

I have no direct knowledge of what American will ultimately ask of its employees or the other elements of its restructuring plan. But I don’t believe the ask will be light, or easy, and that is more a factor of the economics of the industry and the competitive marketplace than anything American could have done through other means.

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.

Capital, Labor and Seniority in the News

We awake this morning to reports that Chrysler will file for Chapter 11 bankruptcy . Despite efforts by the Obama administration to force Chrysler stakeholders to find an out-of-court solution, certain debt holders would not agree to the haircut they would have to take in forgiving debt to the auto giant. What they seem to be saying is that, under the terms of the proposed solution, labor would receive a disproportionate share of equity in the restructured company.

Where seniority for airline workers is earned through longevity, capital structure seniority is a bit different. In a bankruptcy, there are different classes of capital. Debt secured by company assets is the most senior on the list of creditors who will be paid. Unsecured debt capital is next in the pecking order, followed by preferred stock and, lastly, common equity.

Nowhere is “sweat equity” reported on a company’s balance sheet. However, worker concessions have been recognized as capital in a restructuring scenario and have been currency accorded a stake in a reorganized enterprise. Moreover, it is the sweat equity at Chrysler held by current and retired workers that might appear to some as being unduly enriched through the deal that gave them a 55 percent ownership stake in a restructured Chrysler.

A very different scenario played out in the airline industry. There, in bankruptcy cases that resulted in either a termination or freezing of pension plans and/or alterations to retiree benefit plans, creditors made it clear that they would not pay the bills from the past by forgoing profits in the future. For airline companies to emerge from Chapter 11, they needed public capital to fund their exit from bankruptcy. For car companies, the government is the source of exit capital.

This morning’s New York Times, quotes a statement from GM’s bondholders that applies to Chrysler’s issue as well: “We believe the offer to be a blatant disregard of fairness for the bondholders who have funded this company and amounts to using taxpayer money to show political favoritism of one creditor over another.”

As the article notes: “The U.A.W. members at both automakers stand to lose some of their pay and benefits, but the cuts are not as deep as those faced by airline and steel workers when their companies went bankrupt. Under proposed deals devised by the Treasury Department, U.A.W. pensions and retiree health care benefits would largely be protected”.

Airline Seniority In The News

On Tuesday, Terry Maxon of the Dallas Morning News wrote about the former TWA flight attendants and their dissatisfaction over their treatment from the flight attendant union when American purchased the assets of the troubled and iconic carrier in 2001. Also Tuesday, the four-year seniority battle between the merged group of pilots at US Airways got underway in US District Court in Phoenix, Arizona. Read Dawn Gilbertson’s reporting in the Arizona Republic and on the paper’s US Airways blog.

Whether it is in the airline industry or in the automobile industry, there clearly is something wrong with the seniority system. My question: should seniority really be sacred? The current seniority system does not work for shrinking industries like airlines and autos.

I am in stark agreement with the actions taken by the Association of Professional Flight Attendants, the union that represents AA flight service crews, which in protecting the seniority rights of its members decided that former TWA flight attendants would be put at the end of the seniority list when they joined AA ranks. The fact is this wasn’t a merger of equals. At the time of the purchase, TWA had sold most strategic assets and had reached its tipping point. There was nothing left to borrow and no hope except American’s offer to buy its assets.

I am in stark agreement with the America West pilots in their disagreement with the former US Airways [East] pilots who had little hope of a career absent the reorganization plan that involved a merger with America West.

Given that the economy will continue to call into question the future viability of any number of US airlines, this seniority issue is far from over. Plain and simple, it is about economics and the viability of individual carriers. US Airways [East] was not going to survive in its 2004 form for long. TWA would likely have died of natural causes as the effects of 9/11 ravaged the industry.

Concluding Thoughts

Given that the airline industry will likely get smaller before and if it gets bigger, it is high time that organized labor puts down its swords and constructs a national seniority list. Employees should have the right to move within the industry should their carrier cease to exist. Seniority should not be a shield for some to hide behind. Rather it should promote stability for those experienced workers that choose to offer their services for hire in an open market

The economic crisis and its impact on corporate America highlight the need for thoughtful analysis of labor issues. Seniority is only the first of the “third-rail” topics we shouldn’t be afraid to discuss. Another is the “legacy costs” like pension and retiree benefits and whether they should be the sole responsibility of the employer in today’s world. Best that I can tell, this growing financial burden on employers may serve only to stand in the way of active employees working to maximize their earnings.

Time will tell what ultimately will emerge from Chrysler’s bankruptcy; GM’s prospects for the future and whether the deal at Ford positions that company to compete for the long term. The same day might be coming for airlines which would be wise to learn lessons from the industries that come before them.

I make that final statement after reading through Obama’s statements. The US government is constructing a safety net for Chrysler and its workers. Some will fall through and others will be saved. Airline labor should be thinking about the same.