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.

Olympic, Alitalia, American and the Wings Club

And we thought the last 10 days of news regarding financial institutions was interesting. In this industry we have legacy flag carriers dying on many continents. We have continued, and even aggressive, consolidation activity in Europe. In the US we have Delta and Northwest pointing to a date before year end to complete their deal. All that remains a constant, it seems, is the Allied Pilots Association creating press releases that ignore the realities of the world to virtually everyone except Lou Dobbs. But before we go there………

Today, Greece finally announced that it would shut down Olympic Airlines and start anew. The Greek flag carrier has only been going through gyrations of Olympic-sized restructuring efforts since I began to study the industry. Nearly 30 years later, its legacy carcass is finally put to rest.

All the while, the investor group that has been assembled in Italy to rescue Alitalia has given certain unions that have not signed on to their business plan until Thursday to do so. Today, a small union caused the carrier to cancel flights as it struck. The bankruptcy laws in Europe are different than in the US and honestly, they are the kind that should be adopted here. If the investor group were to walk away, there is a high probability that Alitalia could be liquidated. Not that Rome is burning, but maybe a “Flying Pig" Roast is in the offing.

Whereas saving Alitalia has become a front-burner issue for newly elected Prime Minister, Silvio Berlusconi, Rome will not burn; Milan will not burn; and all other markets in Italy will not burn if flag carrier Alitalia does liquidate. The world really will not miss Alitalia. Just like the hub closures that have occurred in the US over the years, replacement capacity will be sure to find the market opportunities that are presented. Lufthansa and Air France and others have already identified markets where they will deploy capacity to address the void left by Alitalia should it exit the space.

So, two more carriers in Europe, each once proud flag carriers, are close to succumbing to the high cost of jet fuel, a slowing economy, a strengthening of the dollar, hyper-competition for traffic flows over European hubs/gateways and high intrinsic cost structures that simply cannot be supported.

Now we turn our attention to the US. Similar pressures are forcing its carriers to engage in gut-wrenching decisions of resizing networks in order to adapt to the new economic order. Leave it to the Allied Pilots Association to cause most interested observers of this industry to scratch our heads yet again. Not only did APA’s President write to the CEO’s of British Airways, Iberia, Finnair and Royal Jordanian advising them not to enter into an immunized alliance structure with American Airlines, they also wrote to the US Government urging them to postpone their review of the application.

When all other carriers, including Southwest, are actively seeking new revenue sources that can only work to bolster the bottom line, the APA continues to act in the most destructive of ways. The revenue sources its company is seeking to participate in are those carried by American’s competitors today. To ignore them only initiates American's walk down the path of Olympic, Alitalia, Sabena, and the many US carriers that have ultimately succumbed to the same fate.

But only APA’s membership can decide if they are being led for the better or ultimately to their detriment. I cannot answer that.

Finally, James Hogan, the Chief Executive of Ethiad, spoke to the Wings Club in New York about a 'New Wave' in Global Aviation. If anyone does not believe for a minute that this “new wave” coming from Dubai, Doha and Abu Dhabi will challenge the European partners of the US carriers in a big way, then you are just not reading the tea leaves.

There are traffic flows that are critical for American and British Airways to participate in that require competitive strength. There are possibilities for Iberia that do not exist today. Today, each of the carriers have a strong position in some markets. Absent a relationship similar to that of STAR and SkyTeam, oneworld’s global market position will only continue to erode and will result in less and less flying for US pilots working under the American Airlines’ seniority list.

Just look at the loss of legacy carrier employment in the US today. American has not suffered the half of what United, US Airways and others have suffered. There is no growth at home and that is precisely why APA’s actions of today just simply ignore the evolution of the global industry and the forces of a global economy. Tomorrow’s world is not about Abilene, it is about Asia. It is not about narrowbodies to Eugene, it is about widebodies to Europe. And it sure as hell is not about Midland/Odessa, it is about the Middle East.

It is also not about 12,000 American pilots that Captain Hill states he represents, it is about the other 65,000+ proud employees of American Airlines.

Thank god for Lee Moak and his counterparts at Northwest. At least they recognized that changes were needed to compete in tomorrow's marketplace.

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’.

The Reality Show Called Airlines

The Biggest Loser(s)

Reality shows have become a fixture on American television. Like them or not, the ratings of many are hard to ignore. So at a time when US carriers consider whether charging by the pound would be good practice, the title today seems appropriate. 2008’s second quarter comes to a close today. Red ink will again be the color to describe the financial results for the US airline industry. Red will also be a color prevalent in calculating changes in liquidity positions for many of the US carriers.

Red should also be the color of the faces of analytical team employed by the Business Travel Coalition as they made public their latest of a long list of scare tactics. It is has been nice to see other bloggers and observers make their views known regarding the information and “analysis” that has been emanating from this group. There are many smart observers of this industry. To even allow BTC’s latest missive find its way from the idea table is head scratching enough. To allow a piece into the public domain without the supporting data and analysis underlying the “findings” is even more bothersome.

My guess is the BTC’s leader is nothing more than a pawn for Jim “Hell NO”berstar and the socialist ideals he thinks are best for the US airline industry.

Closer To Another Method of Treatment, Than A Cancer

Many times I have written about Willie Walsh, British Airways’ Chief Executive and his views on US regulation and its hindrance to the natural evolution of the global airline industry. Today, Mr. Walsh’s views were expanded upon by Martin Broughton, the Chairman of British Airways PLC in an interview in the Wall Street Journal by Daniel Michaels. Some of Mr. Broughton’s comments that I found to be spot on are as follows:

· An eventual relaxation of US airline-ownership rules would spark a world-wide wave of cross-border deals over the next five to 20 years. That would help the troubled aviation sector function more like other industries.
· Mr. Broughton still sees it [US – EU Open Skies Phase I] as a lousy deal because it opened Heathrow, but only opened a small crack in the US market for EU carriers.
· Mr. Broughton hopes economic pressures will do what diplomacy couldn’t. It could be the financial exigencies of the day that finally make for a breakthrough.
· In Europe he cites two cross-border mergers that have shown the potential of multiairline groups: Air France/KLM; and Lufthansa/Swiss. In Latin America, he cites the tremendous success of Chile’s LAN Airlines SA. In Asia he points to the success of Kuala Lumpur-based budget carrier Air Asia.
· Mr. Broughton points to the frustration of Lufthansa’s Chief Executive Wolfgang Mayrhuber with airline-ownership limits. He quotes Mr. Mayrhuber as saying this industry shouldn’t be treated like railroads. It should be like car makers or chemical companies and operate globally.
· Mr. Broughton called America the biggest impediment to relaxing the aviation industry’s ownership and nationality rules. He suggests that if you break US resistance then you have made a big breakthrough on a global scale.
· Broughton believes that financial considerations may soon overtake nationalistic ones. He suggests that even labor should welcome the changes because foreign investment is investment and that is something US carriers have lacked in recent years.

So as we carefully dismantle/deleverage the last 30 years of network architecture as a method to discover individual carrier’s profitable cores, I long for the day when we begin to grow again whether organically or through other means. The combinations cited by Mr. Broughton are those carriers that are leaders in a global context as far as return on invested capital; growth in virtually any measure; and in market capitalization. Moreover they are proof of successful models of cross-border combinations that are producing the right kind of returns for many stakeholders, not just a few.

US Airlines and Portfolio Theory

Attributes of a successful US airline industry are no different than an individual investor or a portfolio manager. Instead of diversifying a portfolio of financial assets, airlines hold a portfolio of routes. Modern Portfolio Theory (MPT) proposes how investors will employ diversification to optimize their portfolio of assets. The model that proposes this diversification assumes that investors are risk averse meaning that if the expected rates of return on two separate investments are equal, then the investor will choose the one with the least risk. On the other hand, an investor will not accept more risk without a commensurate increase in the expected rate of return.

Parochial-thinking lawmakers, regulators and aforementioned observers somehow think that the US airline industry should continually accept more risk all the while accepting a commensurately lower expected rate of return largely driven by policy -- all in the name of competition I guess. For the largest US carriers, the portfolio is simply made of up too many domestic routes. This is how you can characterize the first 30 years of deregulation. Now it is time to break the boom and bust cycles that have characterized this industry.

During the down cycles: Unhealthy competitors remained due to high barriers to exit; new entrants emerged, because of the very low barriers to entry, looking to exploit weaknesses; leading one to argue that this has led to the overcapacity situation that will begin to be addressed immediately after Labor Day. Compounding the “excess capacity” issue, the airline industry emulates other capital intensive, commodity industries by over-expanding during the up cycles.

Surely the Naysayers Recognize that Something Is Wrong?

So here we sit. With nowhere to run, nowhere to hide, and few options to find new capital to invest in a lacking product that will require the consumer to pay more for as a result of high oil prices over the coming months – it will get interesting. Moreover, the consumer will surely have an expectation that increased prices sure as hell better produce an improved product.

I like the idea of foreign capital for this very reason – the need to invest in product that facilitates a new cycle where the ultimate US flag bearers in the global industry begin to differentiate themselves from the local service carriers (formerly called Republic, Ozark and Western) – or today’s equivalent (Southwest, jetBlue and AirTran) – tomorrow. But if I had capital I would not make that investment without commensurate voting power either.

So over the next 12 months or so, it will be interesting to see just who gets voted off of the show.

Yawn

This post represents the longest period between pieces for me since I started swelblog.com in October of 2007. Change has been the theme to date. Change will continue to be a theme. Bloggers typically are not sources for news. Instead we rely on reports from the Wall Street Journal, the Financial Times, Bloomberg and other trusted sources for the news and views.

Last Monday, Susan Carey and Melanie Trottman wrote: Continental Rejects Merger Overtures. The subtitle read: Move Marks Rebuke to Rival United; Shifting Alliances? OK. That story ran on A1. Today Susan Carey writes a piece entitled: UAL Merger Discussions With US Airways Intensify. The subtitle reads: Companies See $1.5 Billion In Savings, Synergies; Decision Within 10 Days. Yawn. This story ran on B1. And of course the story comes replete with the now familiar disclaimer: “according to people familiar with the matter”.

In the past, news of airline mergers and potential structural changes in the industry had an air of intrigue and suggested something new in the age old debate was about to emerge. Not this time. Throughout this current period of M&A discussion, I have hoped for something that suggests a path toward transforming of the industry. Something different. Something that tests the current shackles that tie the industry to the same old, same old.

Something like British Airways testing the ownership limits and investing in American and/or Continental. Deal is intended to highlight the importance of the subject as the US and EU negotiate Phase II. Or, labor agrees to a single collective bargaining agreement that makes changes to scope that opens up the globe to new revenue sources all the while protecting US jobs and ensuring that growth will largely remain with the US carriers involved. In return, labor wins meaningful equity in the deal and ties compensation to the same metrics as management. The changed compensation structure begins the process of aligning interests in the company's success.

But I think the market will be the ultimate driver of change. Not the carriers themselves. But maybe that is the good news in all of this and honestly, the only way it can get done.

Transition v. Transformation (Labor Actions Hold A Key)

No matter what direction the industry was going to fly following the emergence of Delta and Northwest from Bankruptcy in early 2007, the subsequent five years or so was going to be a period of transition. The era was sure to be marked by increased competition from non-US carriers; higher oil prices; an economy that was tiring; and more than likely a recognition that no carrier that filed for protection probably had done enough, or tried to preserve too much, given the trajectory of the oil curve.

Then we were going to be faced by the demands of labor to return what was conceded during the restructuring period. Because that is the way it has always been. Right? So maybe it is labor, and their ultimate actions, that is the transition. The transition to transformation? And this transition holds a high probability of the death of an icon.

We already schooled on the many labor issues surrounding Delta and Northwest. But United and US Airways provide their own interesting twists. And those twists begin with the pilots.

No group of pilots has even approached the unrealistic and "head shaking" behaviors of the American Airlines’ pilots except for the former US Airways pilots (US Airways East). These are the pilots that chose to form an independent union by selling an unachievable (from this writer’s opinion, anyway) overturn of an arbitrator’s decision regarding seniority integration of the former America West and US Airways pilots.

But if United and US Airways do decide to join hands, some very interesting possibilities come to the fore. With 5,000 United pilots represented by ALPA; 2,200 former America West pilots that largely voted for ALPA I would guess; and the 2,700 or so former US Airways East pilots that bought the pipe dream sold by the USAPA upstart – an election for representation is all but ensured. And ALPA would likely win. The integration would more than likely get done - yet again. This is the best hope for the former US Airways' East pilots who should recognize that they were fortunate to have found a way out of Chapter 22.

As for the concept of rent sharing discussed in the previous post, a combination of United and US Airways would result in less transfer of capital from the deal and into hush money paid to labor given the relative proximity of average salaries and productivity levels of the two groups.

A United – US Airways combination would also prove most interesting for the flight attendant group as the AFA-CWA represents not only the United class and craft but each the former US Airways and former America West flight attendants as well. From my perspective, this could very well become a “game changer” in the AFA’s attempt to organize the current Delta flight attendants. AFA will be put under the spotlight as to how the union will deal with the integration of its own members that are sure to have varied interests.

As for the other represented groups in the United – US Airways combination, labor stories exist but they are less headline making than what could go on with each the pilots and flight attendants in this scenario.

Over The Weekend, A Comment From a Reader

In my most recent post, Swelblog.com: Let’s Just Continue the War of Attrition, cp5000 commented: “Bottom line is that in a free market, management and labor are free to do whatever they please and capital should be able to make its way to those companies that make arrangements with their work groups that make sense to the providers of capital. Letting the market place sort this all out is difficult for a politician, particularly for a politician from an area that will lose jobs due to the workings of the market. However, our political leaders should be able to see that the pain experienced by some in the past has led to many benefits today”.

cp was speaking to events like the loss of TWA that arguably provided for the opportunity for jetBlue to be granted the slots necessary at JFK that were instrumental to its successful start. The demise of Pan Am was critical to United building Asia and gaining early access to London Heathrow. It could be said that the loss of Eastern ultimately created the vacuum for AirTran today as it has morphed from its prior incarnation as ValuJet. And Southwest has just “triangulated” its way through it all and now has its footprint in all four corners of the US domestic market..

Charlie Bryan’s Tombstone Would Probably Like Some Company

Whether it be the integration of seniority, the overreach for corporate rents by various stakeholder groups, or the failure to recognize that the historic patterns of bargaining and capital recycling are over – labor will definitely play a role in this transition period.

In a post on October 21, 2007, I wrote a piece where I was addressing employee and community entitlement to employment and air service. “Defining Entitlement Economics: all are conferred a lifelong right to employment and/or abundant service despite the fact that the economics of the US airline industry, particularly its domestic operations, have changed significantly since the early 1990’s”. Nobody is entitled to a lifelong right of anything.

Why this period is not viewed as an opportunity by labor and policymakers, I just do not know. Instead opponents will point to executive compensation; service problems; loss of service; a menu of potential dislocations; and just plain ignore the economic reality that this industry needs to figure out how to make money. Period. That is the only thing that will benefit everyone.

Yawning at United – US Airways and the drumbeat in anticipation of it. Not sure if I am just weary of the tired refrain of executive compensation and entitlement of economics and seniority; or if bored because the arguments and scare tactics remain the same all the while the world around the arguments continues to change; or if oil is just sucking the oxygen out of the industry and limiting the interesting things that could be done proactively. But I will be patient as some great stories and perspective will emerge.

Or maybe it is simply because I celebrate five decades of life on Thursday. I probably should have written this piece on Mayday. But it is Cinco de Mayo.

The Era of Transition, and Hopefully Transformation, Is Top of Mind for British Airways as Well

Industry cycles often adopt a theme – and often too late. The late 1990’s through, at least, the first three quarters of 2000 was arguably a bubble period where revenue generation was too good to be true – even in hindsight. Yet the US industry added billions dollars of costs believing that the revenue trajectory was sustainable. For US carriers, the period from late 2001-2007 was a restructuring period. A period necessary to begin making wholesale changes based on the unrealistic cost structures that developed during the inflating of the bubble.

Now today, we find an industry that has indeed taken billions of dollars of cost out of any number of carrier’s respective operations. But it was clearly not enough to produce an industry structure that can profitably support all of the current players. All you have to do is read 2008’s best-selling daily horror novel named the Wall Street Journal to realize that we are on very shaky ground. And about the only thing we know for sure is that the revenue health of the US and global airline industries is inextricably tied to the health of the US and global macro economies.

Views from Willie Walsh

Back in October, I wrote the shortest swelblog.com post to date. And the themes from that post are the one’s I use most when speaking. In Transforming the Transatlantic Market Into a Transcon Market, I reference a Reuters article that interviewed British Airways’ Chairman Willie Walsh. In that post I characterize the story in the following sentences: “Clearly British Airways is (re)evaluating the best use of its capital as the current architecture of the transatlantic market is being (re)examined. This story comes on the heels of reports that BA is considering a major expansion of new services into the US market”.

In the Reuters article, Walsh uses the term transformational. Transforming the global airline industry is precisely what is being done in Singapore, Dubai, Abu Dhabi, Frankfurt, Paris, Amsterdam, Hong Kong and Sydney. It is precisely what Glenn Tilton of United, Doug Parker of US Airways, and now Richard Anderson of Delta and Doug Steenland of Northwest have been/are saying as well.

There are Many Parallels Between BA’s Views and US Industry Views…..

……and I will touch on a few.

Individual airline growth around the world is taking place in multiple ways. Among the elite Asian carriers, the robust growth is largely organic. The same is true in Latin America. Except for LAN who is expanding through both organic growth as well as providing a brand on which flags of countries with struggling airlines can rely on for access to the global air transportation system. In the Middle East region, it is all about organic growth. This region is blessed with geography, capital and a vision that I appreciate more today than I did just a month ago.

In Europe though, growth for the legacy carriers has largely come through acquisition strategies. Sure Ryanair and Easyjet are growing organically but they are not the answer to Europe’s global access anymore than Southwest, jetBlue and AirTran are in the United States. It is just naïve to believe that the low cost sector is that answer.

On March 7, 2008 the Financial Times wrote a very good story entitled: BA looks to play the consolidation game. It is from this story that I will attempt to draw out some of the many parallels that exist between BA and the thoughts on industry structure espoused by the leaders of the US legacy carriers.

For British Airways, global travel is everything. For the US legacy carriers, global travel is quickly becoming everything as the US domestic market’s fragmented structure promises little to nothing in terms of profitable new business. But when BA looks at the size its principal regional competition (Air France/KLM and Lufthansa/Swiss) has grown to through acquisition, it, like its US counterparts, need to be concerned. They are big in virtually any metric imaginable.

While much is being written about what the new open skies agreement means for the industry in 2008, arguably the most important event for BA begins in December of 2008 when Lufthansa has a call option to begin buying BMI British Midland. With BMI comes a large London Heathrow slot portfolio that is sure to bring lots of interest from carriers around the globe. As BA moves to the brand new T5, and with the move the ability to move many more passengers, the slot issue is not lost on Walsh.

Like the US carriers, BA has shown very little growth since 2001. It has been engaged in its very own restructuring process. BA generates strong cash flow like the US legacy carriers but also relatively low returns on capital which also resembles the US legacy carriers. The FT article states that BA is readying for a growth period that is likely to be some combination of organic and acquisition related. In a theme that is quite reminiscent of what US legacy CEOs have been saying, Walsh is quoted in the article as saying "Some of the shackles have been removed," he told investors and equity analysts on Thursday, "we have not quite fixed the core business, but we are well on the way".

Ah, that core business thing again. To invest? Or not to invest? - and let the enterprise attrit into oblivion. That IS the question.

The FT piece expands on BA’s interest in BMI and goes on to say that an interest remains in Iberia. But outside of these two carriers, there is little interest in anything else European. Walsh states, "We are mindful of the opportunities consolidation can offer," he said. And his gaze is not only fixed on Europe”.

But Before We Go There – Yet Another Parallel

In a paragraph which caused me to pause and read multiple times, Walsh commented on the acquisitions made by each Air France and Lufthansa: "we look with admiration" at how both deals had generated substantial revenue synergies, a possibility BA had largely discounted, as it concentrated much more on the potential for cutting costs”.

This sounds a lot like what Delta and Northwest have been discussing. Network and revenue synergies first. I, along with many observers, have also struggled with the strategy outlined in a number of press reports which suggest that Northwest and Delta will maintain their current network structures. But after a period of domestic cuts and a restructuring of networks with a sharp focus on an international strategy, we will just have to wait and see whether the same synergies can be realized here in the US as are being realized in Paris and Frankfurt.

On US Consolidation and Views on the Regulatory Landscape

The article and Mr. Walsh offer views on US consolidation that are also in concert with statements made by US legacy carrier CEOs. "US consolidation would be a good step forward," said Mr Walsh, "it would benefit the US and the global industries".

There has to be a strong US industry for there to be progress in the next stage of transatlantic liberalisation and a dismantling of US restrictions on the foreign ownership and control of US airlines.

BA had a "good relationship" with its US partner American Airlines, but the development of any deeper deal was "inhibited" by the two groups' lack of antitrust immunity from the US and European competition authorities.

"There is evidence that the regulatory landscape is changing," said Mr Walsh, but it was not yet clear that it had changed sufficiently to make a fresh application for a deal with American, he said. "We will continue to look and examine."

Bringing Back a Few of My Favorite Glenn Tilton Statements

For those of you that have read this blog since the beginning, you will have seen these quotes used before. For the purposes of this blog post, the parallels between a US airline CEO and Mr. Walsh are certainly evident.

Glenn Tilton, UAL’s Chairman and CEO said in a speech to the Nikkei Global Management Forum in Tokyo: “If there is one imperative for every business in the global economy today, it is simply this: evolve, adapt, reinvent . . . or risk irrelevance in the global marketplace”. He went on to say: “As everyone here today knows well: the reality of our world is that globalization is relentless. Think of any industry represented in this room; choose any business listed on the Tokyo Stock Exchange; and one can be sure: it looks nothing like it did ten years ago; and looks nothing like it will ten years from now”.

In his Tokyo speech, Tilton asks the following question: “As globalization gives rise to new economic powers within the developing world, the real question for all of us operating in mature economies today is this: will the legacy systems that contributed to the success in developed nations in the 20th Century be an asset or an impediment to growth in the 21st Century”?

He goes on: “The airline industry is a perfect platform from which to focus this discussion, because it is subject to virtually every imaginable challenge -- every human challenge, industrial challenge, financial, regulatory, and security challenge -- throughout the global economy. And then, of course, we also contend with the weather”.

So BA, like the US legacy carriers have evolved largely by being pushed by economic and competitive forces to engage in a necessary restructuring. The restructuring was necessary to adapt to both a changed and hypercompetitive domestic market and to better prepare for a world that has been largely liberalized. But, the reinvention of former legacy airlines into entities that can thrive in tomorrow’s economic world is not complete. And that is clear for each BA and United and Northwest and Delta and others to be sure.

More to come.

Converging Catalysts Making a Case for Consolidation?

Don’t look now…….

…..but there is something that feels different to me. In the vial, mix:

1. a lot of anxiety with commensurate posturing
2. non-traditional capital sources with skeptical labor
3. parochial tendencies against global economic forces
4. a weak dollar relative to foreign currencies
5. a weakening US economy and record high oil prices that appear to be the new standard

What do you get? Consolidation chatter that has the feel that it is real. Not talk; not speculation . . ..the real deal.

The US Home Market

The last meaningful airline consolidation period that involved multiple players began in the mid-1980s. Piedmont bought Empire; American bought AirCal; Northwest bought Republic; TWA bought Ozark; United bought Pan Am’s Pacific Division; Delta bought Western; USAir bought PSA; USAir and PSA bought Piedmont; United bought Pan Am’s London Heathrow authority; and American bought TWA’s London Heathrow authority. And that’s only the larger transactions of the period.

It is these transactions that formed the commercial backbone of the industry today. Nearly 20 years have passed since the industry recognized that economies of scope, scale and density would prove important to survival in a deregulated network industry. And it brought a significant regional concentration of services. Two Minneapolis hub carriers merged; two St. Louis hub carriers merged; and two predominantly East Coast carriers merged. Arguably, only Delta and Western represented an “end to end” merger of carriers.

In the years since, there have been periods of mainline capacity cuts, mainline capacity growth and regional carrier growth – explosive at times and largely facilitated by technological change and a disparity in labor rates. And by the late 1990s, we also had the explosion in new capacity by low-cost carriers, and not just Southwest. The growth by the LCC sector was largely driven by the gap in the cost structures between the upstarts and the legacy carriers.

That Was Then, This Is Now

We have talked on Swelblog.com about how the barriers to exit are greater for this industry than are the barriers to entry. We learned the latest lesson on this topic during the bankruptcy era when more-than-sufficient capital was available to fund each of the respective plans of reorganization.

I would be surprised if one serious analyst did not question the virtues of the reorganization plans. Costs were cut and network changes were made, to be sure. But now, compounding the price of fuel is a weakening economy. Airline share prices plummeted throughout the month of December. Thus far in 2008, virtually every market is off to one of the worst starts of any year on record. The markets know something. The only time I want to see the highs getting lower, and the lows getting lower, is in my golf score.

At some point, the current credit crisis, increasing food prices and the impact of rising fuel on the consumer pocketbook will begin to put real pressure on consumer disposable income. And this will impact airline travel. Consumers will simply be less inclined to travel, even if the ticket price is right. From everything I read, it is clear that planned capacity for 2008 has not factored in any meaningful loss of consumer disposable income, nor should it as the macro economic indicators continue to provide us with mixed signals at every turn.

The Catalysts for Consolidation

1. The price of fuel: Consolidate this time will mean consolidate, or risk getting smaller. Consolidate means eliminating any and all duplication of service and costs associated with providing that service. And no, it does not have to harm the consumer as I believe that the leadership of the US airline industry may actually be more concerned about further erosion of consumer confidence in the industry than the health of the economy and oil threats.

2. The US domestic economy: A weakening economy will only shine a harsher light on service to communities that can’t be operated at a profit. The US airline industry made a good bet on 50 seat capacity during the latter half of the 1990s. That bet helped the industry to remain connected during the dark days of 2001 – 2004. But if that capacity was not economic at $50 oil, then it certainly is not economic at $90 oil. I do not think the industry has any overt intentions to disenfranchise entire communities from access to the US air transportation system. Rather, the industry will rightly ask if the same revenue can be generated with six frequencies instead of nine or three frequencies instead of five.

3. Hyper domestic competition: If anyone on Capitol Hill ignores the simple fact that US airline industry growth has slowed at home because few profitable opportunities remain, then we will just keep having the circular conversation – mostly driven by parochial concerns – that rejects consolidation out of an irrational fear that it will limit competition.

4. Increased international competition: If not a catalyst today, incursions into our market from foreign carriers promise to become a pressure point in the near term. The immediate impact of the US-EU deal is not much more than a change of the three letter airport code from LGW to LHR. But LHR, like JFK, is important airline real estate. Given this fact, what will bmi do? It has significant slot holdings that are sure to be bid on by any number of carriers like BA, Virgin, Lufthansa (with rights to exercise), Singapore, Emirates or any one of the Indian carriers. Any one of these carriers can force a changed transAtlantic environment overnight if LHR slots land in their portfolio. And we will sit and watch just how BA will compete with its Open Skies subsidiary from non-LHR points on the continent. Game on.

5. Foreign Capital: Just as plenty of money was available from many sources to fund bankruptcy exits in the US, foreign capital will prove to be plentiful as the US considers merger partners and deal structures. I am not convinced that all alliance structures are set in concrete. This being said, the alliances are sure to be most interested parties in how the network structures might evolve. In fact, some of the competition among the alliances to secure their place at a preferred table may be the catalyst to satisfy the many currently unsatisfied shareholders in US airlines today.

6. Labor: In a recent post here (no, not the one where the Terrapins beat the Tar Heels), I wrote about the emerging leadership of Lee Moak, ALPA MEC Chairman at Delta. Since that posting, the leadership of the pilots at United and Northwest have also spoken. Why the rising volume in the union leadership ranks? Because I am increasingly convinced that the industry is moving beyond recognition that structural change is about to occur -- and with that recognition comes preparation. Unions representing pilots and the flight attendants signal that preparations are underway to address respective issues in any consolidation scenario. They are seeming to believe, as do I, that with a seat at the table comes opportunity.

7. Management: In their public statements, the leadership at each of the airlines is increasingly more resolute in their comments regarding consolidation. United’s Tilton and US Airways’ Parker have been joined in recent weeks by Delta’s Anderson and Northwest’s Steenland speaking out in support of consolidation. Keep watching – it appears that Continental’s Kellner and Southwest’s Kelly may not be far behind.

With jetBlue partnering with Lufthansa; Frontier under increasing competitive pressure in Denver; and AirTran certain to be challenged by a growing and more vibrant Delta footprint, this discussion is not confined to a single sector of the industry.

A Few Concluding Thoughts

There is just something different this time. If after taking billions of dollars of cost out of the industry’s operations, all we get is a two-year profit cycle, then there will have to be something different this time. Yes, we might get three years of profitability, but that’s not where the smart money is now. Already profit estimates for 2008 are being reduced by 40 percent versus what the industry earned in 2007.

The fact is, the industry already has used most of the rabbits in its hat. In 1985 the industry was in its infancy and the focus was on the domestic market as network size could not be built organically in the face of deregulated pricing. The same is true in 2008, but now we’re talking about network size in the global marketplace. Like in 1985, the networks that are necessary to survive cannot be built organically, not when airlines lack critical pricing power that stems from a fragmented and hypercompetitive home market.

Some very good things came out of that merger period in the 1980s. Some very good things will come out of this merger period as well. Yes, there will be dislocations and the loss of an icon or two. But we should embrace the change. It may be the last shot for many airlines. And it is a risk worth taking because the current model will only produce the same deaths by a thousand paper cuts.

It Is True: Lufthansa to Buy 19% Stake in jetBlue

jetBlue announced that Lufthansa will purchase up to a 19% stake in the carrier click here. William Greene, the equity analyst at Morgan Stanley, said the deal will bolster liquidity for jetBlue at a time when near term debt obligations exceed expected cash flow from operations and cash on hand.

For Lufthansa, this would seem to be a smart investment in a quality US carrier with a product focus that recognizes that a one size fits all network does not appeal to all customers. Further, this transaction for Lufthansa would appear to be a very shrewd option play for a US carrier when equity values are low and the relationship of the euro to the dollar is high.

In this writer’s opinion, as well as Greene’s, jetBlue’s slot portfolio at JFK has strategic value. Down the road, connectivity to the many Star Alliance partners serving New York could be of value. But the first stage is a pure financial play and no commercial relationship is anticipated. The announcement comes just a day after a talk by Wolfgang Mayrhuber, the chief executive of German airline Lufthansa AG in China where he suggested that global consolidation is a necessary and logical development of the global market click here.

In that Reuter’s article, mention is made of Lufthansa moving away from the possibility of investing in Alitalia. In a previous blog post, we wrote about British Airways’ possibility of reconsidering the use of its capital to consolidate “at home” versus using that capital to invest in other countries, namely the US click here. Well it just happened – or at least the first step was taken. And BA has walked away from its interest in Iberia.

Yes, on the surface this deal may raise questions as to why would Lufthansa make such a deal. Is United, US Airways and/or Air Canada hurt by this transaction? Will this precipitate other similar types of transactions leveraging the current currency relationship to low equity values? WestJet and Air France are considering a closer relationship.

Change is coming. What would Yogi say?

Thank you flyby519

Whereas this blog has not matured to the level of others in terms of receiving a large number of comments to my posts, flyby519 has taken the time to respond twice and asks some very good questions while offering very good insight to the industry. While I am thankful for much this holiday season – family, friends, a successful career redirection and a lower handicap – I am truly thankful to this reader for the questions raised. So my Thanksgiving post will respond to each question asked by flyby519.

In a comment to my post, Wondering Thoughts From 5 Time Zones Away, flyby 519 asked the following questions:

Question 1: “I agree that VA [Virgin America] isn’t going to go far just doing transcon service in a saturated market, but do you think there is a future for them feeding the Virgin Atlantic routes”?

Answer: My simple answer is yes I do. But given that Virgin Atlantic is not a large connecting carrier on the London end, and much of Virgin America’s initial service launched in the US has been from the largest gateway markets to London, it will take some time for the Virgin Atlantic – Virgin America connection to play itself out. My struggle with getting excited about Virgin America is its timing into the US market. 5 years ago, I would have a much different outlook and level of excitement for its ultimate success. But if attrition is expected in the US market, then probably a good bet to make by Branson.

Question 2: “Is creating a global brand the ultimate plan for the Virgin Group”?

Answer: We have to acknowledge that Branson is a branding genius and it is hard to suggest that this venture is any different than any of the 200+ ventures he has entered to date. While feed to Virgin Atlantic may develop over time, enhancing the visibility of the Virgin brand in existing gateways, just as the transatlantic is expected to become even more competitive, will prove to be an import indirect benefit to Virgin Atlantic in the near term.

Question 3: “I also am concerned with the aircraft orders coming just from foreign airlines. The weak dollar and sad state of US airlines are forcing them to pass up expansion, which (combined with open skies) leaves room for invasion from the foreign carriers. What will happen with increased competition and reduction of market share internationally for our struggling carriers”?

Answer: Flyby519, thanks for picking up on this statement as I rank this question in the top 3 or 4 points I have made here.

Your point on the dollar v. foreign currency and the effect it has on the “ability to buy” cannot be underestimated. We are about to witness the Boeing v. Airbus strategies (consolidate v. fragment) play out before our very own eyes. I do believe that the US carriers will be disadvantaged by carriers making extensive new aircraft orders and looking to expand their services into existing gateway markets. In addition, if new carriers begin to serve secondary points in the US, – and we should expect some - much like Continental and Delta are doing from the US into Europe, then the game is truly joined. But the US industry should not be alone in this concern.

If I am a major European carrier with an extensive network built to serve all world regions, I am watching with much anxiety what is going on in Dubai, Doha and multiple points in India where competition for global traffic flows is very much in its infancy. And if there is concern over what competitive juggernauts might be constructed in these regions, then some concern is warranted regarding the existing health and architecture of the global alliances built by the largest US carriers and their global partners as well.

Networks can be made vulnerable in many areas and this global network industry is about to get challenged by well capitalized, aggressive competitors like none we may have seen to date. My view is the game is just being joined and why I blogged on the idea presented by Willie Walsh, British Airways’ CEO last month click here. My question back to you is: Are we being naive to think that domestic consolidation is the best means to stave off vigorous competition from another world region that is sure to degrade our current sources of revenue?

In another comment to my post, "Musings and Meanderings Over the Past Week", flyby519 asked the following questions.

Question 1: It seems that Tilton has been jabbering about mergers, spinoffs, and crazy talk for the past few years. Is he just trying to play the "look at me" game to get investors cash?

Answer: The more I read Mr. Tilton, he is consistent in his message regarding the industry needing to restructure itself. His quote that I used in one of my posts click here - “Think of any industry represented in this room; choose any business listed on the Tokyo Stock Exchange; and one can be sure: it looks nothing like it did ten years ago; and looks nothing like it will ten years from now”- really resonates with me.

Whereas he may be trying to play the “look at me” game, my sense is that he understands that creating value for shareholders is going to happen in one of two ways: 1) a slow liquidation (and I use that phrase guardedly); or 2) despite United’s size in the global spectrum and despite deep cost cutting that occurred during its bankruptcy, the business is far from fixed. In a parochial sense United is big, but in terms of how changes in the global airline architecture might play out the second largest carrier in the US is merely a piece of a much larger puzzle. He may get beat up for how he articulates issues but his arrival to the airline industry as an outsider gives him perspective that should not be totally discounted just because some might not like the message.

Question 2: “I also agree that there are way too many carriers of all types, but how can this be reduced when there is always a startup (ie: skybus, virgin america) waiting to jump into the game? Are the regulatory hurdles for consolidation greater than the barriers of entry for newcomers”?

Answer: Absolutely the regulatory hurdles for consolidation are greater than the barriers of entry for newcomers. Great point! And this is precisely the type of backdrop where the industry should be evaluated. Further, it puts front and center a US Government aviation policy that promotes fragmentation. At some point I would hope that the USG would take a look at the industry from a financial perspective and appreciate, that even with consolidation, significant levels of competition will remain – whether it be to Greenville-Spartanburg or to Geneva or to Seoul.

Oh I digress as that same policy has permitted a carrier like Korean to access multiple points in the US and carry significant levels of US traffic to China because of the route rights it owns on the other end. But in the interest of competition we will promote a policy of what is good for one is good for all and everyone should have rights to China even if the divvying up of service results in a duplication of services in a developing market. What is wrong with a few strong carriers carrying the flag to compete against direct and indirect competition?

Happy Thanksgiving to all. The readership of this blog has grown to levels I never imagined when I undertook this labor of love.

Transforming the Transatlantic Market Into a Transcon Market?

Saturdays can be such dull news days unless of course the story is about the 2007 wacky world of college football. But this story popped up on my radar screen as having intrigue click here. Intrigue, or a sign of things to come as the largest transatlantic carriers explore strategies to best exploit the new US – EU Open Skies deal? Clearly British Airways is (re)evaluating the best use of its capital as the current architecture of the transatlantic market is being (re)examined. This story comes on the heels of reports that BA is considering a major expansion of new services into the US market.

Another interesting aspect to consider is whether the best use of capital is to consolidate at home or with an international partner?