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.

What Would Yoda Say to the APFA?

Where I would typically use this space to talk about the fact that the rumor mill has United and Continental in serious merger talks, I am not going there.  My feelings on a US Airways – United hookup are well documented in a number of posts.  I will be most pleased if United and Continental are indeed in talks.  Each carrier has aggressively pursued a path to the least exposure to the US domestic market, and that is a path resisted by US Airways.

I respect many people at US Airways, particularly those managerial types who have done yeoman’s work with a network that, in my opinion, holds little promise long-term. It is, as I say, presence everywhere and a dominant piece of meaningful real estate nowhere.

To me the biggest piece of news this past week was the fact that the National Mediation Board (NMB) did not release either the Association of Professional Flight Attendants (APFA) or the Transport Workers Union (TWU) into a 30-day cooling off period that each union sought in their negotiations with American Airlines.

At least until we see the rule drafted by the NMB on representation elections, all seems right at the Board.  They did not release a case that is nowhere near exhausting the mediation process, even though I had feared that they might given the political winds in Washington.

So, the APFA is, for the time being, reduced to trying to convince the world of the numerous grievances its members carry. The union’s You Tube videos claim that AA flight attendants are oppressed.  They talk of the past like somehow it will reappear,  even when reality knows it is but a faint memory.  And through it all, APFA’s reckless talk of a strike continues – reckless because the circumstances don’t justify the action as I have written before, most recently in Self-Help or Self Sacrifice or Self Fulfilling Prophecy? What Will This Accomplish?

I am reminded of a quote by Yoda in Star Wars: "Fear is the path to the dark side. Fear leads to anger, anger leads to hate, and hate leads to suffering."

American’s Conundrum

Few people, if any, have been as critical of American’s union leaders as I have.  The one union that has been left unscathed by swelblog has been the TWU because, as a leader, John Conley is typically careful in misusing power and rhetoric.  But in this case even Conley has come close to the line.

Is the fear that a union working to address American’s productivity deficiencies in return for improved wages somehow collaborating with the “dark side”?  I think it is.  The fear of reprisals from a vocal minority of members toward a union’s leadership has led to a campaign based on anger toward the employer.  The anger has become hate as unions try to tie everything wrong in the industry to executive compensation, particularly that part of their pay in at-risk company securities.

But without executive pay, what are the unions really protesting? Change? We’ve got plenty of that in the airline industry, which is all the more reason cooler heads should prevail in approaching negotiations in a way that promises the best long-term pay and job security for airline employees.

But that’s not how the flight attendants union is approaching it. The APFA is trying to stir up a lot of anger and hate with a strike vote that, if it eventually led to a strike, runs the risk of doing serious harm to wages and working conditions for their members.

The APFA has been speaking out of both sides its mouth in urging members to support a strike a vote. On one side it encourages flight attendants to send a message to management and channel their anger by threatening a work stoppage that would bring the carrier to its knees. On other other it tries to calm flight attendants with reassurances that they themselves would not be hurt by going out on strike.

And that’s just wrong. APFA President Laura Glading should be careful what she asks for.

What good did the strike do the BA flight attendants and their union Unite?  Zero. Nothing.  Nada.  It did entice a management to put into place a plan to fly through the “three strikes.”  Three strikes and you are out right?  Glading’s plea to her members is pathetic.  All the while she reminisces about 1993 and 2001, she mentions that a “yes vote” does not mean that they will strike.  She talks about the power of yes.  But she does not once mention the potential risks of a strike to her members.

Glading also does not mention that her flight attendants are the highest paid among her network peers according to MIT’s Airline Data Project; the least productive in terms of hours flow per month; generally lagging in terms of in terms of passengers served per flight attendant equivalent; and the beneficiary of a relatively costly benefit package.  It makes the negotiations between American and its flight attendants very complex and difficult to conclude - even for the most skilled negotiator and/or mediator.  American is asking for increased productivity for one simple reason:  whereas American’s salary per flight attendant is comparable to that received by flight attendants at Continental, if American achieved the same flight attendant productivity as Continental the carrier would require 1,254 fewer flight attendants.  And the carrier has offered to grow into the productivity over time rather than lay off even more flight attendants.

If I am an American flight attendant, I would carefully consider these facts.  Negotiations are now data driven – just like a Presidential Emergency Board (PEB) would be.  APFA likes to talk to the world about labor cost per available seat mile (CASM).  But that metric is fraught with potential error as the calculation is influenced by a wide number of items which are not in the control or purview of the flight attendant collective bargaining agreement.

In fact, as CASM is influenced by factors as varied as seat configurations, stage length, aircraft utilization and network design to name a few, even analysts and economists would be hard pressed to make the kind of bold analytical statements and sweeping conclusions that the APFA is making.  Pay and productivity are expressed in hourly rates and hours worked and that is why the MIT Airline Data Project examines pay and productivity against an hourly foundation.  The APFA refers to staffing as the culprit in American’s  high flight attendant unit cost.  The problem is that the 3-class fleet is a very small portion of the fleet.  Can 3-classes really be responsible for the highest flight attendant costs in the industry among the legacy carriers?  Warning to United:  the same argument is coming your way.

American does have a conundrum in that it is the first major case in front of the NMB and it has the highest costs among its peer group, particularly with its flight attendants who, as a group, are highly paid relative to their low productivity.  In a recent Dallas Morning News, I was quoted by author Terry Maxon suggesting that there will be an airline strike.  Inside of my comment was a challenge to management:  Is the airline ready to take a strike?  If American caves in its position, the industry suffers.   The American Airlines flight attendants suffer because American will have agreed to pay more than it can afford.  Even the best heeled US airline cannot afford what American’s employees are asking from their management. 

American’s unions constantly point to management compensation as unfair but, as is typical, they use only the parts that serve their purpose.  Conveniently, forgotten is the fact that there have been years in which management got well below their target pay (and well below their industry peers) because the system of pay linked to performance actually works.  Yes, management pay is higher than pay on the front lines.

That’s pretty much the way it works in every industry. That’s because the market for management labor is different than the market for flight attendant labor.  That’s a reality.  And in a market-based economy, no one is entitled to more for their labor than what the market will pay. The NMB got it right at this point.  Exposing the company to the destructive threat of a strike doesn’t serve anyone’s interest.

Yoda was right to focus on fear as a path to the dark side.   In this case, the dark side is not so much a strike but, rather, the fear, anger and hate churned up by union leaders that could lead to a disastrous outcome for the members they represent  

US Airline Labor Says Cyclical; Reality Says Secular

Last week, the Labor Department reported preliminary unit labor cost and productivity numbers for the second quarter. It reported that non-farm productivity increased at an annual rate last quarter of 6.4 percent and unit labor costs decreased 5.8 percent. The increase in productivity was the highest since the third quarter of 2003 and the decrease in unit labor costs was the most since the second quarter of 2001.

In theory and in practice, highly productive work forces give companies flexibility in economic upcycles as well as downcycles. That means flexibility that helps companies meet demand – including flexibility to increase wages in return for greater productivity as higher product output can be achieved with less labor input. During this difficult economic period, second quarter corporate earnings results generally exceeded expectations.  Some amount of corporate success in the quarter can be attributed to increased workforce productivity, as many jobs left unfilled meant more work for those on the payroll.

But this is not, sadly, the case in the airline industry.

The Reality of Today’s Airline Revenue Environment

This morning, The Wall Street Journal carried a piece by Susan Carey entitled: “Airline Industry Sees Pain Extending Beyond the Recession.” In this critically insightful piece, Carey examines the relationship of airline revenue to US Gross Domestic Product. “For decades,” she writes, “U.S. airlines could rely on a remarkably stable relationship between their revenue and gross domestic product. Year after year, domestic revenue came in at 0.73% of GDP on average, and total passenger revenue was equal to 0.95% of GDP. For the year ended March 31, domestic revenue was 0.54% of GDP, while total passenger revenue was 0.76% of GDP.”

In the article, Carey cites US Airways President Scott Kirby and his view that the rapid growth of discount airlines is the primary culprit behind what he called "a long-term secular decline" in the revenue-to-GDP relationship.

“Since [before] Sept. 11, low-cost airlines have grown rapidly, putting downward pressure on fares, while travelers increasingly shop for the cheapest tickets on the Internet.” Carey writes. “The Transportation Department estimates that budget airlines now account for 40% of the domestic market, up from 22% in 2001. While lower fares stimulate demand, Mr. Kirby said, airlines still wind up losing revenue overall.”

Carey also offers props to the Massachusetts Institute of Technology Airline Data Project, citing data there that “if the revenue-to-GDP ratio had stayed where it was pre-2001, the airlines would have raked in an additional $27 billion in revenue in the year ended in March.”

She continues,”if thrifty consumers and cost-cutting businesses are this recession's legacies, airlines will be forced to shrink even more. Growing smaller means parking planes, laying off workers and dropping destinations, meaning potential customers have fewer reasons to book. Earlier this month, Delta Air Lines Inc. cited a gloomy revenue outlook for the rest of the year in its plans to cut more management jobs. If passengers don't return to the skies and fares don't rise, some airlines could run low on cash, raising the specter of additional bankruptcies.”

The US Airline Industry is Neither Flexible Nor Agile

An industry governed by a seniority system is virtually assured of decreased productivity as capacity (productive output) is reduced. We’ve recently posted our analysis of 2008 US airline employee compensation and productivity on the Airline Data Project. And that data paints a very clear picture: by the end of last year, US airlines showed neither increased productivity nor decreasing wages, despite an industry beset with very sick revenue generation.

What the data does demonstrate is the industry’s difficulty in its efforts to shrink and realize immediate labor cost benefits. To get smaller, legacy airlines lay off employees – those, of course, with less seniority -- and end up retaining those employees that have accrued more time off. Therefore, more labor is necessary to do the that reduced level of flying. Compounding the problem, the employees that remain are paid at higher hourly rates, trending the average wage for employees upward.

Using Pilot Labor as an Example

Overall, the industry has made tremendous progress in increasing the average number of flight hours per month per pilot – a necessary increase over the artificially low “monthly maximums” that pilot unions protected through collective bargaining agreements since the early years of this decade. [This trend was generally the case across all airline employee groups as well.] But what I find most interesting is this: after years of sequential progress, each of the network carriers nonetheless experienced a decline in pilot productivity in 2008.

I think it important to mention the Delta and Northwest pilot productivity data appears to be affected negatively by their merger completed in 2008’s fourth quarter. But the declines in United’s pilot labor productivity appear to me to highlight the conundrum a unionized airline industry faces – the inability to reduce workforce in concert with capacity.

With productivity in decline, average salaries per pilot equivalent generally increased in 2008 versus the prior year. On the other hand, average salary and benefit costs per pilot equivalent show mixed results. But there are a lot of factors in that calculation, including the costs driven by defined contribution pension plans as companies made historically high contributions; modest increases in compensation negotiated during the restructuring periods; and uneven financial results as many airlines attempt to reduce health care costs and other efforts related to restructuring.

Most disturbing are the trends in output per dollar of total pilot labor cost. The most important metric to me is the marginal cost of a unit of output. Consider the trends in Available Seat Miles per dollar of pilot cost, where labor costs are increasing faster than capacity is being produced. The same downward trend is evident when looking at output per dollar to all employee compensation – which amounts to a steady and stubborn increase in labor costs to productivity that could have a particularly negative impact on Southwest and American over the long term absent a significant new source of revenue.

You Cannot Look at Labor Costs without Understanding Productivity and Revenue

The Journal piece could not have come at a more important time as it provides the revenue backdrop against which all labor negotiations are set. The economy may not continue to shrink, but reality for the airline industry is that its piece of the economic pie is shrinking. While it’s hard to know if the continued sequential relationship of revenue as a percent of GDP will continue, it is increasingly evident that the relationship is not returning to that of the 1980s and 1990s heyday upon which historic labor negotiations patterns were built.

Labor needs to grasp that revenue premiums generated by the legacy carriers are largely gone. When all pricing is transparent and any Internet user can compare any airlines’ fare on any route, there is little room to cross-subsidize, or any grounds for expectations that the industry can repay concessions granted in the past. The revenue environment absolutely underscores that this is the right time in the industry’s maturation cycle to rethink how employees are compensated.

The National Mediation Board is not the answer. There is little logic to the notion that the company and the unions can come in with wide disparities in their respective positions and the Board will merely split the difference. Not unless either party is willing to accept the inevitable result: that this type of decision in today’s world would likely force another carrier into, or back into, bankruptcy court.

Historically, “pattern bargaining” has created an inflationary cycle in which labor groups chase best contracts among other labor groups in the industry. This practice, however, ignores the competitive mix and thus the revenue environment in which any carrier operates.. The only relationship that matters is an airline’s unit cost relationship to its unit revenue. And that is different for every airline.

Simply, Changes Are Secular and Not Cyclic

This is a subtle point. Cyclical and seasonal changes in a longer-term trend line are generally easy to identify and explain and are supported by historic patterns. However, when the changes in a trend line cannot be easily explained in line with historic patterns, then the pattern is broken. We know that the US airline industry’s revenue relationship since the fourth quarter of 2000 has been in decline. We know that the trend cannot be fully attributed to either seasonal patterns or cyclic economic variations. So, those variances that we can’t explain usually point to a permanent or secular change in the industry – and in the airline industry the change has been underway for some time. A return to the past is, quite simply, unlikely.

Therefore airlines will be forced to either adapt their operations to the new environment or to accept their fate in the airline graveyard. A revenue environment that has atrophied to this level can only support so much cost. Therefore as labor negotiations continue into the fall and winter months and become a bigger airline industry story, it is important to acknowledge this change. If I am a union leader, I would bet on smaller fixed wage increases and include a bet on an improving revenue environment as the economy improves in return for flexibility in order that companies can quickly adjust their respective operations.

This is one reason I like what Republic Airlines has accomplished with multiple brands under one umbrella that can succeed in an industry where one size no longer fits all. In some ways, it is not dissimilar to what the successful mega carriers in Europe have been doing all the while the US wallows in the unsustainable cost structure of its past. In this industry, wallowing is a secular trend to be sure.

Is US airline labor ever going to get that featherbedding their own membership roles is actually hurting a smaller number of employees necessary to support a struggling industry?

Swelblog.com: The First 31 Days

Whereas it has only been one month since I ventured into this unknown world of blogdom, suffice it to say that this labor of love has been among the most gratifying endeavors I have ever experienced. As I said in my very first post entitled Swelblog.com Taxiing Into Position: click here “I did not start this blog to win friends or influence anyone. I’m a data guy, and I’ve been studying the industry long enough to come up with some strong opinions . . . many of which aren’t popular in either boardrooms or union halls. My approach is analytical because, in my view, the numbers don’t lie.”

I have been moved by the comments made in other blogs and the press about this site and the use of some of the comments expressed here. To Holly Hegeman Planebuzz, Terry Maxon Airline Biz, Trebor Banstetter Sky Talk, and Loren Steffy Houston Chronicle I am grateful. To these, and all other, enlightened influential watchers of the industry and the many other readers who have commented to me via other mediums, I very much appreciate your welcome.

While I may not need to reiterate this point, I am going to as I want to make sure the readership fully understands that this blog and the MIT Airline Data Project are separate. I use the MIT site’s data to analyze issues because I know how the various metrics have been calculated, vetted and presented.

It was the second post, “All Eyes on Texas” that certainly seemed to launch this blog. Some agreed with my ordering of the difficulty of the pilot negotiations and others questioned my ordering. That is the sort of healthy debate that I hope happens here as the blog matures. As a result of my immediate previous post where I addressed a sensitive issue regarding the cost of the APA pilot opener, there were a number of comments made. I have always wanted this site to show both the “positive” and the “negative” comments regarding what I have written and, until Monday, I have made each of the comments available for public review.

But as the days following that piece unfolded, Monday morning I posted a comment that I should not have posted and ultimately deleted it. While it had some valid points, this blog was starting to become a venue supporting the views of one employee at AA challenging another. Then after I authorized the post to be published, a follow on comment was made which I deemed was exacerbating the situation versus having a meaningful exchange of views. I rejected this post. It is one thing to attack me -- and trust me you are in a long line of those that have had the opportunity long before I started this blog.

I welcome, no, I want comments on the issues discussed here -- but check the emotion at the door. From this point on, this site will not be used for personal attacks on another person commenting – period. There are many other venues for that. This is my blog and my rules. And they are changing as I learn.

There was a comment from flyby519 posted to Swelblog that I did not acknowledge and should have as it was precisely the type of thoughtful comment that I want to address in this blog click here. We will pick up here over the next couple of days.

Happy Halloween

Just Put It On Ice: American’s Ability to Pay ≠ APA’s Expectations

As I read this morning’s Wall Street Journal, the headline on page 2 is “Economy’s Weak Signals Persist” and the headline on page 3 is “Oil Tops $90 on Range of Worries.” What this means for the airline industry is well documented in Planebuzz click here.

We said the eyes would be on Texas airline labor negotiations, and we got a good glimpse of that this week. The Allied Pilots Association presented its Section 6 opener to American Airlines on Tuesday. This writer’s take on what American is seeking is a cost-neutral contract (which in effect preserves APA’s industry leading position) where productivity gains could cross subsidize increases in other sections of the agreement. By contrast, APA asked for pay increases in the 50% percent range.

This is one rich deal. Add the productivity gains and the multiplier effect of wage increases on pension and benefit costs (and well before any opportunity costs or opportunities lost are analyzed), my back of the envelope calculation suggests the price tag on this proposal is comfortably a three comma number. Yes, the number starts with a B and not an M. And this is before negotiations start with the other unions representing the vast majority of AA employees.

Let’s put this in perspective: Today, American has a pilot cost per block hour disadvantage versus every single one of its major competitors in the US market click here. If American had a pilot contract along the lines of the Continental agreement, that is at or above the industry in terms of compensation and productivity, American would need to reduce its annual total pilot costs by as much as $500 million click here. But American is not seeking concessions; it is seeking a competitive contract recognizing the “gives” by labor outside of bankruptcy.

I argue that the APA proposal fails to serve its members. Not just because of the costly demands, including the proposal that pilots receive holiday pay if they fly Super Bowl Sunday, but because the union’s demands insist upon a return to 1992 wages adjusted for inflation. That sets completely unrealistic expectations when put in context of the massive change in the landscape for network carriers, and the US airline industry for that matter, since the mid-1990s. American’s average “nominal” domestic fares were actually lower in 2006 than they were in 1995 click here.

In the media coverage, the APA suggested that its opening proposal would lead to a quick settlement. I beg to differ.

When two sides are so far apart on an agreement that there is no basis for movement, it is said that negotiations are “put on ice.” For many reasons, this round of labor negotiations is the most important since deregulation. For the major airlines to have any hope of succeeding for the long term, this upcoming round of contract talks must produce agreements that are durable and sustainable and make strides toward eliminating the cyclicality that has plagued discussions between labor and management for the deregulation generation.

There remains a real opportunity for these negotiations to be “industry interesting” in a good way and think about ways for employees to share in any upside while still realizing some protection in the downturns. That’s what the unions should be aiming for in getting their members a deal.

But if, in the APA’s view, the upside means in a 50+% increase in base rates then there really is no starting point. Openers are supposed to be starting points, not the point of no return.

Executive Compensation

We cannot discuss industry economics and labor without also discussing executive compensation. For as long as I have been in this industry, airlines have been run for pilots, by pilots and in fear of what pilots might or might not do. As a former flight attendant – that is how I put myself through school - I constantly questioned it and still do. For virtually any carrier, in a list of the top 100, 200 or 500 most highly-compensated employees, the majority would be pilots.

This industry has never had a deep bench of management talent . . . in part because airline executive contracts have historically not been as rich as executive contracts in other industries. The executive management team in the airline industry is usually there because they have jet fuel running through their veins, not because the financial upside is so great.

Many say that there is no justification for the executive payouts in recent years across industry – not just the airline industry, but throughout corporate America. But the simple fact is that markets are at work. Not all markets are rational, but given that markets by definition operate on perfect information, ultimately they return to the trend line.

For CEO’s, CFO’s and CIO’s the market rates are set in New York, Des Moines, Singapore, London and Los Angeles as companies in the US and around the globe are seeking the same talent to do the job for them just as American seeks to find the best people to fill these positions as well.

The reality is, however, that a new market rate has been set for pilots and it is not 1992 times inflation to the sixteenth. It is $120,000 and not $180,000 click here.

For awhile, “pattern bargaining” fueled an unrealistic – and unsustainable – growth in average pilot wages. It began with Delta’s lucrative pilot contract in 1999, followed by United’s topper in 2000 as it followed the "Delta Dot" along the road to bankruptcy.

Now there’s a new pattern, and a new market reality, and that is the contracts reached in bankruptcy and ratified at United and US Airways in 2002 and 2003. That’s how the market works, and airlines – like companies in any other competitive industry – generally compensate management and employees at the going market rate and as necessary to retain its best people – period.

Don’t assume that I support executive compensation packages that have benefited senior leaders while workers have seen their lives negatively impacted. I do not. But, I am a believer in markets. The convergence of what is paid to pilots, flight attendants, ramp workers has found an equilibrium and that is what markets with perfect information do. Will the market rethink executive compensation as well? I think so.

So......

We can spend a lot of time thinking about the APA proposal or just recognize that negotiations in this round will take some time. During restructuring, the market realities dictated quick negotiations and resolution. This time it is different. Neither labor nor management has significant leverage. Labor is trying to create leverage using the executive compensation issue because there is little else that resonates as well with a broad base of employees and the public. Meanwhile, management teams are doing their job and actually posting profits at a time when pricing power continues to decline - with no adjustments for inflation. The only structural change now permitting increases in revenue is in reduced capacity and in the lofty levels where oil is trading and, finally, an industry willing to pass on a portion of those increases to the consumer.

There are many who say the industry’s recent profitability comes on the backs of labor. That argument ignores the fact that the recovery is the result of tactical and strategic decisions, combined with other management actions, to achieve profits in an environment that has been structurally changed.

Keep in mind: $4-5 billion in profits in an industry earning $130 billion in revenue does not signal a healthy recovery.

I’ve titled this post “On Ice” for more than one reason.

The first page I read in the newspaper is the sports page. In an interview in the October 25 USA Today, Paul Kelly, the new Executive Director of the National Hockey League’s Players Association had some profound thoughts to share click here.

1. "Do we need to understand where we should cooperate and where we should draw the line? Absolutely," Kelly said. "But anyone who thinks I'm going to fire the first shot across the bow of the NHL, they've got it all wrong."
2. "My view of the world is that unless you have a personal relationship, a real human relationship with someone, it's difficult to transact real difficult business," Kelly said. "I want to get to know Gary, and I want him to get to know me. And I understand that there is a line there — that we represent different interests."

Perhaps hockey and airlines have little in common. But negotiations are negotiations, and they are not done on an island.

At American, as well as across the industry, pilot negotiations are going to result in "transacting difficult business". Captain Hill, reach out to Gerard Arpey and begin a real negotiating process. Mr. Arpey, reach for Captain Hill and reiterate the commitment you have made, and kept, to maintain pension benefits and retaining the components of the pilot’s agreement that ensure that AA employees will have dignity in retirement and in their day to day living to the best of your ability to pay – something that cannot be said of all carriers in this industry. Otherwise it could be a long, cold winter in Ft. Worth.