Swelbar: Just Thinking About A Few Things

Yesterday’s Wall Street Journal

Susan Carey, Gina Chon and Mike Spector report that Delta Air Lines and TPG Capital are separately evaluating potential bids for American Airlines’ parent, AMR.  This story, along with the myriad of others discussing a US Airways bid for the Fort Worth, TX carrier, is just a warm-up for the main event of AMR’s trip through court-assisted restructuring and the ultimate filing of a plan of reorganization acceptable to creditors.

Delta might seem like an odd suitor.  First, we have to accept the fact Richard Anderson’s Delta is not your father’s Delta.  He and his team are aggressive and understand American holds many assets and relationships that are valuable and thus important to Delta (and SkyTeam) like:  Chicago (where Delta has been adding select domestic flying), a relationship with British Airways, a relationship with JAL, a relationship with LATAM, more of New York (this is where regulators will really struggle along with the absolute size of the combination), a deep South America presence, more of Mexico, Miami (where Delta has been adding select domestic and international flying), and a way to defragment Los Angeles. It could also simply be an attempt to keep a restructured competitor from emerging.

Delta is reported to have performed an antitrust analysis that concluded - with certain carve outs - the massive combination could pass regulatory scrutiny.  While I can see such a combination would bolster Delta’s market positions in many areas including the middle and eastern regions of the U.S., across the Pacific and into burgeoning Latin America, there is also a lot of overlap between hubs.  If Detroit and Cincinnati competed before, imagine the hub competition – and redundant flying – with Chicago thrown into the mix.  Nonetheless, just on sheer size alone, I think an American-Delta combination would  prove hard for U.S. regulators to grasp and approve. Delta would also have a difficult task of selling such a merger to an already skeptical European Union.

Fort Worth-based TPG, on the other hand, likes to work with strategic partners according to the Journal.  TPG has strong ties to the current management team at US Airways.  Richard Schifter, TPG partner, served on US Airways Board of Directors.  Schifter is currently a director at Republic Holdings.  Schifter and another TPG partner, David Bonderman, have extensive ties to the airline industry stretching from Continental to Ryanair.  No one should be surprised a private equity concern like TPG Capital might have an interest in a restructured AMR.  For TPG, the strategic partnership possibilities are many and include US Airways, British Airways or any oneworld partner that fears the loss of its only meaningful access to the traffic rich U.S. market.

This Wall Street Journal story highlights something I think is very important; AMR is attractive to strategic buyers as well as a financial buyer like private equity.  Today, the list of names publicly discussed as interested in AMR is three.  That list will grow over the coming months. 

It is also highly likely that this story was leaked by a party to mask something else.  We will see. It is important to remember potential bidders will likely wait a few months until a lot of difficult decisions regarding network and fleet are largely complete. They’ll wait until contentious negotiations with labor are complete – probably including layoffs -  as any new owner will not want to get their fingernails dirty in that process. Potential bidders will also likely wait to see how creditors are treated in a debtor negotiated exit plan.

A question remains however:  will any bid attempt by a strategic or a financial buyer for AMR be friendly or hostile?  US Airways tried an unsuccessful hostile run for Delta. There are a myriad of possibilities here and all that is guaranteed is the debtor has the exclusive right to file a plan of reorganization until the court says otherwise.  That plan may include an offer from a strategic or a financial interest, but at this point, it is all conjecture providing an opportunity to opine.  That said the news reported yesterday officially begins AMR’s journey through bankruptcy.

LAN/TAM

If there is an airline company built with more innovation and creativity than LAN, then someone give me a call and let me know who it is.  Or was it just being in the right place at the right time?  Either way, LAN Airlines has quietly grown into one of the global elite carriers and has earnings and a market capitalization to match.

LAN is an airline I rarely mention, but have a deep admiration for.   Based in Santiago, Chile, LAN’s strategy of taking equity stakes and, in effect, becoming a surrogate flag carrier for a country in an economically struggling region where other airlines have failed, has been brilliant. The strategy has allowed the former Lan Chile to diversify its traffic base away from Chile-only and grow to become the de facto flag-carrier for other countries on the continent. LAN’s ability to take advantage of non-Chilean country bilaterals has produced growth opportunities where a reliance on Chile-only would have only led to diminishing returns.

The carrier began as Línea Aeropostal Santiago-Arica in 1929 before becoming Línea Aérea Nacional de Chile (Lan Chile) in 1932. The Chilean government privatized Línea Aérea Nacional de Chile in 1989, and the carrier absorbed Chile’s second carrier, Ladeco, in 1995. Today, the LAN umbrella covers LAN Chile; LAN Peru; LAN Dominicana; LAN Ecuador; LAN Argentina; LAN Cargo; and LAN Express, among others. Some said LAN refers to Latin American Network. Any way you cut it, LAN is a brand!

LAN was just given authority to complete its merger with Brazilian-based TAM and the combined entity will be LATAM.  To become a true South American airline powerhouse, LAN absolutely needed a significant stake in Brazil, which it now has.

One of the merger problems is each carrier is currently a member of a competing alliance.  LAN is a member of oneworld and TAM is a member of STAR.  If Brazil was essential for LAN, imagine just how important the emerging market is to each of the global alliances.  This story might take on the characteristics of the fight for JAL between SkyTeam and oneworld.  South America is yet another critical geographic area where oneworld is under attack.

American Eagle

Two months ago, most industry watchers were scratching their heads about the investment reasoning for American Eagle as parent AMR intended to spin it off.  High unit costs largely stemming from a very senior workforce, along with a fleet that was built around an archaic scope clause at mainline American Airlines, defined the carrier.  I am confident virtually every carrier comprising the regional industry had little to no fear that Eagle was going to steal any potential business. 

Now with bankruptcy and the freedoms to cut costs, American Eagle may look very different coming out of court-assisted restructuring.  Fleet alignment is sure to occur, and is happening, with any and all 37 and 44-seat aircraft immediately being taken out of service.  Certainly there are numerous out-of-market leases on aircraft controlled by the parent that can be reduced.  In fact, we may see a new market rate established for a 50-seat aircraft that takes into account a $120 per barrel jet fuel environment.  Labor rates and rules are sure to be reduced.  If the ground handling services Eagle offers were the crown jewel pre-bankruptcy, just imagine how much more attractive Eagle’s rates to other carriers will become after the restructuring.

Don’t let the point regarding a new ownership market rate that takes into account the high cost of jet fuel get lost.  While Eagle might be successful, it is likely that Pinnacle will not.  This factor is potentially significant.  If a new rate can be found through the bankruptcy process along with reduced labor rates, suddenly for American, a number of small markets served could be removed from the chopping block and remain a part of the reorganized American network.   

Whatever the size of Eagle when it emerges, it is going to be much leaner than the majority of its competitors.  My guess is SkyWest, Pinnacle, ExpressJet and others are watching this restructuring with bated breath because a new market rate for 50-seat flying, and other flying for that matter, will present itself in the coming months.  And a new competitor for future regional flying will emerge.

American Pilot Scope and Pilot Negotiations at United-Continental

As American and its pilots union attempted to negotiate a new agreement up until the time the company filed for bankruptcy protection, certain aspects of what was being discussed were leaking into the mainstream media.  The game changer being discussed was the new A319 fleet would be flown at rates and rules much lower to reflect the difficult economics of the domestic business and appropriately reflect the market/aircraft size. 

If this is indeed the road American travels down in its Section 1113 negotiations, there are significant and immediate ramifications for the negotiations taking place between United-Continental and its pilots.  As the UA-CO pilots spend more time taking on the company using safety as a hot-button, a new baseline is about to be established as to how pilots work and get paid.  If the UA-CO are hung up on nothing more than 50 seats, then I ask:  what about 115 seats? 

The United-Continental pilots’ strategy to exert a leverage point blew up in their face on November 29, 2011.  Where AA is going is in the right direction as it accomplishes multiple things that will benefit their business:  1) it is better able to match costs with the domestic revenue environment; and 2) it puts an end to the pilot scope discussion.  Regional partners will not be doing any 100 seat flying because, in this seat range, mainline pilots have a better ability to match the cost of flying done by the regionals.

Whether United-Continental pilots either figure it out (or not), the focus then shifts to Delta where scope is already a hot button issue.  In 2013, US Airways pilots are absolutely going to be forced to consider something similar to what the AA pilots are likely to agree to. 

Then you just have to wonder what Gary Kelly is really thinking.  The tables just may be turning.

my testimony on the continental - united merger before the house judiciary committee

Good afternoon Chairman Conyers, Ranking Member Smith and members of the committee.

My name is William Swelbar.  I am a Research Engineer with the Massachusetts Institute of Technology’s International Center for Air Transportation.  Our program is focused on the economic, financial, operational and competitive aspects of the global airline industry.  I appreciate the opportunity to speak today in support of the merger of United and Continental Airlines.  Whereas I have worked with each United and Continental in a consulting capacity in the past, I appear today as an independent expert on the U.S. and global airline industry.

Many see the global airline industry as somehow U.S.-centric.  It is not.  In aviation, the U.S. is but one piece of a big puzzle that is influenced by global economic interdependencies, just as the U.S. economic recovery could be affected by events in Greece, Portugal, Spain and Hungary.

United and Continental presented in their testimony before the Senate Committee on Commerce Science and Transportation an exhibit showing where U.S. airlines have fallen in their ranking among the globe’s largest airlines.  I am bothered by the fact that the U.S. carriers have been surpassed by Lufthansa/Swiss and Air France/KLM.  This fact is but one reason that helps to explain why United and Continental are pursuing this merger.

For the network carriers like United and Continental, this round of consolidation is as much about preparing to compete with the world’s other big carriers for international traffic as it is about competing with low cost carriers (LCCs) like Southwest, AirTran, jetBlue or Frontier in the domestic market. After all, it is the network carriers and not the low cost carriers that serve communities of all sizes. Despite the footprint established by the low fare carriers that is now national in scope, with their share of domestic traffic approaching 40 percent, it is the network carriers that connect the smallest U.S. markets to the globe’s air transportation grid.

I would like to debunk some of the myths I have heard said about the merger of United and Continental.

• OVERLAPPING ROUTES/HIGHER PRICES:  There are just 15 nonstop, overlapping routes flown by each United and Continental.  None of the 15 would be a monopoly United route after the proposed merger.  Eleven of the 15 overlapping city pairs would have at least two competitors.  Of the four routes that would have but one other nonstop competitor (Houston – Washington, Houston – Los Angeles, Houston – San Francisco and Cleveland – Denver), that other competitor is Southwest Airlines in three of the four and Frontier on the other.  In each of the four routes, the LCC competitor has at least a 25 percent share of traffic. 

In addition to a nonstop competitor, two of the routes have four other carriers providing connecting service; one has three other carriers providing connecting service; and one has two other carriers providing connecting service.  The airline industry is a network industry and connecting options for passengers must be taken into account when considering competitive impacts as they also work to discipline prices.

The U.S. market should not fear the “end to end” network consolidation like Delta – Northwest and the proposed United – Continental merger. The low cost carrier segment of the US airline industry would regale in the fact that network carriers would price well above the market as was the case in the late 1990s and early 2000s as it would serve as the catalyst for growth at the expense of the network carriers again.  The market has demonstrated time and 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. And where there is insufficient capacity, capacity will find the insufficiency.

• START OF ANOTHER BIG MERGER WAVE:  Some predicted that the Northwest-Delta merger in 2008 would be the catalyst to a big merger wave.   Two years later, we have a second merger announcement.  That hardly seems to be a wave.  Nonetheless, each merger case should be considered on its own merits, not based upon what someone speculates might happen.  Moreover, the concerns are most relevant in highly concentrated industries.  The U.S. domestic airline industry will remain fragmented should the proposed merger be approved as seven airlines will have at least a 5 percent market share. 

When thinking about airlines in a global context, no one airline has a 5 percent share of the global market.  The top 10 firms producing mobile handsets comprise 85 percent of their industry; the top 10 automotive manufacturers make up 76 percent of their industry; and the top 10 container shipping firms equal 63 percent of their industry.  Yet the world’s 10 largest airlines make up only 36 percent of the global airline industry.  These define a fragmented industry prohibited from operating as other global industries, not a concentrated one.

• HUB CLOSURES AND FLIGHT REDUCTIONS:  The fear mongers would have us believe unequivocally that there will be reductions in flying, the dislocation of small communities from the global airline map and even hub closures because of consolidation.  Many use TWA and its St. Louis hub as an example.  American Airlines did not merge with a failing TWA.  Rather it acquired certain assets of a failed TWA.  As a result it is a very poor example of what could happen to a hub. 

But was it consolidation of the industry that ultimately caused American to downsize St. Louis or was it the events of 9/11 and the changed economics of the industry that followed that ultimately rendered St. Louis uneconomic?  Might the local economy in St. Louis have contributed to the city no longer being an attractive hub city that produces significant local traffic to support the hub carrier?  St. Louis is but one example of hub closures since September 2001 as US Airways/America West has in effect closed it Las Vegas hub and its Pittsburgh hub.  Neither of the closures can be laid at the feet at the carrier’s merger with US Airways.  In fact if America West had not agreed to merge with US Airways it is highly likely that the old US Airways would have been liquidated.

In the case of this merger, there has been much speculation about the future of Continental’s Cleveland hub.  There is nothing that I can see from this merger that would make Cleveland redundant.  Without knowing what the internal data might say but being knowledgeable about airline planning models, I would guess that the modeling would suggest that Cleveland would be made stronger as a result of the merger and not weaker.  The answer to Cleveland remaining a critical point on the combined carrier map will have everything to do with the condition of the local Cleveland economy as well as the price of oil and little to nothing to do with the decision to merge.

• EMPLOYEE/EMPLOYMENT DISRUPTIONS:   Since 2001, the industry has shed nearly 140,000 airline jobs.  But 400,000+ good jobs where wages and benefits average over $81,000 per year per full time equivalent remain.   In fact, the average wage for airline employment reached its high point for the decade during the third quarter of 2009.  This average employee cost comes after the significant concessions granted at each of the five remaining network carriers between 2002 and 2007.  Headcount reductions were significant during the period as well as companies were forced to reduce their size in response to a changed revenue environment and increasing fuel prices.  The reductions continued into 2008 as oil climbed to $147 per barrel and jet fuel to the equivalent of $172 per barrel.  2009 marked the second largest decrease in industry capacity since 1942.

Susan Carey of The Wall Street Journal wrote an article titled: “Airline Industry Sees Pain Extending Beyond the Recession.”  In this critically insightful piece Carey examines the relationship of airline industry revenue to U.S. Gross Domestic Product.  “For decades 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”.  What this means is that based on the historic norm of the revenue to GDP relationship, there is $27 billion less in revenue today to be shared among the industry’s competitors than there was just 10 years ago.

Consolidation is not the culprit of lost airline jobs or declining airline wages.  Airlines were left with little choice but to restructure given the changed revenue environment precipitated by the growth of the low cost carriers and the transparency in fares facilitated by the internet as a distribution vehicle.

What is clear to me is that no individual airline except possibly Southwest and Delta would have the financial wherewithal to withstand another geopolitical event similar to what occurred on September 11, 2001. Unlike other rounds of consolidation that focused primarily on network scope, scale, revenue and cost synergies, this round is different.  Now the industry is looking at the balance sheet.  Consolidated carriers promise more stability to employees and communities that benefit from the combined strength of the respective balance sheets.

• RE-REGULATION:  Some suggest that re-regulation of the industry will improve the economic well being of certain stakeholders.  Isn’t a goal of policy makers to maximize the number of good paying jobs?  The airline business sells what is best characterized as a highly price elastic product.  Only a segment of the buyers of airline services is less sensitive to price.  Over the past 30 years, the industry has competed away the savings/benefits of nearly every innovation (ex. reduced commission expense) in the name of low and lower fares for consumers.  Some think that reverting back to the days of a regulated industry will benefit certain segments of the industry.  I firmly believe it would harm the industry by causing it to contract further as prices rise as inefficient costs are passed through to the consumer.  A smaller industry would employ fewer workers.

Many government officials and certain industry watchers have instilled fear into the marketplace regarding the impact of current and prospective industry consolidation.  Fears of higher prices, reduced service, more monopoly routes, and labor strife are not well founded.  Their analysis of the industry today parallels an analysis appropriate in a regulated period.

Simply put, the network carrier model of the 1980’s and 1990’s does not work in today’s environment. Consolidation is a logical step to position airlines in a highly fragmented domestic and global industry to better weather the financial challenges that have caused years of economic pain for many stakeholders and a rising tide of red ink.

Thank You.

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?

“Capital Is Global, Labor Is Local”

The title is not my words but rather those of the International Federation of Air Line Pilots’ Associations (IFALPA). On Tuesday of this week, I sat on a panel with Captain Paul Rice of IFALPA to discuss consolidation at the ACI World Conference in Boston. Captain Rice is a most articulate and passionate speaker when it comes to issues important to labor.

As our panel progressed in its discussion, I challenged Captain Rice on his use of his phrase describing events occurring in the industry on consolidation. My basic assertion was: that labor is capital and its flow is being hindered by seniority and other fundamental union rules that probably will not serve tomorrow's work force as currently designed. Restrictions on the flow of capital, or anything, are good for no one. The Boston Beacon reported on our panel.

Yesterday’s Northwest – Delta Shareholder Vote

There is no event currently taking place that highlights the “Labor is Local” mantra more than the pending Northwest - Delta merger. Susan Carey of the Wall Street Journal writes: Northwest's Unions Face Tough Reception at Delta. This comes on the heels of the Association of Flight Attendants – CWA testifying before Congress earlier this week that the rules for union elections at airlines need to be altered. Ah, we are again back to that contemporary law that governs airline labor relations: the Railway Labor Act of 1926 as amended in 1936.

What is interesting to me is that unions negotiate hard to have Sections 3 and 13 of the Allegheny-Mohawk Labor Protective Provisions in their contracts. In February of this year, I wrote a piece entitled: F + E = LPP^DL: Fairness and Equity; Seniority Integration; Union Representation; and Lee Moak Again. Delta had offered these protections to its employees ahead of the announcement of a deal, and they did not have to bargain for it.

There will almost certainly be elections among the IAM and AFA-CWA work forces but now union leaders are concerned that, under NMB rules, a ballot sent to an employee that is not returned is counted as a no vote therefore making a representation election most difficult to win. Just as it has been for years and years.

But like any election, isn’t it up to the union to convince potential new members that being represented by a collective bargaining representative is better than not being represented at all? So, if labor is going to ask that we review only Sections of the Railway Labor Act that serves their local interests only, I say no. If labor is going to ask that an Act of Congress that is more than 70 years old be amended to address issues and concerns that prevent the US airline industry from fully participating in global capital flows because current labor capital says no, then I say yes.

If nothing else, the two mature airline industries in the US and Europe should be able to find common ground that separate continental seniority lists could provide.

Unbundling Our Way On The Search To Find The Inelastic Demand

I am beginning to believe that there is a silver lining in the high price of oil.

Last month, I wrote a piece entitled The Elastic Induced Ride to Inelasticity. With seat belts on, seat backs and tray tables up, we are ready for takeoff. Yesterday, while American and Southwest were holding their Annual Meetings of Shareholders, I was on an airplane back from Honolulu. So I missed the news flying out of those meetings that found its way onto the wires as rapidly as it could be transcribed. I missed the latest $4 per barrel rise in the cost of crude oil that now equates to $4+ per gallon of jet fuel. I missed …….. or, did I really miss anything?

Oh, I missed something all right. Whereas I believed the industry would transform itself more through merger and acquisition activity, I am now a believer that the price of oil, and the market, is truly what is needed to fully address the many structural ills that have plagued this industry for years. I would like to return to a few paragraphs I wrote in an Airline Business piece earlier this year: Are US carriers really ready for competition?

Despite claims to the contrary, nothing is new in the US. The same old ways of doing business remain intact, which calls into question whether the industry’s fabled “restructuring” has made any meaningful changes in the competitive profile of the US airline business. Despite deep cuts, many outmoded, and troubling, business practices remain.

Following an industry life cycle of value destruction, US legacy carriers now face a dilemma: whether to invest in their core businesses or not? Certainly the tendency to legislative and regulatory gridlock did not get restructured. An inflexible labor construct did not get restructured. The fragmentation of the US domestic market did not get restructured. The infrastructure, whether it be ATC or the airport system, did not get restructured. And the historic mindset that capital will be forever recycled among manufacturers, vendors, labor and government imposed actions did not get restructured.

Little has changed when it comes to labor and regulator views on consolidation. The mindset among the 535 decision makers on Capitol Hill still assumes that any congressional district with a runway, a terminal building and security is entitled to air service. Compounding this sense of entitlement is labor’s sense that the industry will return to its previous “pattern bargaining” – a supposition that fails to recognize the structural change in markets, labor and city pair.

Gerard Arpey’s Words

The full text of Mr. Arpey’s comments to his shareholders can be found here: Remarks Of Gerard Arpey At American Airlines Shareholders Meeting. As we approach the 30th birthday of US Airline Deregulation, it is the price of oil that is demonstrating its power to force the industry to address the many legacy mindsets that did not get restructured during the post 9/11 period. Among many, it includes the customer’s assumption that they actually pay the “all-in” price of the service and are therefore entitled to multiple access points to the air transportation system. NOT.

In this morning’s Wall Street Journal front page, column six, story by Susan Carey and Paulo Prada, they wrote: “If oil prices keep climbing, rising fares could start to push a significant percentage of travelers away from flying entirely. That could reverse one of the most dramatic effects of the industry’s deregulation in 1978, which led to a huge increase in flights, and brought intense fare competition, opening the world of air travel to millions of people”.

Ms. Carey and Mr. Prada are right. And the industry is right to evaluate the cost of providing the product at every juncture. And the industry is absolutely right to charge what it costs to produce the product. From the time the customer logs onto the internet to consider purchasing the ticket; to the actual purchase of the ticket; to the airport experience including check-in; the trip through security; down the jetway; taxi out; inflight service; taxi in; deplane; and collect luggage. Everything has a cost. And the management teams of each and every airline are being forced to “drill down” as never before in order to fully calculate those costs. And after calculating the costs of provision, many, many difficult decisions are being made.

Now this does not make any CEO popular. But being a CEO today is not a popularity contest during these difficult times. [And the most popular CEO of all time, stepped down from a 40+ year career BOD position yesterday] Being a CEO today means having the fortitude to say no. Being a CEO today means questioning anything and everything just because that is the way it has always been done. Being a CEO today means making the tough decisions even though dislocations of certain stakeholders might occur. And being a CEO today means having the guts to say out loud what CEOs knew before them but failed to act.

Mr. Arpey said and the WSJ highlighted: “The airline industry will not and cannot continue in its current state”.

Concluding Thoughts

With all of the actions being taken by the industry to charge for things that were never charged for before, what is interesting is how each carrier is sure to ensure that their most important customers will not pay those fees. Loyalty programs have just become a/the most important asset to an airline – not that they were not before – but rather it is this “inelastic” air traveler that the industry needs to rediscover. And cater to. And build for. And so on. And maybe this is why Mr. Arpey suggested that it was just not a good idea to sell its AAdvantage program. And maybe the market will begin to rethink how it values these currently undervalued assets.

This industry is now recognizing that it cannot be everything to everybody. Yes the industry has met its match – and it is not labor, government, or the macro economy. It is the high price of fuel that is causing the industry to continue the process of fully transforming the way business is done. My guess is that if we had not faced this potentially murderous economic period, then the industry would not have been forced to fully examine itself. The current industry architecture is a picture of what the deregulators envisioned – and the industry delivered. But the architecture produced does not work.

So Mr. Arpey, as your unions marched, I for one am glad you spoke. And you spoke clearly as to how American is moving forward. Your message was not popular. Your message pushed the envelope a little further and added to the debate significantly. No one knows how all of this will really play out. There has to be recognition before there is action. The industry is taking action and one can only hope that labor and government begin to recognize that we are not going back to the same old, same old.

Except for the fact that each airline will "return their attention" to those core, “inelastic”, customers that are willing and able to pay for the service being provided. And those customers will complain less over time. As for the rest of the traveling public and lawmakers that believe they are entitled to air service - well you are not.

More to come.

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.

Northwest – Delta Back On?

Susan Carey and Paulo Prada report: Northwest Reworks Plan For Merger With Delta - WSJ.com.

Clearly, more to come.

First Labor Hurdle Cleared in Delta – Northwest Deal?

The Devil Will Be In The Details

As Delta Air Line’s Board of Directors prepares to meet tomorrow in New York, Nathan Hurst of the Detroit News reports that the pilots of each Delta and Northwest have tentatively agreed to a framework of a deal. As in all things difficult, the devil is in the details. But the story suggests that an agreement on seniority integration has been reached subject to membership ratification.

There is no mention of a construct of a single collective bargaining agreement but the article does suggest that the pilots will receive an equity stake and a voting board seat in the combined entity. In the event the tentative agreement is not ratified by the membership, a binding arbitration mechanism has been put in place.

Susan Carey and Paulo Prada report in today's Wall Street Journal that a number of other “deal issues” still need to be finalized including the size of the Air France/KLM stake, compensation for non-pilot employees, a premium for Northwest shareholders among other items.

In the Journal story, Carey and Prada write “Some industry executives have worried privately how zero capacity reductions and higher labor rates would hurt the rest of the industry”? I am an analyst that wonders the very same thing but as mentioned above, the devil is in the details.

But it sure looks like tomorrow’s Board meeting is important and maybe we can start to look at the details instead of wondering what they might be. Or, maybe we will hear as soon as today or tomorrow according to the Atlanta Journal-Constitution.

F + E = LPP^DL: Fairness and Equity; Seniority Integration; Union Representation; and Lee Moak Again

In a Delta Air Lines Deal, Labor Protective Provisions Were Board Approved Before the Law Was Passed

Well, leave it to Susan Carey, along with Dennis K. Berman and Paulo Prada, of the Wall Street Journal to again write, and break the most recent period of silence surrounding a potential deal between Delta Air Lines and Northwest Airlines. In the same story, she reports that the preliminary talks that have taken place between United Airlines and Continental Airlines “have grown more serious”.

Whereas news on the deal side has been quiet, I have also noted the deafening silence from Lee Moak, the Chairman of the Delta chapter of the Air Line Pilots Association. My guess is Captain Moak is doing what all labor leaders should be doing and that is preparing for what is arguably going to be the most important period for organized labor since the passing of the Airline Deregulation Act.

A Recent Law Was Passed…..but the tenets had already been adopted by the Delta Board of Directors

SEC. 117. LABOR INTEGRATION. (a) LABOR INTEGRATION- With respect to any covered transaction involving two or more covered air carriers that results in the combination of crafts or classes that are subject to the Railway Labor Act (45 U.S.C. 151 et seq.), sections 3 and 13 of the labor protective provisions imposed by the Civil Aeronautics Board in the Allegheny-Mohawk merger (as published at 59 C.A.B. 45) shall apply to the integration of covered employees of the covered air carriers; except that--
(1) if the same collective bargaining agent represents the combining crafts or classes at each of the covered air carriers, that collective bargaining agent's internal policies regarding integration, if any, will not be affected by and will supersede the requirements of this section; and
(2) the requirements of any collective bargaining agreement that may be applicable to the terms of integration involving covered employees of a covered air carrier shall not be affected by the requirements of this section as to the employees covered by that agreement, so long as those provisions allow for the protections afforded by sections 3 and 13 of the Allegheny-Mohawk provisions.
(b) DEFINITIONS- In this section, the following definitions apply:
(1) AIR CARRIER- The term `air carrier' means an air carrier that holds a certificate issued under chapter 411 of title 49, United States Code.
(2) COVERED AIR CARRIER- The term `covered air carrier' means an air carrier that is involved in a covered transaction.
(3) COVERED EMPLOYEE- The term `covered employee' means an employee who--
(A) is not a temporary employee; and
(B) is a member of a craft or class that is subject to the Railway Labor Act (45 U.S.C. 151 et seq.).
(4) COVERED TRANSACTION- The term `covered transaction' means--
(A) a transaction for the combination of multiple air carriers into a single air carrier; and which
(B) involves the transfer of ownership or control of--
(i) 50 percent or more of the equity securities (as defined in section 101 of title 11, United States Code) of an air carrier; or
(ii) 50 percent or more (by value) of the assets of the air carrier.
(c) APPLICATION- This section shall not apply to any covered transaction involving a covered air carrier that took place before the date of enactment of this Act.
(d) EFFECTIVENESS OF PROVISION- This section shall become effective on the date of enactment of this Act and shall continue in effect in fiscal years after fiscal year 2008.

As we move forward there will be lots of stories about labor issues, air service to communities of all sizes, domestic issues, international issues, consumer issues and of course the horror stories of past deals gone bad to name a few. I sincerely believe that “smart labor” recognizes that the current speculation of possible combinations is not just talk but may be their best hope to position themselves for the future. Naïve thinking that Section 6 bargaining will return to its historical nature – well it is just naïve.

As we have written here many times and in many different ways, the current industry construct does not work for many, if any, major industry stakeholder(s). Any concept of change is difficult to accept on both the emotional and rational levels for sure. Short- term displacements and pain for some -- yes. Being forced to step back and accept that tomorrow will be significantly different -- absolutely.

But the burning question for me is: is the implementation risk of a merger deal (seniority integration, single collective bargaining agreement etc.) any greater than a leader having to manage the expectations of any employee group that actually believes they can make themselves whole in the next round of Section 6 negotiations? I do not think so with the industry facing an oil environment that was imagined by only a few, a weakening economy, increased global competition, general lack of an investment thesis, presence everywhere and pricing power no where -- no matter who you are.

My guess is Captain Moak has taken the basic tenets (fairness and equity) of the Allegheny-Mohawk merger protection provisions to heart and is studying the same merger scenarios that his management is. The primary difference in his due diligence is that he is focused on seniority lists and not EBITDAR. In his diligence process, I am sure he is figuring how to best analyze and “game out” the combination that treats each his own pilots as well as all pilots of a combined entity fairly and equitably. That is what leaders do and in this case it is leaders from both management and labor.

The integration process has evolved over the years since the Allegheny-Mohawk Labor Protective Provisions were originally enacted. There have been more failures at adopting fairness and equity than not to be sure. But it is incumbant for labor and management leadership this time to ensure that career expectations are met for all employees. Simply this concept means that the relative seniority of a combined list is not significantly different for a respective employee in a combined entity than it is for that employee today.

On the labor side, rigorous analysis of seniority lists can be done ahead of an announcement. My only hope is that Moak is being joined by his counterparts in Chicago, Minneapolis/St. Paul, Houston and other airline corporate homes. From what I read, Moak understands that a short implementation period is a friend of the deal and a long implementation period is well – just look at US Airways. Moreover, if pilots and other employees are seriously interested in a piece of equity ownership of the new entity, labor should absolutely want a short implementation period too.

Yes, There Are Employees Other Than Pilots

What makes any Delta combination interesting is the fact that other than the pilots and dispatchers, the company is non-union. Delta is a company that has trumpeted the idea of fair and equitable throughout its existence whether in union avoidance strategies directly or in the day to day management of its various class and crafts of employees. Whether conscious union avoidance or not, along the way you have to walk the walk and not just talk the talk. And in Atlanta there has obviously been more walkin’ the talk than talkin’ the walk.

Just How Might Delta’s Current Non Union Workforce Play Out

Any deal led by Delta, or involving Delta, opens up a potential union representation box. Stated otherwise, if a combination of any class and craft of employees involves two different unions, then more than likely there will be an election; and if there is a combination of any class and craft of employees where one is union and the other non-union, and the unionized group comprises 35% or more of the total employees, then there would likely be an election.

In the Delta combinations being discussed, in each case the pilots are organized and members of the same union so no representation elections are expected.

But the flight attendants are a different story. The Northwest and United flight attendants are represented by the Association of Flight Attendants, AFA-CWA. And given that a combined entity would be comprised of 35% or more union represented employees, a representation election would likely occur. In that election the flight attendants could either vote for AFA-CWA, another flight attendant union or for no representation in either merger scenario.

AFA-CWA has an organizing campaign underway at Delta. The decision point for the combined work force would be simply: am I better off working under a collective bargaining agreement or under the wage and working conditions employed by Delta with its current flight attendant work force.

As for the mechanics, this one also has some interesting nuances to it as well. Delta’s in house maintenance work force is unorganized and the company has begun to increase its insourcing of maintenance work. Each United and Northwest have been outsourcing an increasing amount of their maintenance work albeit for different reasons. Northwest’s mechanics were in effect disenfranchised by AMFA’s poorly conceived decision to strike Northwest and therefore, based on my read of the LPPs, the mechanics of a combined Delta – Northwest entity would not trigger a representation election. In a United - Delta combination, an election would be triggered but who the incumbent union would be is not known at United because currently the Teamsters are challenging AMFA. Got that?

As for the ground and related employees, the scenarios for either a Delta and Northwest or a Delta and United combination are the same. An election would more than likely be triggered given that the International Association of Machinists and Aerospace Workers (IAM) represent the various class and crafts of employees in this broad group at each Northwest and United. The definition of class and craft here will be a story to watch and they include ramp, customer service and reservations.

And more than likely, a representation election would be triggered by combining the dispatch groups. Although small in number, they are governed by the same rules as well.

Bigger Concerns than Unionization

In addition to the capable leadership of Moak, Delta management is led by Michael Campbell, their EVP of Human Resources, Labor Relations and Communications. Campbell was Gordon Bethune’s head of labor at Continental. The issues of representation and combining collective bargaining agreements are complicated for sure - but in capable and professional hands.

Should the investment community be concerned of union representation at Delta? No. The investment community should be more concerned with seeing that labor integration is done as quickly as possible, whether it involves unions or not, as this provides the shortest pathway to realizing merger synergies. For Delta, fairness and equity has been adopted at the Board level. Now it is law and this is important for many to consider when the naysayers repeatedly and continually tell us all to remember the menu of historic disasters.

At the end of the day, what was important for Delta yesterday will carry the same weight for Delta tomorrow. Given the current lack of unionization at the carrier, some might say that something was done right. Delta has historically understood that higher wages in return for commensurately higher productivity has served its employees and the company well. This concept is a most important model for the industry to sustain and will promise to be a most important theme in any upcoming negotiation. Further, it will be important for any combination to maintain - and sustain - the highest productivity possible as the industry needs to continue to shed fixed costs and not add to them.

Isn’t that really the issue behind today’s consolidation push anyway? I think Delta and others have learned from past mistakes.