US and AA Labor: Stop Hiding Behind the Idea of Consumer Benefits

When it comes to Wall Street analyst commentary on the proposed merger of American and US Airways, I have come to appreciate the work of John Godyn at Morgan Stanley.  He is a pragmatist.  His analysis and commentary are not fraught with emotion and Henny Pennyish ramblings as if the sky is falling if a deal does not get done.  He models the industry assuming a deal does not get done.  Certainly Godyn would prefer a deal versus no deal.  However, he assigns a probability of less than 50 percent of a deal happening, much like this observer.

This week’s Wall Street analysis and media coverage caught my eye.  First US Airways’ Captain Bill Pollack, a man I know and respect, wrote an op-ed in the USA Today in support of the merger. The subtitle reads:  “Airline employees have made concessions to survive. It's time our sacrifices paid off.”  Godyn hosted American’s flight attendant union, APFA, to a lunch to discuss the merger.  Like Pollack, the unions tout what they claim are enormous benefits to the consumer but fail to define them.  Then a note comes across my desk:  “Today, Representatives Marc Veasey (D-TX) and Ed Pastor (D-AZ) and 66 of their Democratic colleagues sent a letter to President Barack Obama calling on the Department of Justice (DOJ) to allow American Airlines and US Airways to move forward with a merger.”

Imagine what Jim Oberstar is thinking now?  Imagine, 68 Democrats supporting a merger of two airlines that will ultimately put 87 percent of domestic supply into the hands of four companies.  A party that prides itself in being the protector of the consumer.  Let’s stop kidding ourselves; this merger is about labor and the notion, and a near-term truth, that a consolidated industry can pay more than a fragmented industry. 

This would-be merger is perhaps the most sophisticated labor deal ever struck in the deregulated airline industry.  But don’t be fooled by the rhetoric. This is not about the consumer.  This is not about small communities.  This is about a very clever strategy by a management team to win over labor in order to achieve an exit strategy for US Airways - a highly performing company in search of an identity in tomorrow's industry.  In my view, Doug Parker’s US Airways was no true competitor to the network giants, even before they merged.  So to get there, he agreed to write a check to the airline unions that US Airways – I mean the “New American” - may not be able to afford . . . now, or in the future.

What’s wrong with this picture?  For one, union interests run contrary to consumer interests even if simply when labor costs go up, consumers pays more.  The unions say the merger is necessary to compete with the Delta and United duopoly. What does that mean? Even Parker agrees that mature industries yield few growth opportunities, so the synergies that the “New American” touts are likely to come from a share shift away from incumbents rather than generating new business.  Do we really think that Delta and United are going to sit back and surrender their market to a “new competitor” without a fight?  I don’t think so either.

But the check to labor has been written.

As Glenn Engel points out in his work, “being important is better than being big.”  This is based on the fundamental economics of the S-Curve in which each capacity share point above 30 percent in a given market drives a greater than 1 percent share of revenue up, at least until some point when the law of diminishing returns takes over.  In a merger that touts little to no overlap, where is the consolidation of two carrier’s positions that results in outsized revenue gains to the tune of $1 billion?

That’s right, the check has been written.

In Godyn’s note he talks with the APFA about the lack of a Plan B: “Consistent with what we heard from the APA, the APFA is universally focused on ‘Plan A’ which is to help management raise the probability that LCC is successful and is not actively pursuing any standalone plan alternative,” he wrote. “They also reminded us that no standalone plan had actually been formally submitted and approved by the creditors. Thus, if the deal does not go through, a new reorganization plan would need to be created and approved by creditors.” 

Godyn continues:  “Why are labor costs omitted from the complaint? The APFA expressed real concern that if a deal did not go through the short-term ramifications could cause existing labor contracts to be revisited and the pension to be put at risk, depending on how the new plan of reorganization is shaped as well as the judge. A restructured labor contract could not only include lower wages but also workforce reduction – not to mention labor discontent.” 

Exactly right because this a labor deal.

It is time that we start thinking about Plan B. Let’s assume that, because a number of senior US Airways’ executives have already moved to Dallas and enrolled their kids in school, Parker et al will run the “New American.”  But he has a track record in this type of case, and that is that the company will likely get smaller before it gets bigger. [An idea that will make Wall Street happy.]  A network considered inferior to others cannot pay its workers the same as can larger competition. The workforce will likely need to get smaller rather than reap the benefits promised. Parker’s conundrum is his exuberance to parcel out the synergies before they were realized.  Remember that share shift idea.

Suddenly, Plan B gets somewhat complicated even with the Golden Boy in charge.  In the event a merger is blocked, what if another party enters the fray and files a separate plan of reorganization?  That could happen in a Plan B scenario and my guess is capital would likely be treated more favorably than labor in that case.  So it may not be only Tom Horton who ends up on labor’s dart board.

I have long been critical of labor leaders who indulge in the overpromise and under deliver message.  But it is no different than Parker and his merry band buying labor favor without first proving on the battlefield that it can win the revenue necessary to fund those promises.  Remember, this is a labor deal. And US Airways may have reached too far in its assumption that it can accomplish what Delta and United did after being number 4 at the altar.  I am not aware of fourth mover benefits.  Think of the concept of the S-Curve and the idea that being important is better than being big.

The merger’s proponents are right that the “New American” will be able to offer more destinations. They are right that it will be able to offer more services in competition with Delta and United.  But proponents also are right in acknowledging that Plan B would result is something far less than labor has been promised. 

Where the unions get this wrong is in the assumption that because they have been to the table and made concessions they are entitled to the same compensation paid to employees of Delta and United, which have generated the revenues to support higher labor costs.  Other than an expanded network, where/what are the benefits for consumers?  I see many benefits for US Airways’ flyers; I see fewer for today’s American flyers.  Other benefits like investing in a re-fleeting and international growth are being implemented.

The DOJ is right to at least challenge the combination.  It may not win, but it is right to challenge.  The industry’s structure is much more concentrated than when it considered and approved the prior three mergers.  If this is indeed the last big deal in the US airline industry, it deserves a very close look.  Based on the combinations that preceded it and the string of events that have impacted the industry since the first merger was approved, it is really difficult to find any consumer benefits other than the fact that a profitable industry is finally investing in products that the consumer wants and desires.

In advocating for the merger, unions are doing what they should be doing to reap the promises the new management team made.  I would be doing the same.  But they should stop hiding behind the consumer because their interests are not aligned.  It will take customers to pay off Doug’s dubious deal and, as a result, customers will pay more - a necessary fact for decades.  And that’s the reality.

Note to readers:  I am long in the equities of Delta Air Lines, United Airlines, Sprit Airlines and Hawaiian Airlines.  Thank you to many readers that have reached out over the past months encouraging me to return the keyboard.  It is nice to be back.

THE END GAME: IT’S ULTIMATELY ABOUT RETAINING THE CUSTOMER

Paint me a skeptic.  Paint me a contrarian.  Paint me stupid.  I’ve been painted with worse colors. I’ve been one of the lone voices really challenging the proposed merger between American and US Airways – one that any read of the newspapers makes clear will likely go forward. And to be honest, many of the concerns I have raised about the merger have been addressed in the talks underway.

By all accounts, the deal is done but for a decision about who will lead the new airline. The analysts and the unions are betting on Doug Parker in the leadership beauty contest between American’s Tom Horton and the US Airways’ CEO.  It’s the nature of this kind of deal to want to crown a winner.

I’m not going to weigh in on the relative merits of Parker over Horton or make this about personalities or executive legacy, which misses the point. In my view, the most successful mergers focus not on the victor to whom goes the spoils, but rather focus on building a leadership structure that brings the experience necessary to maximize the synergies and fulfill promises made to stakeholders.

So for that reason and many others, it would be an error to approach a merger of AA and US as another notch in Parker’s bedpost so he can impose his personal style on the combined airline. US Airways has done a very good job of running the airline it is, but it will take a breadth and depth of experience to a run the airline the new American would be. This is the case because this merger perhaps more than any others will require a delicate marriage of cultures and operating styles.

There is little comparison to the three big mergers that have preceded it:  Delta – Northwest; United – Continental; and Southwest – AirTran.  All three had some international angle to the redrawn networks. Northwest brought the Pacific to Delta and Delta brought some Latin America to Northwest; United brought the Pacific to Continental and Continental brought Latin America to United; and AirTran brought international capabilities to Southwest, providing Southwest the ability to “take out” a potential long-term nemesis in the lower cost AirTran. 

Other than strengthening American’s presence in the northeast US and along the eastern seaboard, US Airways brings little to American from a network perspective. US Airways will transfer a nice chunk of international revenue away from the STAR Alliance to oneworld, and, of course, the sheer size of the combined carrier would return the new American to the number one spot American lost when Delta and Northwest merged.

But to effectively run the combined airline, the new American can’t alienate its high-value business customers who won’t put up with the growing pains we’ve seen with United-Continental. And if the new airline is uncertain in its pace or fails to impress those most valuable customers – many of them the core of American’s revenue base – then a successful merger is far less certain.

The award for the biggest network airline merger failure should go to the team that put together the 1987 deal to combine PEOPLExpress, Frontier and New York Air into Continental Airlines.  The idea was to merge Texas Air Corp.’s holdings to form the nation’s third largest carrier.  But instead of creating a worthy competitor for the two largest airlines at the time, the combination resulted in a balance sheet bloated with debt, unit revenue deficiencies in every corner of the network and no commonality in the combined fleets.  The merged company ultimately filed for bankruptcy protection in in 1990, emerging three years after that.  Ultimately a new management was put in place and the turnaround is legend.  

An American – US Airways combination would not be Continental circa 1987. American is simply too good of an asset.  Nor do I think it will be Delta–Northwest circa 2008, in part because the execution risk strikes me as very high, particularly considering disparities between each airline’s model and culture. One flies to China, the other to Chattanooga.  As a result, they bring two very different customer bases to the entity as well, so customer expectations will differ, too. 

Many analysts have focused on US Airways’ deft courtship of American’s labor leaders as evidence that the US Airways culture is a superior model. But I believe that analysis focuses on the wrong stakeholder group.  At this late stage of the consolidation process, American’s ability to retain existing customers and win new ones is critical to the success of the new airline. A culture transplant alone won’t get the job done. The highest barrier to success would be the one set by a new leadership team that insisted upon its way or the highway in running a combined airline.

Collaboration is critical. That doesn’t mean Tom Horton must be a part of the new American if the architects of any deal determine he’s not welcome. Nor does it mean that the entire American team in place today is necessarily the best choice.  But if the leadership crown goes to Parker’s Phoenix posse, they would be making a grave error to impose the US Airways style on the new American without leveraging American’s successes and cultural assets.

American has proven adept at managing its regional affiliations, code share partners, joint ventures with British Airways and JAL and a loyalty program that arguably is more valuable than US Airways itself.  Its marketing and IT capabilities exceed anything US Airways has ever tried. And American knows far better than its potential new partner how to treat the premium customer who wants warm nuts and lie-flat seats in first class.

I can only hope that the “best of the best” of the two companies will be a part of any new one, because that’s the only way the new airline will compete effectively with first movers Delta, United and Southwest.

Mirror Mirror on the Wall: What about American after All?

This week AMR CEO Gerard Arpey and CFO Tom Horton are taking their “look at American” story to Wall Street. The AMR Investor Presentation starts and ends with the company’s Flight Plan 2020 – a plan that frames the company’s strategy around 5 tenets:  Fly Profitably; Strengthen and Defend Our Global Network; Invest Wisely; Earn Customer Loyalty; and Be a Good Place for Good People.  It’s not uncommon for Wall Street to be skeptical of this kind of strategic framework. Consider, for example, the sharp-tongued response of JP Morgan analyst Jamie Baker during AMR’s 1Q earnings call with Arpey and Horton. Referring to Flight Plan 2020 and its bullet-pointed strategy, Baker asked:

“Is this really all you have got?”

But Baker didn’t stop there. “I don’t want to beat around the bush here,” he said during the Q&A with analysts. “You have the highest costs. You have the lowest margins. You are the only major airline expected to lose money this year. Your year-to-date equity performance has trailed that of your peers. In other businesses I can think of when there is a company standing out like this you sort of expect a major overhaul and it isn’t clear to me that Flight Plan 2020 is that plan.”

In many ways, Baker’s question is a fair one for a company that appears more plodding in its strategy than what we’ve seen elsewhere in the industry during recent years of bankruptcies, mergers and acquisitions. I think American is looking at anything that flies and assessing whether the benefits of the combination outweigh the costs of combining.  And there’s no doubt that American is taking stock of how Delta’s merger with Northwest and the proposed merger between Continental and United will hurt AA sales in key US and global markets.  It is the ability to sell to corporate customers that may be the ultimate arbiter of whether to merge or not.

In its investor presentation, AMR rightfully focuses on its network and the expected approval of both its transatlantic and transpacific joint ventures..  It talks about its focus on the largest population centers in the US – New York, Los Angeles, Chicago, Dallas/Ft Worth and Miami.  It talks about AA and oneworld’s focus on the largest population centers around the globe – New York, London, Los Angeles, Tokyo and Hong Kong.  The AA/oneworld strategy clearly targets the STAR Alliance with United and Continental and its focus on the largest population centers in the US, but pays less heed to the SkyTeam network with more small cities in its route portfolio. I am not saying that oneworld is ignoring SkyTeam at all and New York is but one example.

Let’s Talk Network

My review of the latest available origin and destination data offers some surprises about where AA is strong relative to other carriers.  The markets are listed in descending order of American origin and destination passengers for the first quarter of 2010.

1.           Dallas (DFW, DAL):                          AA, 52.7; WN, 21.4%; US, 5.8%; DL, 5.6%
2.           Miami (MIA, FLL, PBI):                      AA, 24.1%; DL, 13.4%; B6, 9.7; WN, 9.0%
3.           Chicago (ORD, MDW):                      AA, 25.3%; UA, 24.6%; WN, 22.6%; DL, 6.2%
4.           New York (EWR, JFK, LGA):              CO, 19.4%; DL, 16.4%; AA, 14.2%, B6, 13.6%
5.           LA Basin (BUR, LGB, LAX, ONT, SNA): WN, 26.3%; AA, 12.2%; UA, 11.3%; DL, 8.5%
6.           Washington (BWI, DCA, IAD):          WN, 21.6%; UA, 16.8%; US, 13.7%, AA, 9.8%
7.           Boston (BOS):                                  B6, 19.1%; AA, 15.1%; DL, 14.2%; US, 13.8%
8.           SF Bay (OAK, SFO, SJC):                   WN, 31.7%; UA, 18.4%; AA, 7.8%; DL, 6.2%
9.           St Louis (STL):                                  WN, 38.1%; AA, 25.2%; DL, 11.0%; US, 6.8%
10.           Transcon:                                         UA, 21.7%; AA, 18.2%; B6, 15.1%, VX, 12.0%
11.           Raleigh (RDU):                                  WN, 23.6%; AA, 20.9%; DL, 18.4%; US, 15.4%

So AA enjoys a position of strength relative to other network carriers in 4 out of 5 of the markets in its “cornerstone strategy” ­ -- Los Angeles, Chicago, Dallas and Miami.  In New York, AA is currently third, But coming in fourth is jetBlue, AA’s most recent partner feeding 12 international markets from 18 of the low cost carrier’s markets.  If one of the tenets of Flight Plan 2020 is to strengthen and defend its network, then AA is beginning to address its relative weakness in New York with the jetBlue relationship.  Among AA’s largest  ”origin and destination” markets, it is neither #1 or #2 in New York, Washington or the San Francisco Bay Area. 

American’s strength in the domestic markets will translate into added benefits if, as expected, anti-trust exemptions are approved to allow joint ventures with British Airways/Iberia/Finnair/Royal Jordanian and JAL.  Whereas American receives significant traffic from its partners today, there will be significant new benefits that will accrue to American as a result of being able to coordinate schedules and prices as well as jointly market the combined services – a benefit the other two global alliances already enjoy.  So alliance competition is about to take off as we transition to a three carrier contest for travelers rather than the global market that today favors STAR and SkyTeam.

Cost Advantages/Disadvantages

I’m no fan of American’s answer to its labor cost disadvantage, in which the company has said that labor costs will inevitably rise at the other airlines to even the playing field among carriers where now AA labor costs are markedly higher than its competitions’. Sadly this suggests that pattern bargaining is alive and well and that the industry will simply recycle profits among stakeholders as it has done for decades rather than focus on producing some return on capital. 

But I understand why American cannot talk any other way about its labor cost disadvantage.  Why? Because it is smack dab in the middle of negotiations with its unions – in some cases in mediated contract talks or in the process of awaiting union member votes on tentative agreements.  That makes any talk of labor costs particularly delicate, even considering the reality that the company’s current labor costs – in all cases at or near the top of the industry, means that AA doesn’t have much to give at the bargaining table.  Based on the tentative agreements reached so far, American is clearly willing to trade higher wages for the promise of higher productivity.  Beyond that, it remains to be seen – and the devil is in the details -- whether better productivity can mitigate the costs of the agreements.  If not, American’s labor costs are only going to increase further.

One thing the company can and should be talking about is what’s known as “non-labor” costs – all those costs outside of wages and benefits that are not driven by collective bargaining agreements. In this area AA has led the industry in lower costs over the past five years. In fact, non-labor costs at American should only keep coming down as the company takes a new aircraft every 10 days to replace the outdated and inefficient MD80 fleet, American should be touting this other side of its cost equation – the fact that its success in trimming non-labor costs mitigate some of its labor cost disadvantage, rather than bank on the hope that labor cost convergence at the other carriers will ease some of its labor pain.

So what should American say to the Jamie Bakers of Wall Street?

American says that between its cornerstone strategy and its expected immunized alliances, once fully implemented, could mean an additional $500 million on the books.  I believe that it could be even higher, particularly given American’s current position in which it lacks the legal ability to coordinate schedules, set prices and jointly market services with its partner airlines.

Some say that bankruptcy is the only option for American to strip out costs and strengthen the balance sheet against strong competition.  But this is not the post-9/11 era when it was a geopolitical catalyst that allowed several airlines to leverage bankruptcy to rewrite contracts and jettison debt and pensions.

I’ve read many stories that attempt to write American Airlines’ obituary. But the rumors of the airline’s demise have been greatly exaggerated.  In theory, the unmerged US Airways and American and other carriers should benefit, albeit indirectly, from industry consolidation.  Moreover, most of these stories missed the fact that consolidation is taking place at the bottom of a recovery cycle, not at the top.  Assuming that the health of the US airline industry is inextricably tied to the health of the US macroeconomy, then a rising tide should benefit the entire industry.

On May 3, Vaughn Cordle of Airline Forecasts Inc. published a white paper titled:  “United + Continental is Good News for all Stakeholders:  More Mergers are Needed.  Is American and US Airways next?” Cordle writes: “If the industry is not allowed to consolidate in the most rational manner, the result will be a continuation of the slow liquidation and the inevitable failure of US and AA, the two remaining network airlines in need of restructuring.  The most likely outcome would be an AA bankruptcy and outright liquidation of US.”

The analysts may want a more compelling story, but sometimes slow and steady wins the race. After all, past acquisitions at American have not produced much for the airline’s bottom line. I believe American would benefit more by getting its labor house in order before making a big play.  There is enough work to be done in the interim to coordinate schedules with its immunized alliance partners.  There is enough work to be done to get the tentative agreements ratified and complete negotiations with its pilots and flight attendants.  And there is enough work to be done to improve the operational integrity of the system -- a renewed fleet will help but it is not the complete answer.  I am willing to believe that bankruptcy may be an answer for American only if its employees push it there . . . and they may be the ones hurt most by the experience. 

Mirror mirror on the wall:  the tortoise may beat the hare after all. 

Airline Stuff: A Little of Last Week; A Little of This Week; A lot of Cynicism

Consolidation; the National Mediation Board; APFA; Republic Holdings and Captain Prater

Last week, Reuters held its Travel and Leisure Summit in New York.  A number of airline CFOs participated, including Kathryn Mikells of United, Tom Horton of American, Derek Kerr of US Airways and Laura Wright of Southwest.  It was, overall, a really good group of voices who spoke pretty much in concert about the challenges facing the airline industry. Then came the sour note, from another invitee, Captain John Prater, president of the Air Line Pilots Association, whose. comments nearly caused me to choke on Cheerios. But more on that later.

Consolidation was the big storyline in the coverage.  Southwest continues to not rule out the possibility of a merger, although Wright made it clear that organic growth is its preferred route.  Mikells talked more broadly about consolidation and did not limit herself to discussing consolidation within sovereign borders.  Kerr, too, spoke favorably about consolidation but suggested that merger activity would have a more positive effect on the industry’s fundamentals if it involved a carrier with a US domestic presence.

"It's five major carriers, it's too fragmented," Kerr said of the U.S. airline industry. "You have too many hubs, all chasing the same passengers trying to connect through the country. We believe that it needs to be consolidated."

One issue that puzzles me though is that the consolidation discussion focuses only on the five legacy carriers. I think the most interesting sector for consolidation is the regional sector (on which, as it turns out, Prater appears to agree with me.)  But why are names like Alaska, jetBlue and AirTran not part of the discussion? What about Air Canada?  Is consolidation limited to just two carriers?  What if United, or American, or US Airways, wanted to sell part of their domestic operation to one carrier and another part to a third carrier? That concept is not so different than the slot swap deal that Delta and US Airways negotiated only to have the government make such dramatic changes to the terms of the deal that it now makes no sense.

Now back to Prater. In his remarks, Prater said that ALPA is for what he called the “right: consolidation – one that “actually protects and enhances jobs and creates a profitable carrier."  Just to be sure, I read it twice.  Yep, those were the words of the same pilot leader who has done little to nothing for his membership for the past three years.  Then I remembered that it is an election year at ALPA. Maybe that is why Prater’s words and tone have changed to better mirror what Captain Moak said and carried out at Delta during its largely successful merger with Northwest. 

Where was Prater when the US Airways and America West guys needed leadership?  If my memory serves, I believe he was flexing his muscles after winning election on a “we will take it back” campaign.  Of course, there is still little evidence to suggest that United is any better positioned than any other legacy carrier to return to the days of the bloated and inefficient labor contracts that helped tipped the carrier into bankruptcy. So Prater might be testing out a new campaign platform to convince UAL pilots that he deserves a second term.

From the management perspective, the CFOs wholeheartedly agreed that capacity discipline is the key for the industry to become and possibly remain profitable.  They also agreed that alliances are here to stay as the industry’s answer to mergers across borders that are forbidden by rules and regulations. 

"What you will see United and other industry participants doing, is basically within the regulatory framework that we have today, trying to get some merger-like benefits without merging," United's Mikells said.  The discussion that followed focused on the big three alliances and their efforts to find cost synergies as well as the revenue synergies already in place.

And that’s where airline labor comes in.  In the past, many unions have been cool to any merger that might threaten the union’s stranglehold on flying for its own members, even when that flying comes at a high price. Prater’s ALPA, for example, is a loud opponent of global mergers, even when the alliances in place today support so many pilot jobs in the US.  Surely he does not think that each of the five legacy carriers would be as big as they are even today if they were not carrying alliance partner traffic?  So the “consolidation that actually protects and enhances jobs” he talks about actually occurs every day when that United flight leaves Washington Dulles for Frankfurt with 60 percent of its passengers bound for points beyond Frankfurt on STAR partner Lufthansa.  Just like the American Airlines flight leaving Washington Dulles for Los Angeles that is carrying a cabin full of passengers connecting with Qantas to Sydney and beyond?

Republic Is Confusing, Confounding

What the Hell Is Republic Doing?  I get notes from really smart people in the industry asking me this question.  After all, I was really jazzed over the prospects for Republic’s purchase of Frontier and wrote a lot about the possibilities here on swelblog.  Now I am confused.  First, I have not understood the level of management energy spent on the presumption that Midwest can be reborn.  TPG had already destroyed the carrier literally and figuratively.  I can see the possibilities of keeping in place some of Midwest’s best flying.  But messing with Frontier’s brand to right-size Milwaukee makes absolutely no sense.

Ann Schrader of the Denver Post wrote about Republic’s “bumpy integration” in her February 21 story Merger muddles Republic Airways' branding. I appreciate that piecing together an airline is much easier said than done.  But every day Republic seems to further confuse the confusion.  And if serious industry watchers are confused, then just imagine how former loyalists to Midwest and Frontier must feel. It is those loyalists that are the brand – or maybe were the brand?  I am a Daniel Shurz fan and I have every confidence that he can get the right aircraft in the right place at the right time.  But there is much more to this delicate exercise than moving airplanes and picking markets.

I will buy the decision to dismantle Lynx (Frontier’s regional operation) given that it would have taken many more aircraft in the Q400 fleet to realize scale economics.  Now Republic has placed an order for Bombardier’s C-Series airplane.  On paper the aircraft is interesting – but why have orders been so hard to come by – unless someone needed to trade out of an aircraft type?  Then Republic puts an unproven engine on a not yet embraced airframe.  Confused. 

A big part of the Frontier and Midwest brands was the people.  This is about as bad a job of managing work forces as I have witnessed.  Given the new representation rules likely coming this week from the National Mediation Board, Bedford’s Republic promises to be a ripe target for union organizers.  Surely this is not Bedford making these calls?  I have gone so far to say that Republic will play in tomorrow’s US domestic market in a meaningful way.  Now I am not so sure.   And I am simply confounded by any decision to upset the work force at Frontier.

The way this seems to be playing out is that under Republic, both the Frontier and Midwest names will disappear.  So why then buy Frontier, an acquisition clever because Republic was buying a great brand. The deal in fact gave Republic an actual airline – something Republic is not.  The purchase also bought Republic a management team that knew how to run an airline and an IT infrastructure that made the deal really interesting.  But now it seems that Republic’s management team thinks you can feed a cookie (Midwest) to Grizwald or Montana (Frontier) and out comes Herman the Duck (Republic).  Remember that brand?

The National Mediation Board

This is a week to pay attention to the National Mediation Board. Jennifer Michaels at Aviation Week reports that the Board’s “cram down” representation rule change will be published in the Federal Register on Friday.  I believe that there will have to be some comment time or at least that is the way things used to work in Washington prior to this administration.  Unfortunately this issue is playing out the way the health care debate is playing out – along party lines.

The other story playing at the NMB this week involves American Airlines’ which is again in “lock down” negotiations with its flight attendant union, APFA.  The APFA already has threatened to request a release from the NMB if the two sides fail to reach a deal by the end of this round of talks. Whether the NMB will do so is questionable given what I see as the administration’s reluctance to risk a strike in the midst of a fragile recovery.  Moreover, we typically do not see releases during the busy travel season – particularly when economic recovery is at stake.  And rarely do we see releases when, by all reports, the parties are still pretty far apart based on what the union is demanding and the company believes it can afford.

The APFA, in all that I have read, does not seem willing to embrace any productivity in return for increased income for its members.  American has been transparent in communicating its proposals, including on a public website. So what might the NMB do with the parties if a deal is not reached?  Grant the APFA a release?  No.  Grant the APFA its release with the full intention of creating a Presidential Emergency Board?  Maybe. Put the negotiations on ice?  Maybe.  Set new dates for the parties to resume negotiations?  I think not.

Will the Board be proactive in trying to close a deal?  That is the question.  It is what watchers of this incredibly difficult round are trying to discern.  How will this NMB deal?  So far, with only a few airline labor negotiations cases closed, the NMB has not yet been pushed to the brink. But there are still 82 open cases.  The AA – flight attendant deal might be the first big test.

Europe and Strikes

Speaking of the APFA and its loose-lipped talk of strikes, last week was most interesting in Europe.  The Lufthansa pilots.  The BA flight attendants.  The French air traffic controllers.  And of course, all things Greece

Europe is undergoing today what the US airline industry has been experiencing for the past 20+ years: the need to continually transform business models with relatively high cost structures in the face of declining revenues.  Unbridled competition in the US domestic market was its catalyst to reduce costs, particularly labor costs.  The decline in premium class revenue and the blurring of borders that used to protect individual flag carriers will serve as the catalyst for the European carriers to also reduce their labor costs.

The labor instability in the European airline industry demonstrates an expected collision of socialist policies promoting entitlement with an industry forced to adapt to market forces.  I expect that there will be more weeks like this one as the European unions come to grips with market realities that could make any number of flag carriers irrelevant in tomorrow’s global airline industry. Unless, that is, those unions instead choose to adapt to the industry’s evolution . . . a story that has played out in the US in the names of Pan Am, TWA and Eastern Airlines to name a few.

It’s not just Europe.  Look at what is happening in Japan where JAL, another legacy carrier with outsized costs relative to revenue, is in bankruptcy.  Following 9/11, more than half of the US airline industry was in bankruptcy at one time.  European airlines – and their respective unions - are not immune to the same market forces.  And there are certainly lessons that can be learned from the US experience. 

Horton Says American Means It

Last month, in a blog post Begging ……. The Questions, I wondered aloud if the US industry, that had announced capacity cuts in July as crude touched $147 per barrel and jet fuel approached $180 per barrel "in the wing", would rollback their capacity cutting plans as oil prices have dropped nearly $40 per barrel since.

At least in Ft. Worth, announced capacity cuts will be actual capacity cuts. Tom Horton, American’s CFO said the domestic capacity cuts are permanent in an interview with the Associated Press. Horton touches on two important cost benefits that will be realized by the decisions his company is taking: 1) the fleet being retired is not efficient from a fuel consumption perspective; and 2) older aircraft require much greater expenditures to maintain.

American Airlines has been aggressive in its capacity planning and has been joined by United and others. Airports around the air transportation system will certainly point to the fact that oil has dropped significantly in the past two months. But we cannot lose sight of the fact that the price of crude oil is only part of the equation; remember the crack spread or the cost to refine crude oil into jet fuel.

The industry is still paying roughly a $140 per barrel equivalent for jet fuel. On average, the industry spent the equivalent of $90.93 per barrel for jet fuel in 2007. It is the difficult management actions that are being undertaken like capacity reductions, ancillary fees and additional employee dislocations that are giving Wall Street some hope that the industry just might be profitable in 2009. But, that all depends on the actual condition of the economy doesn’t it? And I am not sure we can even get an accurate temperature read today.

A Demand Prism?

Let’s not lose sight of the important guidance the cargo side of the business gives to the passenger business despite the fact that they are very different business models. It was the cargo sector that first warned of a slowing economy earlier in the year and the effects it saw on its business outlook. The cargo business addresses more traffic that is demanded on a just-in-time basis and as a result is less price-sensitive. The cargo business is a more leading indicator of things to come. The passenger business sells a significant level of its product well ahead of the actual delivery and tends to be more price-sensitive for a majority of its demand.

Last night, William Greene of Morgan Stanley wrote a piece on Federal Express. It was entitled: Weak Guidance Highlights Cyclical Pressures. And I quote: "Cyclical headwinds clearly a challenge for earnings. As we noted when we downgraded FDX shares back in late July, we struggle to find a compelling reason to own parcel stocks. Although lower fuel prices have pushed off some of our secular concerns about a permanent modal shift, a global slowdown is undermining one of the few remaining areas of strength – international. Moreover, air fuel surcharges are still high from a historical perspective and domestic volumes remain under pressure."

A couple of things in closing. Oil is down but still 50 percent higher after the fall than the average price paid in 2007. And, passenger airlines now face the reality of economic forces and the actual health of consumer’s pocketbooks as the peak travel season just completed was sold in February and March of this year. Fuel coming down is good for all of us, but its fickle nature should not be ignored. Nor should it suggest that the hard decisions made by the industry earlier in the year to park capacity are no longer necessary.

Interesting too is Greene’s assessment that international markets might be weakening. Does the cargo sector offer a prism for the passenger side of the business? I think so and you do not have to read aviation news from around the world everyday to reach that conclusion.

I must say I am amazed that I have not read any uneducated and uniformed reporting to date that suggests that the capacity cuts are not needed given the fall in crude oil prices – but I am sure that I will. Maybe even one written in 2002?

More to come.