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

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

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

Views from Willie Walsh

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

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

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

……and I will touch on a few.

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

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

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

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

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

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

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

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

But Before We Go There – Yet Another Parallel

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

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

On US Consolidation and Views on the Regulatory Landscape

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

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

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

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

Bringing Back a Few of My Favorite Glenn Tilton Statements

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

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

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

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

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

More to come.

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.

Self Help

No, I am not talking about the expiration of a “cooling off period” under the Railway Labor Act where a deal is not reached and either management or the union has the ability to engage in self help. Rather, I am captivated by the creative bargaining that is taking place between the United Auto Workers (UAW) and the “Big 3” US automakers. As I was flying home yesterday from Boston, I found myself reading an article in the Wall Street Journal twice and reflecting on the airline industry.

The article, How Less Pay, More Risk ‘Sells Itself,’ is a compelling read for anyone in the airline industry click here. The UAW – GM deal has three major tenets:
1) freezing base pay for 4 years
2) shifting a significant amount of the burden of retiree health care from GM to the union
3) creating a two-tier compensation structure in return for job protections of the current workforce.

According to the WSJ, the UAW leadership set out to manage the expectations of its members because it recognized “that the problems facing unionized U.S. auto makers were deep-seated and not the result of cyclical forces soon to change.” These comments were made to the current UAW leadership by Doug Fraser, the revered UAW leader who had to navigate his way through a deep concessionary period in the early 1980’s as the auto industry began feeling the pressures of new competitive forces. Sound familiar? The recognition of “structural change” in the industry and “far sighted solutions” became the mantra for the new UAW leadership as a result of the comments from Fraser.

The GM deal with the UAW was ratified yesterday, the same day the UAW reached a tentative agreement with Chrysler. The Chrysler deal is reported to have the similar tenets as the deal with GM, including the two-tier compensation structure. Now it is off to Ford where the “structural issues” are even worse than those at either GM or Chrysler.

So why are we talking about the auto industry? Because it has similar attributes to the airline industry. Just to name a few: 1) It is capital intensive; 2) It is labor intensive; 3) It is a mature industry; 4) It has major legacy cost issues; 5) It is a hyper competitive industry (although it can be argued it has more global competition versus the airline industry with domestic competition); 6) it is susceptible to the ebb and flow of the domestic and global economies and 7) The cycles of competitive forces impacting labor negotiations are eerily similar.

In this blog I have written about the need to get the mainline GROWING again. We have talked about pilot scope. What pilot scope limits have done is allowed the regional sector of the industry to grow at the expense of the mainline. We have talked about “structural changes” in the industry namely in passenger revenue click here which lies at the core of the industry’s need to maintain a vigilant focus on costs.

We have talked about labor arbitrage and the fact that as total compensation rates have converged, this round of negotiations places us at a crossroads. Or stated another way, an opportunity is present to discuss “far sighted solutions” like reconsidering a two-tier compensation structure as the UAW ultimately did. In fact it was this system that provided the fuel for the airline industry to grow and build lasting networks following deregulation.

This is real “structural change” an issue recognized by the leadership of the UAW, but yet to be acknowledged in public comments by airline labor leaders. So, absent this recognition of the structural change, it is hard to even think about discussing “far sighted solutions.” But the tired notion of entitlement and the restoration of pay levels in an environment where average fares are the equivalent of those earned in the 1990’s is not the answer. The answer is also not base pay rates but variable compensation that can address many of the cyclical issues that have plagued collective bargaining negotiations in the past.

The historic compensation levels in this industry were built largely around technological innovation, government actions and a growing economy. Suffice it to say that two of the three are not present today. And, if government action is needed to make the system operate more efficiently, then technology cannot operate at its stated maximum output.

Somewhere in the problems lie what I think is more effective “self help” – and that is the kind of “far sighted solutions” that incorporate risk for labor, management and shareholders – thereby vesting everyone in the ultimate success of the industry so that everyone is better off in the long term.