Colgan 3407: Fatigue, Commuting and Compensation

Justin Bachman at Business Week is fast becoming a must-read aviation reporter. In a May 17, 2009 column, Bachman asks: Have Airlines Cut Too Deep? This question of course was also being asked at the NTSB hearings on Colgan Airlines flight 3407. What makes Bachman’s work a must read is the context he provides on the economics of the situation. That is what the best reporters do.

But context in the reporting on Colgan 3407 was generally lacking in many of the press accounts. We read about the most sensational aspects of the story, like one pilot commuting from Seattle; like the other sleeping on a couch in the crew lounge; like the salaries paid at regional airlines; that somehow flight time/duty time was at issue; and of course fatigue. You didn’t need to read too far between the lines to see the supposed correlation between salary and safety.

Fatigue and Commuting

Unless the flight crew was on a suicide mission, this is a grossly unfortunate attempt at sensational reporting. It is incumbent on flight crews that choose to commute to arrive at their domicile rested and fit to fly a schedule that complies with flight time/duty time regulations. And through it all, there was no mention that “Sully” Sullenberger lives in Danville, CA and is based in Charlotte, NC. Or that the same flight time/duty time limits that applied to Sully’s trip applied to the Colgan crew’s trip as well.

Fatigue is a difficult issue. To conduct a meaningful scientific study, one must first assume that the crew is rested prior to the trip that they are scheduled to fly. That is their responsibility. In the case of the Colgan crew, the two pilots did not meet that obligation to the company, their fellow crew members or the passengers on the doomed plane. What is certain to come will be scrutiny on the issue of commuting and a debate as to whether we will return to the days when crew members are required to live in their domiciles.

Already some claim that low salaries force airline employees to live in places other than the metro areas where hubs are located. But that’s an individual choice, and most cities have a broad range of housing available.

The subject didn’t come up in the Sully case in part because, as a captain for a major carrier, he likely makes a pretty good living even after the concessions imposed on US Airways employees and so many airline workers as the industry struggles to turn a profit. But I’m pretty sure living in Danville, CA is not cheap, nor is Seattle known for its budget housing.

But long commutes for airline professionals should be reviewed and possibly prohibited if there is a connection between that travel and fatigue. And the fatigue issue cannot be studied until commuting practices are completely divorced from the regulations covering time on duty for flight crew members.

My guess, however, is that as the Colgan investigation continues, the real debate is going to involve pay.

Over the past weeks, there has been discussion here and elsewhere about the role of seniority in the airline industry and a system that chains flight crews to the fortunes of a single carrier because they risk losing the benefits of seniority if they change jobs. I’ve joined others in advocating for a national seniority list that will help crews preserve the seniority credits they’ve earned in the event of a merger of two airlines. A national seniority list also would provide portability in the event of furloughs or an airline’s shut down, meaning a pilot or flight attendant wouldn’t have to land at the bottom of another carrier’s list and all but start over.

This system wouldn’t offer a job guarantee – there’s no such thing in the airline industry -- but in the event a surviving airline is hiring, an employee would have the opportunity to compete for an open position and be paid in keeping with his or her experience.

As I envision it, a national seniority list would not serve the whims of those who perhaps want to fly for a carrier in Florida in the winter and a different carrier the rest of the year. Seniority is not necessarily an indicator of the industry’s or a company’s best employees – as important as experience is. But it does serve as the structure that governs pay and benefits.

So let’s talk about pay. Today’s regional industry is yesterday’s B-Scale. Back when the industry began experimenting with a tiered pay scale, the unions argued to get rid of B-Scale wages because one employee doing the same job with the same seniority should not be paid less than another. While the advent of the B-Scale compensation structure in the mid-1980’s led to explosive growth for the industry, the unions were successful in eliminating the two-tier wage scale in the subsequent round of negotiations.

Today, regional carriers like Colgan, Comair, American Eagle and others account for roughly half of all domestic departures. The regional sector has experienced explosive growth because small jet aircraft have allowed airlines to continue to serve smaller markets that couldn’t support bigger planes, in addition to cost and competitive pressures in the industry that have forced down average wages and benefits.

Here is where Business Week’s Bachman provides the proper context: “Anyone horrified by Shaw's [first officer on Colgan flight 3407] salary must also confront their own primary motivation when booking an airline ticket: finding the lowest possible fare. The two are connected, say airline executives and pilots. "People will spend three hours on the Internet to save $8," says Arne Haak, vice-president for finance at AirTran Airways (AAI). "You know this! You do it yourself."

So, What to Do?

Pay rates for pilots have been largely dictated by the size and weight of a particular aircraft type. Supporting this is the idea that more responsibility is associated with flying 250 people versus 130 or 50. The recent NTSB hearings highlight the pay discrepancies between mainline pilots and regional pilots. They are very different sectors flying very different revenue generating flights. But . . .

The pay differences between the mainline and the regionals have become too great. In many ways, the gap between what captains earn and what first officers earn has grown too large. It used to be said that unions employ practices that eat their young. But with an industry in contraction, we have reached a point where current pay practices even eat the old. As the legacy carriers are forced to reduce capacity even further, we now have former captains flying as first officers on the mainline. That’s taking seat progression the wrong direction.

Much has been made about executive compensation in this industry and across the US. But perhaps we should look at pay practices elsewhere in the industry as well. Should a pilot flying 130 passengers be paid three times more than a pilot flying 50 passengers? I think not. Just as it is time to rethink seniority; it is also time for the airline industry to rethink how flight crews are paid. With lighter materials ensured on tomorrow’s airplanes, weight becomes less of an issue. Carriers’ fleets are increasingly made up of smaller aircraft. Perhaps it is time to shed the complex calculation that goes into pilot pay, and consider salaries for cockpit personnel and flight attendants.

Such a system certainly would have better served the first officers at the mainline today who once sat in the captain’s seat. Those pilots took a disproportionate cut in pay relative to the captains that were not forced to move from the left seat to the right during the last restructuring. Given that segments are typically divided between captains and first officers, the industry should reconsider the 35-50 percent difference in their pay. And differences between the mainline and their regional partners should not be 200 percent.

I am certain that a transition to a new pay system will increase costs to the industry. But either the unions get their arms around the issue and come up with a more equitable system, or someone will make that decision for them. Pilot wages are inextricably linked to the industry’s ability to bring in revenues. As we continue to rethink what will help strengthen our domestic airline industry, we should also be thinking about how we allocate those pilot labor dollars.

I am suggesting a sea change in thinking about compensation. Further what I am suggesting will require a challenge to those who fail to recognize new realities in the industry, among them some of the union leaders who have responded to new competitive challenges with nothing but stubborn recalcitrance. In an industry that cannot earn a profit on a sustainable basis let alone earn its cost of capital, maybe the compensation structure that Captain Sullenberger speaks to should be changed to in order to obtain the best and the brightest on all levels.

The upside would be less but the perception that somehow safety of the airline system is somehow tied to salary would be addressed. Moreover, a salary structure is more stable, more predictable, more in line with revenue picture that drives the global industry and certainly more in line with an industry that will not experience the rampant changes in technology that drove productivity of employees in the past.

It is a conundrum. But while in the restructuring mode, address the fundamentals. The airline industry can learn from the head in the sand mistakes made in the auto and steel industries because if not fixed, the industry will continue to contract.

Former America West Pilots Prevail in Phoenix District Court

A group of former America West pilots prevailed this afternoon in a Phoenix, Arizona courtroom.The jury ruled that the US Airline Pilots Association failed to uphold its Duty of Fair Representation. Read the story by Dawn Gilbertson of the Arizona Republic.

Nobody should be terribly surprised by the outcome. Unfortunately, it is only the fifth inning of a scheduled nine inning game for the US Airways pilots to agree to a merged list. The right decision was reached by the jury in this case.

Are represented employees ever going to learn that the grass is never greener when AMFA ideology is utilized? Their approach is simply to over promise and under deliver.

What no one will say publicly at least: without the plan of reorganization for the former US Airways that included a merger with America West, the former US Airways [East] pilots would likely have landed in the unemployment line.  And someone other than "Sully" Sullenberger would have been the captain on the flight that successfully landed on the Hudson.

It really is high time to put together a national seniority list in order that transactions like mergers can take place without labor diversions. 

Can Autos Learn from Airline Bankruptcies?

Funny When the Shoe Is On the Other Foot

A major US industry employing hundreds of thousands of workers that was once the envy of the world is in trouble. Some of the biggest names in the industry have filed for bankruptcy, leading to significant job loss and cuts to retiree health and pension benefits.

No, I am not talking about the state of the US auto industry in 2009. I am looking back to 2002 at the start of the US airline industry's painful restructuring.

On Aug. 11, 2002 US Airways filed for protection under Chapter 11 of US Bankruptcy Code. On December 9, 2002 United Airlines followed suit.. On April 18, 2003 American announced agreements with all of its unions on concessionary contracts to cut labor costs outside the bankruptcy court. On September 12, 2004, US Airways having emerged from bankruptcy too weak to survive, filed Chapter 11 for the second time. On October 20, 2004 Continental announces plans to seek concessions from workers. Then on September 15, 2005, Delta files for bankruptcy, joined within the hour by Northwest Airlines.

Though years apart and radically dissimilar in many ways, the automobile industry might learn a few things from the experience of the airlines . . . then - and now.

US airlines were largely successful in using bankruptcy to reduce bloated operating cost structures, but the agreements between the debtors and the various stakeholders were based on the belief that the companies would achieve some sort of sustained recovery. We now know this not to be the case.

Since 1980, the US airline industry has lost nearly $20 billion. Over the same period, the non-US airline industry made nearly $20 billion. How do we account for the $40 billion dollar difference?

Bankruptcy can help whittle down costs and provide a mechanism to cleanse a balance sheet full of stupid capital. But it does not address government actions that dictate how an industry can compete. So, as “stress tests” become a part of banking vernacular, the very same tests should be applied to other industries struggling to adapt to a new economy.

Stress Test #1: Labor

For most US airlines, bankruptcy did little to address the expectations and entitlements common in unionized industries. For example, there is still scope language in most pilot contracts that serves as a sort of a “job bank” provision and there are plenty of contractual penalties to pay should the enterprise need to shrink capacity. So far, the airlines that have emerged from bankruptcy are anything but agile. One might say that networks were adjusted to adapt the market’s revenue reality, but my view is that they were really just outsourced to a carrier’s regional partners.  An economic fix in pilot contracts remains unfixed.

If Chrysler, and possibly GM, is to learn anything from airline bankruptcies regarding labor issues, start from a clean whiteboard and negotiate what you need to implement your new business plan. Airline bankruptcies, while incredibly painful to employees, gave too much leeway to the unions in negotiating the level of concessions. Real change comes in addressing emotional labor issues – many left over from an earlier era of trade unionism – like the work rules and job protections that constrain a company’s ability to be flexible and agile in its operations.

And while the airlines were able to make crude cuts to their cost structures, most retain many of the same labor constraints and “protections” that hindered their success in the first place.

Stress Test #2: Capital

Capital considerations are one area where the government and the auto industry each learned from the airline experience in bankruptcy: legacy costs like pensions and retiree health provisions take a tremendous toll on a company’s economic health and financing flexibility. Cerberus Capital may be the sole exception but, anyway you look at, it is clear that the airlines created a case study for other shrinking industries. A lesson the airline industry would have preferred not to teach.

As costs were cut and capital destroyed during the airline restructurings, it became apparent that, without significant changes to its legacy obligations, United was not going to be able to get to a Plan of Reorganization (POR) that would produce the kind of debt coverage any new capital would require. Other airlines inevitably followed United’s lead -- freezing or fleeing some of these expensive plans -- as the private capital waiting in the wings to fund airline exits offered the money with that as a chief condition.

The auto industry understood this as well demonstrated by the UAW’s significant concessions in the last round of negotiations.

All of this is not to say that other economic factors didn’t play a role. For the airline industry, it was the price of oil in the early stages of its march to unprecedented and unthinkable levels as several carriers began to emerge from bankruptcy. And for the auto industry, the ailing economiy exposed the reality that an industry already diminished in size and economic might cannot pay these bills alone.

Stress Test #3: Government

Isn’t it ironic, then, that some in the US government are trying to legislate and limit international airline alliances at the same time the White House opts to save Chrysler by putting it in the hands of Italian carmaker Fiat SpA. In that deal, Fiat acquired an initial 20 percent stake in Chrysler – a stake that will increase to 35 percent if it invests in US small car technology;and could eventually control 51 percent of iconic US automaker once all government loans are repaid.

Still, in Congress, Rep. James Oberstar is trying to push through new challenges to the very global alliances that help US airlines expand their networks and promote growth. The congressman already has cast a suspicious glare at granting immunity for a proposed oneworld alliance between American, British Airways and Iberia – even though those airlines seek only an even playing field with SkyTeam and STAR – the other alliances that include Delta, United and Continental. Oberstar is also gunning at those existing alliances, trying to subject them to a governmental review every three years .

He [Oberstar] claims he is acting only to protect consumers. But what Oberstar appears to discount is the fact that alliances have produced significant new revenue streams for US carriers and benefits for American travelers. Adding oneworld introduces yet more competition – hence, benefiting consumers.

Without leveraging these international partnerships, there is little new revenue for carriers to mine or easy cost-cuts to make. [Just ask US airline darling Southwest Airlines] Fiat plans to improve the bottom line by employing new technology and finding new efficiencies by joining forces with Chrysler. Why shouldn’t US airlines have the same opportunities by partnering with Lufthansa or Air France or KLM or British Airways?

Interestingly, one of the reasons cited for Chrysler’s continued financial problems was its near sole reliance on the US domestic market to sell its cars. And that sounds an awful lot like an airline industry that has struggled through nearly three decades of unhealthy domestic competition because lawmakers - parochial in their thinking - failed to recognize that competition for competition’s sake can destroy industries.

The US airline industry as we know it is at a tipping point. I don’t believe that foreign capital alone will make everything right in US airlineland. But these partnerships offer great potential, particularly if they provide domestic carriers with the ability to upgrade their products and services so that US airline offerings on transoceanic routes are on par with alliance partners. That would be a smart use of capital.

Foreign capital is not tainted. Hell, does anyone really think that US airline capital is not held by non-US parties today? US airlines need it to bring in new revenues and make investments that produce a product that people are willing to pay for. And airline alliances need to be permitted to go to the next step and reduce expenses as well.  Instead, we’ll continue to watch foreign carriers invest in that product while the US airlines slug it out for traffic from Lubbock and Boise.

Stress Test #4: Government Promises

The auto industry is lucky to have the full faith and credit of the United States in back of its restructuring. The airline industry had none of that except for the pension obligations offloaded to the Pension Benefit Guarantee Corporation . . . and for some of the employees affected that amounted to only pennies on the dollar.

But what the airline industry really needs is for the government to fulfill a decades-old promise to invest in the air-traffic control infrastructure that serves as the backbone for the entire industry.. That is a use of “government money” – one likely funded through taxes and user fees -- that actually offers a decent return on investment.

Concluding Thoughts

The airline industry has many lessons to teach Detroit.

One, you can’t simply cut labor costs without also getting the operational flexibility a corporation needs to compete effectively.

Two, any industry should seriously question whether equity in exchange for benefit obligations will produce a stronger company in the long run. The airline industry makes clear that smaller companies cannot pay for the past in a highly competitive revenue environment.

It’s a new era. What a difference a few years make when a Democratic President of the United States emphatically believes that transferring ownership to a foreign entity is in the best interest of a US company. This is an area where the US airline industry may finally have a case to make that what is good for one industry is good for another.

As for government promises, I only hope that the US auto industry fares better than the US airline industry.

At some point the duplicity must stop.

Update on 05.12.2009 by swelbar

After posting, Cliff Winston of the Brookings Institution offered another Stress Test to consider. For those who follow this industry closely you will recognize Cliff Winston as the author of numerous and authoratative pieces on the airline industry. I am a follower of his thoughts and insight and appreciate his offering below.

Let me suggest another “stress test”: Matching Capacity with Demand. That has been the biggest problem for the airline industry, especially because it has experienced several shocks that have made it difficult to forecast demand.

The problem with the US automakers is that they have been able to live in denial. Although their market share has continued to shrink, macro expansions, trade protection, and low gas prices have enabled them to be profitable. But they were losing the quality race with foreign automakers. The attached paper indicates that the entire loss in market share in the past decade can be explained by the US automakers’ inferior attributes. Their share would continue to shrink under those conditions. Add on a shock like the financial crisis and capacity greatly exceeds demand leading to bankruptcy—just like the airlines. BUT unlike the airlines, cutting prices and costs won’t fill much capacity if demand continues to shrink because of inferior attributes.

Regards, Cliff Winston

Capital, Labor and Seniority in the News

We awake this morning to reports that Chrysler will file for Chapter 11 bankruptcy . Despite efforts by the Obama administration to force Chrysler stakeholders to find an out-of-court solution, certain debt holders would not agree to the haircut they would have to take in forgiving debt to the auto giant. What they seem to be saying is that, under the terms of the proposed solution, labor would receive a disproportionate share of equity in the restructured company.

Where seniority for airline workers is earned through longevity, capital structure seniority is a bit different. In a bankruptcy, there are different classes of capital. Debt secured by company assets is the most senior on the list of creditors who will be paid. Unsecured debt capital is next in the pecking order, followed by preferred stock and, lastly, common equity.

Nowhere is “sweat equity” reported on a company’s balance sheet. However, worker concessions have been recognized as capital in a restructuring scenario and have been currency accorded a stake in a reorganized enterprise. Moreover, it is the sweat equity at Chrysler held by current and retired workers that might appear to some as being unduly enriched through the deal that gave them a 55 percent ownership stake in a restructured Chrysler.

A very different scenario played out in the airline industry. There, in bankruptcy cases that resulted in either a termination or freezing of pension plans and/or alterations to retiree benefit plans, creditors made it clear that they would not pay the bills from the past by forgoing profits in the future. For airline companies to emerge from Chapter 11, they needed public capital to fund their exit from bankruptcy. For car companies, the government is the source of exit capital.

This morning’s New York Times, quotes a statement from GM’s bondholders that applies to Chrysler’s issue as well: “We believe the offer to be a blatant disregard of fairness for the bondholders who have funded this company and amounts to using taxpayer money to show political favoritism of one creditor over another.”

As the article notes: “The U.A.W. members at both automakers stand to lose some of their pay and benefits, but the cuts are not as deep as those faced by airline and steel workers when their companies went bankrupt. Under proposed deals devised by the Treasury Department, U.A.W. pensions and retiree health care benefits would largely be protected”.

Airline Seniority In The News

On Tuesday, Terry Maxon of the Dallas Morning News wrote about the former TWA flight attendants and their dissatisfaction over their treatment from the flight attendant union when American purchased the assets of the troubled and iconic carrier in 2001. Also Tuesday, the four-year seniority battle between the merged group of pilots at US Airways got underway in US District Court in Phoenix, Arizona. Read Dawn Gilbertson’s reporting in the Arizona Republic and on the paper’s US Airways blog.

Whether it is in the airline industry or in the automobile industry, there clearly is something wrong with the seniority system. My question: should seniority really be sacred? The current seniority system does not work for shrinking industries like airlines and autos.

I am in stark agreement with the actions taken by the Association of Professional Flight Attendants, the union that represents AA flight service crews, which in protecting the seniority rights of its members decided that former TWA flight attendants would be put at the end of the seniority list when they joined AA ranks. The fact is this wasn’t a merger of equals. At the time of the purchase, TWA had sold most strategic assets and had reached its tipping point. There was nothing left to borrow and no hope except American’s offer to buy its assets.

I am in stark agreement with the America West pilots in their disagreement with the former US Airways [East] pilots who had little hope of a career absent the reorganization plan that involved a merger with America West.

Given that the economy will continue to call into question the future viability of any number of US airlines, this seniority issue is far from over. Plain and simple, it is about economics and the viability of individual carriers. US Airways [East] was not going to survive in its 2004 form for long. TWA would likely have died of natural causes as the effects of 9/11 ravaged the industry.

Concluding Thoughts

Given that the airline industry will likely get smaller before and if it gets bigger, it is high time that organized labor puts down its swords and constructs a national seniority list. Employees should have the right to move within the industry should their carrier cease to exist. Seniority should not be a shield for some to hide behind. Rather it should promote stability for those experienced workers that choose to offer their services for hire in an open market

The economic crisis and its impact on corporate America highlight the need for thoughtful analysis of labor issues. Seniority is only the first of the “third-rail” topics we shouldn’t be afraid to discuss. Another is the “legacy costs” like pension and retiree benefits and whether they should be the sole responsibility of the employer in today’s world. Best that I can tell, this growing financial burden on employers may serve only to stand in the way of active employees working to maximize their earnings.

Time will tell what ultimately will emerge from Chrysler’s bankruptcy; GM’s prospects for the future and whether the deal at Ford positions that company to compete for the long term. The same day might be coming for airlines which would be wise to learn lessons from the industries that come before them.

I make that final statement after reading through Obama’s statements. The US government is constructing a safety net for Chrysler and its workers. Some will fall through and others will be saved. Airline labor should be thinking about the same.

1st Quarter Earnings Calls: Unbungling; Unbundling But Not Unshackled

Three legacy carrier earnings calls down, two to go. Southwest and Allegiant have reported. So has SkyWest. But the clear takeaways are difficult to discern. Everyone wants to know if the industry has reached a bottom. But there are no clear answers while we are still in the middle of an economic tsunami. For all those who have said the domestic market is stabilizing (me among them) the only hard evidence on our side right now is that the environment is not getting worse.

Every carrier is supremely focused on unbungling their operations. Yes, unbungling. Because we all know that operations at many carriers have been a mess, with many factors to blame. And, as painful as the process has been, many carriers are making progress getting their operations and costs in order. US Airways led an amazing turnaround focused on its once-troubled Philadelphia hub. Many very good reforms are underway at United. And all things operational are improving at American, albeit at a slower pace than at some of their legacy peers.

Moreover, virtually every carrier – except for Southwest – remains committed to continuing the unbundling process and to maximizing secondary revenue sources. Today, Delta went so far as to announce a fee for the second checked bag on international flights -- becoming the first in the industry to do so. The industry is unequivocal that the fees will stay and that where opportunities are present to do more, they will. Further, a heartening storyline has emerged regarding distribution, where carriers increasingly see opportunities to move away from paying intermediaries to sell their tickets and to turn that model on its head so that airlines get a fee from the middle man for the right to sell their product.

The United Call

I do not have the transcript of this call in front of me, but this was a most interesting listen. My favorite part was when Morgan Stanley’s Bill Greene posed a very fundamental question that went something like this: With planned capital expenditures less than depreciation, how are we supposed to think about United, or the industry, on a going forward basis from an investment point of view?

Or, as Helane Becker of Jessup and Lamont put it: Should UAL have public equity at all, or instead raise only debt capital from the public markets? Then there was Ted Reed of TheStreet.com, who was blunt in asking whether, just maybe, United had “shrunk too much.”

Good questions. Unfortunately, they are ones that the current environment makes very difficult to answer with conviction.

In my last post, I questioned the airline industry’s access to capital given fragile economic fundamentals in an industry that, over its long history, has failed to produce so much as a dime in retained earnings. In my view, the industry is at a tipping point in which smart investors should question the structural integrity of some carriers and networks during what amounts to a market stress test . . . one that just might reveal which airlines have few moves left to shed uneconomic capacity.

This is the “new and irreversible development” I referred to, a trajectory that might change only through serious effort to remove the many regulatory shackles around this industry. Some necessary changes might not be politically popular -- increased foreign ownership of US airlines comes to mind – but the industry’s options are narrowing when you consider that revenue trends do not hold out much immediate promise.

Looking ahead, with credit tight, where will capital – affordable capital – be found unless it is from another participant in the same industry? If companies are struggling to realize any return on invested capital today, then what happens as interest rates continue to increase in lockstep with capital scarcity? As standalone companies, there is just not enough room for individual carriers to maneuver around an income statement that holds little promise of further significant reductions in the short-term. Based on Greene’s point, even United seems reluctant to reinvest much of its own, and limited, capital into a business that does not hold promise of a reasonable return.

This is not just about United. This is an industry issue. And not just a US industry issue . . . it is fast becoming a global industry issue.

In North America, Air Canada has long been the poster child of an airline that needs an influx of foreign capital necessary to keep the company relevant in the global market place. Air Canada faces some unique challenges: namely that nearly two-thirds of Canada’s air travel demand is found in just eight markets.

Meanwhile, the Delta/Northwest merger is fast proving that the combined entity is far less vulnerable than either of the two carriers would have been had they not merged. Just think about the vulnerability of each Delta’s and Northwest’s respective hubs to the economies in the interior of the US footprint.

With US Airways the exception among the legacy carriers as to international market exposure, we as a nation should at very least acknowledge the reality that globally-oriented airlines need to be just that. I’m not talking about domestic airlines with global extensions -- we tried that, in a way, with TWA, Eastern and Pan Am . But absent any real alliances that left each of them dependent only on US-origin traffic, those carriers suffered a common fate -- shut down in sagging economies as capital became tight.

Concluding Thoughts

Following an industry life cycle of value destruction, US legacy carriers now face a dilemma: whether to invest in their core businesses or not?

As the US airline industry is now six full years into a major restructuring, the tendency to legislative and regulatory gridlock did not get restructured. An inflexible labor construct did not get restructured. Policies promoting the fragmentation of the US domestic market did not get restructured – until the airlines themselves took on this task through capacity reductions in redundant markets out of necessity. 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.

In truth, the US market should not fear individual carrier failures or consolidation. Indeed, this market has demonstrated time and time again that where competition is vulnerable, a new entrant will exploit that vulnerability. Where there are market opportunities, there will be a carrier to leverage that opportunity. Where there is insufficient capacity, capacity will be sure to find the insufficiency.

At a minimum, government should take a very serious look at where this industry sits. The US airline industry is not asking for government handouts. Rather it is my view that this industry seeks nothing more than the same rights to operate as virtually every other successful US industry selling to the global marketplace is permitted.

Few shackles unless consumer harm can be proven. Going backward will result in significantly more dislocation for virtually every stakeholder remaining in the industry today as it begins with an industry even smaller than today’s.  It would be a shame to waste six years of some very good work.

Liquidity, Labor and Legislation

Earnings season is upon us and we all anxiously await guidance from airline executives on a forward looking basis. On the eve of past earning seasons, cues from industry executives have mostly used words starting with “C.” This time around, I want to hear commentary on topics starting with “L” namely:

Liquidity

I believe that we are nearing the final chapters for one carrier, possibly two. I do not know which they might be, only that there are not enough rabbits left in the hat for every airline to survive in this market.

Why?

- Because labor will not be the internal source of capital that it has been in the past;
- Fuel costs are uncontrollable;
- Maintenance repair and overhaul will not offer hundreds of millions of dollars in savings in the future as most airlines already have outsourced as much of that business as they can;
- Distribution costs already have been wrung out of the system at every airline;
- Airport costs ebb and flow with the level of traffic;
- Aircraft rentals and other vendor contracts are largely fixed;
- Commitments made to feed providers are contractual;
- Interest obligations are known.

In other words, there just is not much room on the income statement for airlines to maneuver.

In the U.S. airline industry, we could be fast approaching the tipping point– the critical juncture in an evolving situation that leads to a new and irreversible development. With credit tight, would you put money into an industry that has historically destroyed capital? Would you bankroll an industry that has few opportunities to reduce costs in a weak economy? Would you lend money to companies facing labor strife? To get to the bottom line, would you invest in a company in an industry that has never made a dime? In this economy, there may not be many takers.

The airline industry is not special. Like other industries, it needs a plan to earn at least its cost of capital and compete for a limited pool of funding. And those who hold the capital will likely look first toward companies and industries that reward their capital providers more than once or twice every two decades.

I share the belief of some others that the domestic market may be stabilizing, but think this recovery will be an uneven one. The real driver may be the international market and the global economy’s interdependencies that I do not pretend to fully grasp. So I have concerns about American, Continental, Delta and United. Asia has been troubled in certain spots for nearly a decade now. Europe was a strong performer while the US industry faltered, but now shows signs of weakness across the continent. And Latin America’s economy appears to be similarly troubled.

Beginning today, when American leads the first quarter’s earnings parade, I will be all ears. Because what I see for some is troubling. Others will benefit from the weakness.

Labor

The recalcitrant unions at American remain the lead story as outlined in Mike Esterl’s piece in an April 14 Wall Street Journal entitled: Labor Negotiations Cloud Outlook for American Airlines Parent. American is being joined by United which opens negotiations with all of its major unions this month. Between the two, there will be plenty to read and write about as union leaders at each airline continue to promise outcomes to their members that could not be met even in the best of times. Real leadership would instead recognize that no airline can long survive overpriced labor contracts that put them at a competitive disadvantage in the industry.

I read somewhere this week that the United Airlines flight attendants union is promising its members a new contract that will give them industry-leading pay rates. The American pilots union is taking an old page out of the Continental pilots’ playbook that “the loan is due” to gain back pay levels the industry no longer supports. The problem is that concessions granted or forced in past years were a necessary correction of market costs that had risen above the industry’s ability to absorb those costs. Those concessions were never a “loan” and there isn’t a labor contract in the industry that includes terms on rates or principal that would make them so.

American has a first – at least in my recollection – in having all of its negotiations in mediation at the same time. United could be in the same place as date certain contractual understandings are in place to file for mediation in the event no agreement is reached. As for US Airways and the labor unions that have not been able to complete an agreement following the airline’s merger with America West, I have given up trying to apply logic to that situation. The damage done to employees is done and that was the work of the unions involved.

OhhhhhhBama – Release Me (And Let Me Love Again)

The Allied Pilots Association, which represents American pilots, has been on an ill-conceived, death-march strategy that the leadership somehow believes will get them closer to a release from mediation. Negotiations began in September 2006 -- a long haul by any perspective – but the clock was reset when a new union president, Lloyd Hill, was elected in June 2007. I don’t pretend to know the union’s strategy in these negotiations beyond what plays out publicly, but I do know that the Hill administration has made contract demands that are so far removed from reality that I question whether he is really representing the best interests of AA pilots.

With each union that files for mediation, my guess is the American pilots move yet another group down the pecking order for a release and thus the ability to engage in Self Help. The APA should be taking a clue from the Obama administration and its dealings with the UAW. The UAW’s Gettelfinger demonstrated a real understanding of that industry in balancing the interests of his members with the economic reality, in part by working to preserve wages and benefits of current employees by negotiating lower rates for new employees. But even that didn’t change the reality that, as the economy continues to collapse; the UAW is still not close to having moved far enough from work rules and wage rates that put the Big Three at a huge cost disadvantage in the global auto industry.

Finally, to the pilot leadership, I can’t imagine what possible benefit you would gain through strikes or other work actions that few airlines could survive. First, there is little chance the White House would allow a union at a carrier the size of American or United or Continental to actually go on strike and potentially threaten the economy’s ability to recover. No matter how labor friendly the new administration is, I believe that any union will need to make a pretty powerful case to the White House as to why a strike is more important than the recovery of the United States economy. Any union that can make a case that restoration of inflation-adjusted wages can be easily paid for by the airlines may have a chance, but that’s going to be a tough case to make.

I refer to the American pilots union in this example, but it applies to any large airline. Too much stimulus is potentially threatened by a strike in an industry as crucial to commerce as the airline industry.

Here’s my bet on where pilot contract negotiations will end up at the legacy airlines: With the Delta deal done under the leadership of ALPA’s Captain Lee Moak, the remaining negotiations will be completed in the following order: 2) Continental; 3) United (following the lead taken in the CO negotiations); 4) US Airways (assuming a final resolution to the seniority issues scheduled for the end of April); and 5) American (and perhaps only after a “leadership” change takes place.)

Congrats to Southwest for having put to bed their negotiation with multiple groups at reasonable rate increases.  With little management distraction, the airline can focus on finding needed revenue.

Legislation

Finally, there are legislative issues important to this industry that deserves color in the upcoming earnings calls. First and foremost is a reauthorization bill that will fund the FAA’s activities. A committed industry must find a way to fund enhancements to the air traffic control system. Everyone in the industry recognizes the need to make changes. Now we’re just fighting over who will pay for them. It’s time to move forward and for the various factions to present a united front on "who will pay what".

Second on the legislative front is Oberstar’s bill to evaluate airline alliances every three years -- a clear attempt to make the formation of these alliances increasingly difficult. Never did I think I would write that former AMR Chairman Bob Crandall and Minnesota Congressman Jim Oberstar are on the same page regarding a controversial commercial issue, but I am - and I am even writing it in the same sentence.

In an interview with the National Journal’s Lisa Caruso, Crandall actually says: “In my view, an objective observer would have to look very hard to find a way in which alliances have benefited consumers.” His remarks point to the “dominance” of slots at Frankfurt and Paris by the aligned carriers. Is this any different than the structure "Crandall built" in the US domestic market where carriers were reluctant to offer service between the hubs of a competitor? Absolutely not. Instead, the competition offered a menu of one-stop competing services that presented the consumer a choice.

Are we not to acknowledge that the air travel consumer in Toledo benefited significantly from the Northwest – KLM alliance that offered seamless connecting service to Amsterdam and points beyond? Wasn’t it Crandall that coveted a partner in Brussels to partake in these very same traffic flows? Does Crandall really believe that Detroit and Minneapolis would have multiple non-stop services to Amsterdam if not for the alliance? Does Oberstar really believe that Minneapolis would have the international service to Europe it does without the network of KLM and now Air France on the other end?

Crandall even makes the point that the foreign carriers have been the beneficiaries at the expense of US carrier interests. Crandall is the one that brought the concept of time-of-day departures to the networks of the nation’s carriers. This alone has contributed to a significant amount of the uneconomic capacity that pervades the industry today. Do we really think that all of the departures that “Bob built” were good for anyone? If we did not have alliances to begin filling all of the ill-conceived capacity deployed in Crandall’s domestic network, then we would have even fewer US carrier domestic departures than we do today – even after all of the cuts.

For a guy I admired, Crandall’s comments leave me perplexed, confused and confounded. Some of his fixes are on point, like a changed labor structure. But Crandall should accept some of the blame for an industry struggling today as his pit bull instinct toward competition became a blueprint to build an industry too big. Or maybe he should explain to airline employees that his blueprint caused an industry to hire too many people that now believe they are entitled to wages higher than the industry can pay.

More to come on this one.

Empathy for Ron Gettelfinger

What, Swelbar showing empathy for a labor leader? Yes. In fact, my feelings are not dissimilar to the emotion I felt for airline labor leaders a few years back, when the solvency of so many carriers was in question and some of the biggest went on to file bankruptcy. Trust me, no one wanted to be a labor leader in the airline industry following 9/11. Today, I’d bet that there is no human being that wants to sit in for Ron Gettelfinger, the damned-if-you do, damned-if-you-don’t President of the United Auto Workers (UAW).

On Tuesday, Fox.com posted a piece entitled: With GM's Wagoner Ousted, Should Union Head Have Met the Same Fate? In my view, absolutely not. In the early days of Swelblog.com I wrote a piece entitled Self Help in which I praised the negotiating strategy of the UAW. This was on October 11, 2007, long before the spike in oil prices, the freeze in credit markets and the downturn in the economy that has left consumers with little to no confidence in the future and contributed to a decline in consumer spending.

The contracts Gettelfinger negotiated at GM 18 months ago attempted to address many of the competitive disadvantages the US auto industry faced. Those negotiations resulted in, among other items: 1) freezing base pay for 4 years; 2) shifting a significant share of the burden of retiree health care from GM to the union; 3) creating a two-tier compensation structure in return for job protections for the current workforce.

Think about these terms. Unpopular? Anti-worker? Unsuccessful? Yes to all. But the new contract made significant ground in bringing about some of the necessary changes to a collective bargaining agreement born of decades of negotiation between the UAW and the Big Three carmakers and costs that had spiraled out of control. These were well-intended fixes to contractual language written when times were different – but the fixes allowed some historical language to remain. This was well-intended language that would only produce real benefit if the industry grew.

It is like pilot scope clauses: there is only value in the language when it happens. Some might argue this point – don’t scope clauses restrict airlines from even considering new routes/planes/partners when it would potentially violate scope – even when company growth presents itself? Only growth is not in the cards for U.S. auto industry, - or the US airline industry - at least not unless, and until, there is real change.

Just like the automakers, the legacy airlines continue to negotiate from outdated language. Most of these contracts were written when technological changes facilitated productivity improvements that could offset pay increases, and when targeted capacity growth would build airline markets where there was no evidence that the market could support new air service. At the time, collective bargaining agreements did more to ensure that labor would take advantage of technology change rather than to adjust work rules and expectations to account for the advantages new technology brought.

Unfortunately for the airline industry, there is no techological change on the horizon that will increase the speed of the aircraft in a meaningful way.

I have written many times here that the auto industry cannot make the necessary changes without a court-assisted restructuring. The same was true for the airline industry. The problem is that, even in bankruptcy, the airline industry still left decades-old and largely irrelevant language in their collective bargaining agreements. Bankruptcy was effective in dealing with the low-hanging fruit, but did not do enough to position the airlines for long-term success.  Simply, the flexibility to match the work force to the demand environment was not negotiated.

So here we sit with significant negotiations to be done at United, American, US Airways, Continental and AirTran. No labor leader at any of these carriers has stepped up the way Gettelfinger did 18 months ago when he was willing to challenge decade’s worth of old-labor ideas and ideals in return for better positioning GM in tomorrow’s world.

Lee Moak, the head of the pilots’ union at Delta, came closer than any other union leader in acknowledging that change was inevitable as the Delta-Northwest merger moved forward. Moak did what any first-mover in a merger world would do and negotiated the best deal for his members. The problem is that Moak did too good of a job given the state of international markets. I only hope he can hang on to what he negotiated.

We have new contracts getting done across the industry. Interesting and different mindsets at Alaska and Hawaiian have produced some very different agreements. Southwest ground workers have ratified a deal. Southwest has announced a tentative agreement with its flight attendants.

And Southwest this week revealed details of an agreement with its pilots that in my view will prove to be a mistake – with the company caving to the union and giving pilots too much specificity in scope. Southwest did show amazing restraint in agreeing to wage increases, but I had expected it to come without “handcuffs” on code sharing. With this contract, we can see quite clearly how Southwest is aging and facing many of the very same labor struggles that have long dogged the legacy carriers.

I feel for those employees that have “given back,” whether through concessionary contracts or at the demand of a bankruptcy court. But that doesn’t change the fact that the give back was from a level that was unsustainable and would have occurred, eventually, come hell or high water.

This current negotiating period is important to both management and labor. Hopefully, the airline industry will produce leaders like Gettelfinger that recognize that tomorrow has different challenges than yesterday, and that labor leaders have a crucial role in negotiating contracts that protect the workers who helped build the industry, while at the same time ensuring that US aviation can be competitive in the future.

Some call this approach “eating their young”. I call it smart. Because there is nothing that Gettelfinger and the UAW can do today to fix what was done 20 years ago. But labor leaders in the airline industry should do everything in their power to avoid the situation automobile labor now faces. Labor leaders who succeed in the long term will be those who set realistic expectations for their members, resist the urge to overpromise and, like Gettelfinger, recognize that change is inevitable and that labor can and should be a key player in making it work.

More to come.

The United – Aer Lingus Venture: The Chicago Tribune Perpetuating the Past

Since starting this blog and taking advantage of opportunities to be “media trained” over the years, I was told that I would never read the news the same again. How true.

I am a little late in weighing in on a March 16 story by Julie Johnnson in the Chicago Tribune: Clipping Union’s Wings; United – Aer Lingus Plan to Outsource Pilots on Overseas Flights, which I believe errs in just about every aspect in understanding what is really going on in the airline industry.

In the article, Johnnson suggests that the arrangement between United and Aer Lingus will spark an uproar as pilot contract negotiations begin next month. But what the author fails to mention is that the Airline Pilots Association (ALPA) knew of this deal long ago. And while I am not in the business of selling newspapers as the Chicago Tribune is, I do believe that negotiations that already stoke emotional fires do not benefit from stories that throw fuel on those fires.

I’ll start with the article’s assertion that the United-Aer Lingus deal would allow the airlines to “outsource” pilots and, in the process, clip the union’s wings. But this argument ignores the fact that the UA – AE venture is permitted by the UAL pilots’ collective bargaining agreement.

Indeed, there is no evidence to suggest that the collaboration between the airlines is equivalent to outsourcing or in any way a violation of the pilot agreement. Worse, the story goes further by suggesting that these flights would be flown by under qualified pilots.

The article also raises questions – unfairly in my view -- about safety, noting that it is unclear who would regulate an airline not based in the home country of a parent carrier. U.S. limits on foreign ownership would not apply because the partnership would be based overseas. The author’s raising of the safety issue is specious as established carriers like United and Aer Lingus would not put their reputations at stake by knowingly engaging in unsafe practices.

But the story does underscore a common slant of some newspapers that key challenges can all be distilled into labor issues. It is, perhaps, no coincidence that the story implies that the company is working against the best interests of it pilots, while failing to mention that United has begun paying bonuses to its employees for operational performance.

So let me say what the newspaper article didn’t. The real story is network economics.

In this alliance, United is considering Washington Dulles to Madrid for the initial route. Keep in mind that Madrid is a hub for Iberia, which is part of the oneworld alliance. And so the plot thickens, as industry observers know that several oneworld carriers (American, British Airways, Iberia, Royal Jordanian and Finnair) have applied for anti-trust immunity to fly between the US and Europe. United, meanwhile, is part of the STAR alliance. The majority of its transatlantic flying is gateway-to-gateway flying between North American carrier gateways and gateways of European partners.

The advantages of gateway-to-gateway flying are many. Foremost is the ability to sell not just traffic in the local market; but also traffic behind the US gateway to the European hub. And not just traffic from the US local market to points beyond the European gateway; but also bridge traffic traveling from points behind the US gateway to points beyond the European gateway.

The STAR alliance is not now well positioned geographically to serve Madrid and Lisbon and even some points in the UK and France because its primary gateways are located much deeper into the European market. So for United to make Washington – Madrid work by itself requires the carrier to rely only on local Washington – Madrid traffic and feed traffic to Madrid from cities connected to the Washington gateway. The route therefore has a limited pool of traffic and revenue as compared to Washington – Frankfurt or Washington – Munich. Moreover, the Washington – Madrid route is much different from Washington – London where the local market itself can support multiple daily flights.

Iberia currently serves Washington Dulles - Madrid. My guess is that United, and STAR, have identified this as a strategically important flight to its network. But as a stand-alone UA route -- with its inherent cost structure (labor or otherwise) – I would be surprised if United could turn a profit. All of which demonstrates how important it is for United and STAR to establish a presence in a strategically important city pair at a cost structure that will improve the economics of the route.

The United Pilot Collective Bargaining Agreement

Under the terms negotiated between United and its pilot union, Section 1 of the collective bargaining agreement explicitly states that, prior to entering into code sharing agreements with foreign carriers, UA will confer with ALPA.

The agreement further obligates United to negotiate with the prospective partner any labor protections that it deems appropriate to the circumstances consistent with its business judgment, including a commitment to negotiate as much reciprocal code share as possible taking into account limitations that are beyond the company's control.

In my read, there is nothing in the scope section of the UAL-ALPA contract that prohibits revenue sharing, cost sharing or branding, as long as the code share tests are met. The agreement also stipulates that the company cannot remove a scheduled non-stop flight from a joint international non-stop market unless it can demonstrate that the flight fails to pass what is known as “base rate of return” test – in other words a route must achieve pre-ordained financial results. Moreover, the pilots’ contract permits United or one of its affiliates to acquire as much as 50 percent of the equity of a STAR alliance carrier, contingent upon certain details.

Concluding Thoughts

Finally, the story concludes with predictable comments from the unions representing pilots at both United and American – the two carriers expected to face the toughest contract negotiations and where the unions are most openly antagonistic toward management. These negotiations capture some of the most difficult issues facing domestic airlines, where in many cases labor leaders have failed to acknowledge or address some of the core structural economic factors changing the industry. But the story, and its take on this development, would be greatly strengthened by providing more context regarding the global airline environment and the pressures on US airlines to build a truly global network and route structure.

The question, quite simply, is whether the US airline industry can compete with lower-cost and better capitalized carriers from around the world, particularly in this challenging global economy?

The reality is that United is doing nothing more than what it is permitted under its agreement with its pilots. Yes, there may be union leaders and airline employees who simply resent that the era of US dominance in global aviation is on the wane, but to ignore this reality does nothing to position any airline for a new global marketplace.

Perhaps the Tribune erred mostly by painting the challenges and opportunities facing United in the time-worn management-labor construct, rather than with the complexity the situation demands. The industry will change and change dramatically. And companies that fail to find new ways to create value through branding and revenue sharing and cost sharing could fail to exist.

Thinking about the Federal Reserve’s Beige Book

A couple of headlines in the past days got me thinking. The first is: "Emirates to pull A380 from NY routes on downturn". The second story is based on analyst reports from Kevin Crissey at UBS and Bill Greene at Morgan Stanley on the declines in unit revenue at Continental Airlines in February and the expectations that March revenue will come in even lower.

Think about it. New York is the first US gateway city for almost every airline. Emirates is not vacating the route but, is downgrading from the flagship A380 aircraft it flies in the world’s largest O&D market after just months in the market with the aircraft.

Add to that the report that Continental, which over the years has established itself as the bellwether on the direction/trajectory of US carrier unit revenue, announced unit revenue declines of 12 percent in February and an estimated 18 percent decline in March, which makes me wonder what’s coming from other carriers.

The Federal Reserve’s Beige Book

This brings me to the Beige Book, in which each of the 12 Federal Reserve districts (Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco) publish a report on current economic conditions eight times a year.

According to the Federal Reserve, the report is based on “anecdotal information” on economic conditions in each district based on reports from bank and branch directors and interviews with business contacts, economists, market experts, and other sources.

So What Does This Have to Do With Anything?

Now think for a moment about where airline hubs are located. For example, Continental’s Houston and New York hubs no longer provide the carrier the same geographic advantages they did even a year ago. Why? Because in the first part of 2008, the Houston economy was still soaring on oil priced at $100+ per barrel, and the New York hub served a still-humming community of investment bankers and financiers. One year later, the price of oil has plummeted by $95 a barrel and the government now rules the canyons of Wall Street.

I’m not saying that the Beige Book provides certain insight into the regional economies that house major airline operations, but there is a clear correlation between the Fed’s primary districts and the hub cities that define commercial air travel. I believe that individual airline financial performance in 2009 will be largely predicated on the strength of these local and regional economies. And they will be different -- and uneven results will occur.

That may be good news for US Airways. The January 2009 Beige Book reports deteriorating economic conditions in the U.S. Southwest, which should have a significant - negative -  impact on the carrier based in Phoenix. On the other hand, US Airways is the least exposed to international markets that were, until recently, considered the most lucrative revenue opportunity for US airlines. Isn’t it interesting that the legacy carrier most exposed to the rigors of the US domestic markets is seeing a different picture?

Concluding Meanderings

As is so often the case, macroeconomics rule airline markets. And geographic macroeconomics likely will have significant impact on individual airlines in 2009. Those carriers with a disproportionate presence in the Northeast U.S. may have a better year than those with a similarly situated route portfolio in the Southwest U.S.. Those with a US domestic presence may do better than those with an international presence. Those with a dominant Pacific presence may do worse than those with a dominant Latin presence. You get the picture.

The only thing that is increasingly clear to me is that some of today’s carriers are going to do distinctly better than others, thus making themselves better short-term credit risks. Those with better access to credit may be able to grow or acquire assets and take advantage of opportunities not available to competitors with riskier credit. And those with geographic advantages -- whether domestically or internationally -- may be best positioned to gain market share and competitive advantage this year. In this economy, the Beige Book might just provide a roadmap not historically relied upon.

Jim "Hell NO”berstar and Thomas K. Merton

 Jim "Hell NO”berstar and the Fear Mongers; Thomas K. Merton and the Unintended Consequences

Saturday morning’s headline in the Washington Post read: “Job Losses Could Drown Stimulus.” The headlines in the Wall Street Journal read: “Jobless Rate Tops 8%, Highest in 26 years”. Getting the FAA Reauthorization bill moving toward action on the floor of the House, Congressman Jim Oberstar does the unthinkable. He attaches ill-conceived language to the reauthorization bill that would make it increasingly difficult for airlines to form new, or maintain international alliances to augment revenue –whether those airlines with applications for alliances now under consideration, or current alliances that must win anti-trust immunity every three years.

The FAA Reauthorization bill is, in and of itself, critical to commercial aviation. It funds many of the operations and projects necessary for the effective functioning of the nation’s airspace, and also includes monies to implement NextGen technology to upgrade the nation’s air traffic control system. In an industry in which all stakeholders will benefit from enhanced efficiency, NextGen is critically important.

But the current version of the reauthorization bill does not come close to making this a priority. Instead it is a bill that serves primarily as a vehicle for the amendments that Oberstar and his labor constituents find appealing, including funding for US-based maintenance and aviation repair facilities; an initiative to legislate the Aviation and Safety Action Program (ASAP); and language that includes key elements of the Passenger Bill of Rights.

As I read what the House and Congressman Oberstar are proposing, I started thinking back on my courses in economics and public policy. And in this case, the law of unintended consequences comes to mind.

In the Concise Encyclopedia of Economics, Rob Norton writes: “The law of unintended consequences, often cited but rarely defined, is that actions of people—and especially of government—always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it”.

Some Background on the Subtitle

It was during the Delta-Northwest merger discussions and related testimony before Congress that I first began to pay close attention to Oberstar’s remarks and motivations. When asked if there would be any airline mergers, it was Oberstar who responded “Hell, no.” Thus my nickname for the Congressman, Jim “Hell NO”berstar.

Then it was the witness list of past critics of consolidation, including the Business Travel Coalition and others, who lined up to offer their “analysis” -- insisting that the world was coming to an end because the airline alliances would soon control over 90 percent of the activity across the Atlantic. It was this group that I dubbed the Fear Mongers. As the process continued, the one hit wonders were born.

Bands are often influenced by those that came before them. Unfortunately, “Hell NO”berstar and the Fear Mongers failed to acknowledge the sounds of Thomas K. Merton and the Unintended Consequences.

Thomas K. Merton

In a 1936 paper, American Sociologist Merton wrote the first meaningful analysis of unintended consequences in a paper entitled: “The Unanticipated Consequences of Purposive Social Action.” According to Wikipedia: Possible causes of unintended consequences include the world's inherent complexity (parts of a system responding to changes in the environment), perverse incentives, human stupidity, self-deception or other cognitive or emotional biases.

Merton listed five possible causes of unanticipated consequences:[3]

1. Ignorance (It is impossible to anticipate everything, thereby leading to incomplete analysis)
2. Error (Incorrect analysis of the problem or following habits that worked in the past but may not apply to the current situation)
3. Immediate interest, which may override long-term interests
4. Basic values may require or prohibit certain actions even if the long-term result might be unfavorable (these long-term consequences may eventually cause changes in basic values)
5. Self-defeating prophecy (Fear of some consequence drives people to find solutions before the problem occurs, thus the non-occurrence of the problem is unanticipated)

Of the five possible causes, ignorance and error are perhaps the most insidious. Oberstar has clearly demonstrated error in assessing the structure of the airline industry. Most recently, Oberstar insisted that the Delta-Northwest merger would lead to a domino effect of other mergers in the industry.

That certainly did not happen.

The Unintended Consequences

For whatever reason, the 8th District Congressman from Minnesota remains a loud voice on aviation issues. Perhaps, as it has been described to me, aviation is so far down the ladder that the industry is assigned the lowest common denominator when it comes to representation. When I compare the Congressional advocate voices of aviation to Congressional advocates like Bob Corker and the business acumen he has lent to the public policy debate on the auto industry, this airline industry is best described as suffering a leadership void.

In his analysis of Oberstar’s legislative objectives, Merrill Lynch analyst Mike Linenberg said: “The first major ATI agreement was implemented between Northwest and KLM in 1992 and became the basis for a major joint venture which as of KLM’s last fiscal year (ending March 2008) generated approximately $600 million of operating income on about $4 billion of revenue,” Linenberg said in commentary released on March 6: “The ATI agreement has been a huge positive for the growth in air travel to Minnesota (Northwest has a major hub in Minneapolis) and the company’s local employees, which, ironically are constituents of Representative Oberstar who hails from the same state.”

Linenberg continues: “Our view is that if airlines could operate like most other global industries and be allowed to pursue cross-border mergers, then there would be no need for alliances, and therefore, legislation like what is being proposed above would be unnecessary. But oddly enough, Representative Oberstar is also proposing another clause in the aforementioned FAA bill that would potentially make it difficult to achieve some of the foreign ownership objectives expected to be part of phase two negotiations of the U.S. – EU Open Skies Agreement.”

I am also reminded of a piece I read recently on American Airlines’ Negotiations website by Jeff Brundage citing the number of passengers American carries each and every day as a result of relationships with partners. Brundage writes that American carries 8,200 passengers each day from international feed, or enough to fill 73 MD-80’s. 73 MD-80’s represents approximately 25 percent of American’s domestic narrowbody fleet and approximately 15 percent of its total fleet. And this, despite the fact that American does not even have anti-trust immunity.

But if this is where we are headed, then organized labor’s mouthpiece Oberstar potentially causes employment in the industry to be cut yet again – not because of the price of fuel or a failing economy - but rather because of twisted logic being used in implementing public policy. The very thing Merton’s paper addressed in 1936. The Air Transport Association estimates that 15,000 airline industry jobs are at risk. I believe the number is significantly greater even before considering reprisals from the international community.

It is sad when all you can be is cynical when it comes to airline issues on Capitol Hill. In other words, let’s not make the most fundamental infrastructure architecture efficient because that might translate into an improved bottom line for the industry’s air service providers. Instead, let’s punish all things outsourcing even if it is in the best interest of a specific airline; and let’s be sure to legislate provisions from the Passenger Bill of Rights because that will surely aid all stakeholders.

Aviation labor, which has been a long time financial supporter of Oberstar’s campaigns, should be thinking long and hard about this. Unions are about dues-paying members. If Oberstar is successful in this effort, then labor may well have fewer members.

CONCLUDING THOUGHTS

It is true that the airline industry needs to get smaller just like banks and other far flung network-based industries in this economic environment. Past legislation and bad management-labor decisions have pushed the auto industry to the brink. Past legislation and bad labor-management decisions ensured that the US would be only a secondary producer of steel. If Oberstar wants to implement public policy that ensures that US commercial aviation is nothing but a feeder system to the more efficient global carriers, then public policy, like H.R. 915, should be passed. If labor wants fewer jobs as a result of their PAC contributions and inward thinking, then you succeeded in your lobbying efforts. But I am sure that is not how you will explain it to your remaining members.

At some point Oberstar and Congress must recognize the conflict of interest between consumers and labor. I thought the Obama administration is first about job creation, then job preservation. Not only does this bill work to reduce jobs it also has a detrimental effect on consumers as well through reduced service options, the loss of reciprocal frequent flyer benefits and increased costs to the consumer based on the failure to address issues fundamental to the industry’s success to name a few.

Ignorance, error and self-serving interests seem to be guiding aviation public policy yet again. Will we ever learn?

Sullying the Airline Safety Story

In my recent speech to the Aero Club of Washington, I said that I have seen plenty of reckless labor leadership in my day. And that I believe that the use of safety as a stick to create economic leverage for contract bargaining purposes – as the unions have done at United, US Airways and American -- is not just wrong, it’s contemptible.

That’s essentially what happened at Tuesday’s House Aviation Subcommittee hearing on the US Airways Flight 1549 accident. According to the Summary of Subject Matter, the hearing was to focus on safety issues including Pilot and Crew Procedures for Emergency Landings; Crew Training; Crash Survivability; Bird Strikes; Engine Design and Testing; and Bird Radar Detection. Nowhere in my reading was this hearing intended as a platform for employee compensation or airline industry labor relations. That, however was the story the media told.

Headlines like: “Sullenberger: Pay Cuts Driving Pilots From Job”;”‘Sully:’ Airlines Risking Safety With Cuts”;” Pay Cuts Put Lives at Risk – Hero Pilot”; “Hero Pilot Says Benefit Cuts Driving Out Experienced Pilots”; and “Airline Finances May Hurt Safety, Sullenberger Says” took one small piece of a day’s testimony and, leveraging Sully’s popularity, sensationalized the story. What didn’t make the headlines were the very safety issues the hearing was called to spotlight: the dangers bird strikes pose or the industry’s efforts to address the problem.

This morning, Ben Mutzabaugh blogging for the USA Today writes: Advances make airline crashes more survivable. This is the real story. Mutzabaugh quotes Kieren Daly of Air Transport Intelligence from a CNN interview: "the low number of casualties in both crashes [US Airways and Turkish Airlines] was testament to technical advances made by the aviation industry." As Daly tells CNN: "It is a tribute to Boeing and Airbus that their aircraft are so safe. Most accidents now are caused by single causes, like bird strikes, that you simply can't legislate against."

It appears to me that U.S. Airline Pilots Association, the union that represents US Airways pilots, is using Sully’s well-deserved celebrity to take their disputes with management public. Sadly, the mainstream press writes the labor relations story and no one talks about the advances in safety that also contributed to minimizing casualties.

Sullenberger argues in this testimony that the future of the pilot profession will be harmed by reduced earnings – a troubling reality for all airline employees in recent years as the industry has changed and simply no longer supports the same costs it used to. Today’s airline pilots are rightly frustrated, but until the market is such that passengers are willing to pay much more per seat thus improving the financial structure of the business, the airlines can only pay pilots what the market will bear. And that market is not the unsustainable wages and benefits paid at the top of the last boom cycle.

Keep in mind, too, that pilot salaries are pretty high compared to the norm – even after the reductions airline restructuring brought. Most major carrier captains earn well more than $100,000 per year. And pilot attrition rates are down.

I sympathize with the depth of some of the pilot pay cuts and I certainly sympathize with those airline workers who lost defined benefit plans in bankruptcy. But what the unions fail to tell you is that disproportionate pay reductions on many of their members is the direct result of language in respective collective bargaining agreements written over 40 years ago.

Among pilots, some of the pay reductions are the result of moving from the left seat to the right seat as airlines reduce capacity and get smaller – another effect is moving from a bigger piece of equipment to a smaller piece of equipment. It is the terms of collective bargaining agreements that set pay, with that for captains higher than that for first officers.

Maybe it is time to rethink how we pay pilots. Contracts that pay hourly rates based on the equipment a pilot flies may not fairly take into account other realities of flying today. In a maturing industry that does not promise growth rates like those experienced over the past 30 years, it is probably time to pay a salary so that downsizing does not disproportionately impact some pilot's pay more than others.

I have thought long and hard about writing this particular piece. But enough is enough. In no way am I insinuating that the actions by Captain Chesley B. Sullenberger III and his crew were not exemplary, professional or even heroic in their Hudson River landing on January 15, 2009. They were and more.

Mumblin’, Bumblin’ and Stumblin’ for Something to Write

It’s pretty sad when . . .

. . . the reports that US Airways will discontinue charging for water and soft drinks is the best news out there. Not just in the airline industry, but in any industry for that matter. Water for nothin’ and cokes for free.My guess is Southwest was more than happy to have US Airways charging for water and soft drinks. And that is the nature of a competitive market– what is good for someone in this industry may not be good for another.

For me, the best news out there are reports that the government is telling the automotive industry that its turnaround plans do not go far enough in addressing the structural problems of Detroit’s automakers. The Big 3 is about to become the Big 1.75.

What will that mean for the airline industry which already is suffering from a sharp decline in business travel?For one, it will probably throw a klieg light on the fact that U.S. airlines have too many hubs in the middle part of the country. That might provide incentive for the industry to actually rid itself of marginal hubs that have outlived their useful lives. And that could portend well for the underlying economics of the industry once the toxins are extinguished from the macro economy.

In other news, Delta flight attendants have come up with a seniority list they say embraces the important tenets of equity and fairness for the former Northwest flight attendants who joined their ranks following the merger. The problem is that the Association of Flight Attendants, which represents the former Northwest cabin crews, does not yet recognize the combined airlines as a single carrier. It is no surprise that the AFA is digging in its heels – after all, Delta flight attendants are not unionized and in fact twice voted down the union’s organizing efforts -- in 2008 and in 2002. Merging workforces is never easy and anxiety over relative seniority will only grow if further capacity reductions become necessary. Expect a tough battle when the AFA goes back for yet another unionization vote.

Speaking of capacity, we are now seeing more impact from the transfer of industry capacity from domestic markets to international that began in 2004. All trends point to a very tough international environment, particularly for transatlantic services. Deteriorating fundamentals at British Airways have been in the news off and on for the past year. Now even Air France and KLM are cutting capacity. Lufthansa just keeps shopping but being the smart carrier it is – a deal is a deal and they will not pay too much.

Pacific region fundamentals are holding up, but China could change that equation. At a time that the West really needs China to increase consumption, that trend now is on hold as the Chinese economy continues to sicken. Economic problems in India that took route last fall continue to grow. Now the economic weakness is beginning to impact airlines throughout the region. Japan Air Lines is looking to its government for a $2+ billion dollar handout and economic ills already are beginning to hurt financial performance at Singapore and Qantas and Cathay Pacific.

The Middle East is perhaps the only economic bright spot for the airline industry, where both fledgling and well-financed carriers continue to grow and take delivery of new equipment, although not without occasional talk of potential mergers. And while Latin America shows pockets of strength, don’t forget that more than half of that region’s demand is focused on Mexico and Brazil.

In the US, we actually have some labor deals getting done. Earlier this year, Southwest ratified an agreement with its mechanics and announced an agreement in principle with its pilots. This month, Alaska Airlines announced a tentative agreement with its flight attendants with a vote scheduled for March. In each case, the contracts demonstrate the difficult state of labor negotiations in the industry. A prime example is the Southwest pilot agreement that attempts a delicate mix of pay increases, productivity measures and new scope restrictions.

Finally stock prices seem to be suggesting that another round of bankruptcy filings might just be around the corner. It is hard to totally discount what market values seem to tell us. Air Canada finds itself back in the news as a bankruptcy possibility following the financial engineering done in the prior bankruptcy that leaves the airline with nothing to fall back on this time around. At this point it looks like the only potential safety net is the Canadian government, which seems intent on increasing the ownership limit to 49 percent, but it is too soon to say how that will ultimately play.

Maybe the current economic Armageddon will generate interests in increasing the ownership limit for U.S. airlines– which could provide them a source of new capital and the opportunity to minimize expenses and leverage economies of scale. Most important, such a change would force recognition that competition for competition’s sake at home does not make for an industry structure that can grow and prosper.

Last week I had the opportunity to speak to the Aero Club of Washington and addressed the legislation limiting airline alliances that sponsors -- visionary Rep. James Oberstar among them – support based on misguided arguments of anti-trust issues. To make the point, I quoted economist Henry George who said:“What protectionism teaches us is to do to ourslves in time of peace what enemies seek to do to us in time of war”. George is absolutely right when it comes to those regulating the U.S. airline industry, which in their protectionist views have largely done what George suggests.

This time is different. Very different. The past is less prologue. Those companies that revise history will be best served because simply, you cannot do business today with yesterday’s mindset and practices and hope to be in business tomorrow. This will prove to be true in the airline industry over the next 18 months.