A Look at US Airline CEO Compensation Through a Different Lens

'Tis the season when we will begin buying tickets to the Fourth Annual US Airline Executive Compensation Kabuki Dance. The airline dance follows the US CEO Kabuki Ball that has been playing out on Wall Street since the T.A.R.P. monies began to fill the coffers at many investment banks. Then we learned that some $18 billion of those taxpayer monies were used to pay executive bonuses in a year where the US banks clearly underperformed. Yes the Wall Street number starts with B.

Ever wonder whether: if the bankers had worked half time would they have lost only half as much? And based on losing half as much, they probably would have made more than the $18 billion.  But I digress . .

Last week, Andrew Compart writing on Aviation Week’s blog, Things With Wings, posted a piece entitled Executive Pay And U.S. Airlines.  After reading Mr. Compart’s piece, I was left wanting more – a deeper look at airline CEO compensation. 

According to the Institute for Policy Studies and United for a Fair Economy, the ratio between the average compensation of U.S. CEOs and the average income of U.S. workers was 344-to-1 in 2007. How, then, does CEO pay in the US airline industry compare to compensation for airline employees? 

In Mr. Compart’s analysis of executive pay at the 10 major US airlines operating independently at year-end 2007, he includes among executives’ salaries, bonuses, stock awards, stock options, payments to savings plans, and other income and rewards reported in federal filings. As Mr. Compart points out, a CEO’s salary typically accounts for only 20 percent of his or her total compensation.

I turned to MIT’s Airline Data Project to explore a bigger picture, looking at average salary and benefit packages for each the employee and pilot workgroups at the same 10 airlines.  Then I did a simple ratio analysis by company.  One technical note: per diem pay should have been included for any employee groups that receive it; however the way this date is reported makes it impossible to do an exact accounting.  Therefore, per diem expense is excluded for employees and pilots and would have been included in other compensation for the CEO.

In 2007, CEO compensation ranged from a high of $10.3 million at United to a low of $800,000 at jetBlue.  At $10.3 million Glenn Tilton’s pay is 142 times that of the average worker at United.  The 142 multiple is 41 percent of the average multiple of 344 experienced across all US industry in 2007.  The simple average for the 10 airline grouping was 63 times the average airline worker, or 18 percent of US multiple of 344.

The employees at Southwest and American have the highest average employee compensation among the airlines studied, with ratios at 14 and 57 respectively.  Of the six legacy carriers operating in 2007, Delta had the lowest ratio of CEO compensation at 52 – a year when Gerry Grinstein passed the gavel to Richard Anderson.  Among the LCCs, AirTran had the highest ratio at 53 times.  It is interesting to note that in 1980, the multiple of CEO compensation to average worker compensation was 40. 

Among pilot groups, United’s CEO compensation was 68 times that of the average United pilot’s compensation.  The average for the 10 airline group was 29 times.  jetBlue had the lowest at 6 times, a year when Dave Barger replaced founder David Neeleman as CEO.  Among the legacy carriers, American had the lowest ratio of CEO compensation to average pilot compensation at 23 times.

Concluding Thoughts

The relationship of executive compensation to worker compensation has been a measure used for decades by those on both sides of the “is it fair?” debate.  I am not trying to answer that question. What is relevant is the perspective and context as it pertains to the US airline industry.  It is right that airline executives have a large performance component of their compensation.

CEO and executive compensation is volatile in part because the money a proxy officer pockets is risk-based and therefore highly dependent on market conditions.  Most employee compensation, by contrast, is guaranteed and has very little risk so the denominator (employee pay) does not deviate to the extent that the numerator (executive pay) does.

If nothing else, this simple analysis underscores what I’ve long preached: on balance, jobs in the airline industry pay quite well as they relate to jobs that require similar training and experience across the employment spectrum.  And too often, that fact gets lost in the debate.  

Disequilibrium Everywhere; Stimulus Nowhere

It will be clear soon as to why my writing time has largely been invested elsewhere.

I have been thinking about a theme for this post for a few days as I criss-crossed the country. I started considering “Pigs at the Trough” as a theme as I read story after story about the pork finding its way into the various versions of the stimulus bill. I then moved to something like, “For Organized Labor: Will It Be OHbama or NObama” as it pertains to the controversial “card check” legislation? Then it was something like, “And this Little Piggy Cried Wee, Wee, Wee All the Way Home” after reading about Jim “Hell NO”berstar introducing legislation to block additional immunization of airline alliances and explore ways to undo those that exist.

What a sad state of affairs this country finds itself in. What a sad state of affairs airline labor finds itself in . . . where union leaders have time and again failed to lead because they’ve put politics and self-promotion first rather than face hard truths and labor’s role in improving productivity and helping turn around the long decline of the domestic airline industry. What a sad state of affairs the US and global airline industries find themselves in because of patronizing, parochial protectionists like Oberstar whose antiquated, short-sighted views fly in the face of everything we know about the industry’s current financial challenges and competitive burdens.

I am not only disheartened but dismayed. There is plenty of blame to go around. Some goes to the airline executives that have returned to cutting fares in a misguided stimulus plan to fill seats – and too few controls on the number of cheap seats up for sale. There is little to “stimulate” when you consider that some major portion of historic demand for air travel was created by consumer access to easy credit – whether through the new Mastercard that arrived every few months in the mail or the willingness of Americans to take out a third home equity loan to finance yet another family trip to see Mickey Mouse.

By looking at the traffic, capacity and load factor data for January 2009 it becomes pretty clear that the aligning of supply and demand still requires work. Moreover, a realignment will have to occur in international flying as the economies in Europe and Asia particularly are sick and getting sicker.

What is it going to take to get the politicians – whether those in Congress or big labor– to understand that the US airline industry is headed down the very same destructive path that the US auto industry is headed? Many airlines did the right thing last year when, faced with record fuel costs, cut capacity and made some hard choices about pricing and costs. That was an industry that demonstrated discipline with conviction. But to work for the long term, capacity discipline must be practiced with pricing discipline too. After all, that is the theory at work with the industry’s too little, too late recognition that it is the revenue line holds promise for profits.

In my view, the system should have let the weaker airlines liquidate because, in the longer run, they aren’t strong enough to survive. Just look at US auto industry, which supports too many brands; has too much manufacturing capacity; carries legacy labor costs that can possibly be sustained only by a growing industry; and is modeled on an outdated demand curve built on cheap oil and readily-available capital.

The airline industry, too, has too many brands; too many hubs; a product priced below cost; and a high-cost, inflexible labor construct that limits a company’s flexibility and ability to adapt the size of the operation to economic realities. Current contracts and labor assumptions force airlines to pay nothing short of ransom to make necessary operational changes, and only because that is the way it has always been done. Just like the job bank provision in the auto industry.

To bet on a profitable 2009 just because of the price of oil today is, to me, nothing but an attempt to mine fool’s gold. I get the math..... On the other hand, liquidating an airline or two, and investing the proceeds in gold could be a proposition with some upside for airline shareholders.

The Virtuous Circle of Value Destruction is taxiing into position to prepare for a rendezvous with history – I fear.

In Dallas/Ft. Worth: Compare and Contrast; Contrast and Compare

This blog has made no bones about its fascination with airlines in Texas generally and those in the Dallas Metroplex specifically. This past weekend’s post on Southwest Airlines ranks among the most widely read posts ever on Swelblog.com. Despite recording it 36th consecutive year of profitability, many are writing opinions on Southwest that are very different from those we have historically come to know.

I have been traveling or otherwise less connected this week and I am behind on my reading.

But I was glad I was sitting down when I read a Sunday column from Mitchell Schnurman of the Ft. Worth Star-Telegram on Southwest’s cross-town competitor, American Airlines. The title of Schnurman’s piece: Things are looking up at AMR. Schnurman takes a look back at the numerous management actions undertaken by the legacy carrier’s management absolutely necessary to position the high cost airline for a better tomorrow. For what seems like a very long time, there have not been many positive stories written about American, its prospects or its management.

Schnurman is correct that there has been a lot done at American. And there remains a lot more to do. If AA had not taken the actions it has since its 2003 restructuring, Schnurman would have written a very different story. A story that might have been reminiscing rather than thinking that tomorrow will be better.

The compare and contrast as we begin 2009 is very interesting. Particularly in the Dallas Metroplex where at least one or two of 2009's most impacting aviation stories will likely be written.

“South by Southwest”: A Theme of Mistaken Identity; Deception; or the Airline’s New Reality?

Hitchcock’s “North by Northwest” title offered no clue about the movie’s content either. It has even been said that it is an “anomaly and a clue to the absurd, confused plot where no one is who they appear to be.” “South by Southwest” is an anomaly at least from the growth story that has defined its corporate life. But a confused plot – no. It is nothing more than the reality this blogger has been writing and talking about for years. There are simply few profitable route opportunities even for those with very low unit costs. And nobody really wants to acknowledge it.

Three airline earnings calls down. More to go. The general consensus is that the fourth quarter of 2008 would result in deep losses as would the first quarter of 2009 largely due to “hedges gone bad,” as well as the fact that the two quarters define the shoulder season for this industry and the fact that demand in this new world is not fully understood. Jamie Baker, airline analyst with J.P Morgan, went as far as to say to a reporter: "Out of respect for our clients and managements, we do intend to show up for work during earnings season, in the event anything interesting should occur." Baker went on to say, "Our suspicion is that nothing will."

I have agreed with Mr. Baker on many points over the years. But I do not agree that this quarter’s calls are lacking in storylines. Items of interest have emerged from this week’s calls with United, American and Southwest that will prove important as 2009 unfolds. In fact, they may prove to be among the most important stories -- ones that dictate the evolution of the North American marketplace as we know it.

Cost per Available Seat Mile (ex-Fuel)

This year, non-fuel unit costs in a time of decreasing capacity will test management at all airlines. Managing unit costs of any kind, in any network industry, in a shrinking capacity environment challenges the best managers even in the most favorable economic conditions. Between United and American, we heard two very different stories.

United demonstrated excellent non-fuel CASM performance during the quarter, reporting that it will be able to manage 2009 costs at something less than a 3 percent increase. On the other hand, American pointed to sharply higher non-fuel CASM performance as its capacity shrinks further and underperforming pension assets add to the carrier’s numerator. For 2009, its non-fuel CASM is expected to increase more than 7.5 percent.

Yep, it is one thing to talk about managing unit costs at American and United – two carriers that have been forced to rethink many old operating practices as options for cost cutting dwindle. Yet, it is an entirely different thing to think about Southwest sans growth. I’m talking about the “G” word. Growth is the bedrock strategy that arguably has been the single most important component of the company’s ability to build – and maintain – its enviable culture and low unit operating costs. Growth does many things: moves a pilot from the right seat to the left seat; allows a flight attendant to have weekends off; and even masks cost mistakes in the short term.

A Redrawing of the Competitive Landscape?

A Southwest in capacity retreat – albeit only 4 percent worth – is a very different story than the one written between 2002 and 2006 when the carrier grew at the expense of the crippled network carriers. And it is a very different story than the one that sets Southwest apart from the industry’s competitors: its low unit costs, ex labor, ex fuel. Yes, its "hedges gone good" made Southwest nothing more than a "flying trading desk" since 2004, a carrier setting profitability records while on the Airline Growth Hormone (AGH). Now it is time for the airline to be something very different.

I admire Southwest CEO Gary Kelly. I, and others, acknowledge that there is no harder CEO Job in the global industry today because the storybook company must now remake itself just as the network carriers were forced to do. Southwest must undergo surgery as capacity shrinks. And it cannot do cosmetic surgery; it must do invasive surgery.

The Revenue Line

Southwest anticipated that it would have to begin a process of weaning itself off of AGH. Kelly has done what any good CEO would do in fully anticipating that cosmetic surgery was not an option. He and his team focused on the revenue line - and they have delivered good results. Despite Southwest’s dominance in frequency in the markets it serves though, the airline was still pricing itself more than 40 percent less than competitors in common origin-destination markets as early as 2000.

Since that time, Southwest has worked hard to increase fares as its cost advantage was eroded by the restructuring network carriers undertook – a restructuring forced in part by Southwest’s competitive challenge. I predict that Southwest will still be pricing fares well below its competition across its network for years to come. And therein lies the rub.

For a carrier that is so reliant on low unit costs to offset its historic pricing strategy (read: low non-labor unit costs,) a shrinking of capacity only makes the carrier’s job harder. As I have written and lectured, the carrier’s costs will only increase due to structural issues that define the few remaining markets without Southwest or low-cost carrier competition.

Tables Turning?

Much is being written about fares on the decline. While I am not happy to hear this, the economic headwinds and the need to manage revenue in the shoulder season probably drive pricing actions – even with significantly less capacity. So, let’s think about this from a different point of view.

For the past 15 years, Southwest has largely dictated pricing actions in the US domestic market. Yes, up until the late 1990s, the actions were mostly predicated on the carrier’s limited geographic presence. But today it can be said that Southwest is at least virtually present (including highway access) in US markets that comprise 95+ percent of domestic demand.

Southwest absolutely needs to raise fares – or find other revenue. The carrier can now be said to have a cost disadvantage - particularly its labor costs. The other carriers in Southwest markets can cross-subsidize their base fares with ancillary fees -- fees that Southwest has said it will not charge. My guess is that the network carriers are now setting the base fare price and are more than happy to decrease base fares to keep a non-hedged Southwest in detox as it gets treatment for AGH and the fact that it is no longer a flying trading desk.

Just Another Airline?

Of course, Southwest is anything but just another airline. But it is about to have to deal for the first time with issues that other airlines have struggled with for two decades, in many cases contributing to the undoing of their respective cultures. This is particularly true of carriers that had weaned themselves off of AGH in the late 1980’s, even when AMR’s-revered CEO Bob Crandall was preaching “time of day” service was the only answer to tomorrow’s success.

How does Southwest tell its workers that it cannot afford increases in its union contracts? Can it generate enough revenue to close its historic pricing gap? Can it even consider pulling out of markets that are economically challenging given its long track record of staying? Can Southwest be a US domestic player alone? Can it be only a US provider for international revenue sources? Can it actually reduce costs and restructure its operations without layoffs or other changes that threaten the culture it has built?

Concluding Thoughts

I have been on the other side of Southwest issues for years. So with all due respect to Mr. Baker, I think there is a hell of a story to come from the earnings announcements. A shrinking Southwest is a big part of that story– one that has the potential to reset the many arguments that have been used to demonstrate US domestic competition. In fact, it potentially resets many myths surrounding the US’s most luved carrier.

Finally, maybe finally, the story will read that the network carriers are responsible for driving down fares and promoting competition as capacity goes “South by Southwest”. How do you think Jim “Hell No”berstar and the Fear Mongers will feel about that?

Much more to come.

Part Trap(ed); Part T.A.R.P.(ed)

This post is in part influenced by the seemingly infinite depth of government pockets for the banks as demonstrated by the inclusion of Bank of America under what I’m calling The US Nationalization Bank. And the de-leveraging effect – and the resulting need for even more government capital - continues to be a headline story as banks announce their quarterly losses. A constant reminder that we are far from out of the woods.

In addition, this post is influenced in part by the upcoming earnings season for US airlines. Wall Street’s best analysts already suggest that 2009 may be a very good year for the industry. But I’m uncomfortable about some of these predictions which are based on how far the revenue line would have to fall before it overwhelms the savings in fuel, without giving appropriate consideration to demand.

John Maynard Keynes and the Liquidity Trap

As the stimulus story unfolds, we are reminded that Keynesian economics are back in vogue and more important than monetarist policies in helping to pull the US out of this downturn.

For those who remember Economics 101, Keynes theory promotes that C (consumption) + I (investment) + G (government spending) + X (exports) – M (imports) = National Income. We have talked many times here about the virtuous circle of airline prosperity. Keynes also held that there was a virtuous circle: the flow of the money supply whereby one person’s spending becomes another person’s income, propagating a cycle where consumption drives incomes, drives more spending, and so on.

Keynes first made a name for himself during the Great Depression based on the other side of his theory in which he argued that savings or investment slows consumption, contributing to negative economic output, or a recessionary environment. According to Keynes, a depression occurs when a recession falls into a “liquidity trap”. A liquidity trap occurs when consumers curtail spending to conserve cash; banks do not loan or businesses do not see a need to borrow; and there is little investment because prospects are not promising.

From Keynes perspective, government intervention through increasing the money supply is the solution to the liquidity trap, allowing the virtuous circle to begin anew.

Fear and Greed; Greed and Fear

It is said that fear and greed are the two primary psychological drivers of investing and the markets. In the past I have referenced the concept of the velocity of the money supply, where greed has been at the epicenter for some time. Greed is bad in that it ultimately leads to asset bubbles as emotional buying supplants proven practices of smart buying. But just as devastating is fear which leads to emotional selling and unintended consequences for the macroeconomy.

Is T.A.R.P. a Trap?

There are many smart economists out there assessing not only the credit crisis and all things banks but also the policies and programs that may succeed in steering the country back onto the virtuous circle of economic prosperity. In this space, I’ve discussed the deleveraging of banks and the multipliers at work as banks do just that.

For simplicity’s sake, let’s think about in terms of a multiplier of 10. The banks have stepped up their timetables to announce their financials – in this case likely multi-billion dollar losses.

In the banking world, these losses should be multiplied by 10 to determine the effect on the money supply. Assume the banks announce pre-tax losses of $100 billion for the current quarter, a good starting point because the initial outlays from T.A.R.P. tranche #1 have been made. So, absent even more government intervention, a $100 billion loss would have another $1 trillion impact on the money supply. Bank of America is the most recent example. Having already announced losses greater than expected, the government hands over $20 billion more in T.A.R.P. funds and agrees to backstop even more.

The problem is that the U.S. government keeps writing checks we cannot afford. The question is whether we can afford to not write the checks? A supply of money with no velocity does no one any good. The unintended consequence is consumer fear. And cautious consumers may lead to a hoarding of disposable income except for items that are essential for day-to-day living - thus perpetuating a self-fulfilling prophecy.

What Does Any of This Have to Do With the Airline Industry?

The success of the airline industry is unequivocally tied to the health of the macroeconomy.

I cringe at recent media reports that Delta Air Lines expects industry revenue to shrink 10 percent in 2009. For Delta alone, that implies a revenue loss as high as $2.5 billion. The reports then go on to paint a rosier picture based on fuel costs that, at current prices, could save Delta as much as $5 billion this year. Does that mean a $2.5 billion profit for Delta and windfalls across the industry?

Ain’t gonna happen.

Time will tell. But I’m not ready to jump on the bandwagon that is predicting airline profitability just yet. Yes, the industry’s efforts to cut costs and control capacity have impressed analysts and that could be a boon for airline shareholders who have been on a wild ride in recent years.

But a closer analysis through a Keynesian lens tells a more cautious tale. History provides a prism to make learned predictions. Keynes would say that a Depression is the result of a recession that fell into a liquidity trap. We may not be there yet, but I fail to see how the other tools in Keynesian Theory could be used to stimulate economic activity today. Unless consumers begin to feel, and act, more optimistic, airlines should not count on a stronger demand for their product. As the industry continues its remake in response to an ever changing economic environment – and capacity likely to shrink further – it is increasingly difficult to predict what 2009 will bring for U.S. airlines.

I am not confident that we really understand the true demand for air travel because, historically, the numbers include a large component of emotional, non-core demand. A fair question is whether yesterday's emotionally purchased air travel should be included in today's demand calculus or not? Therefore, until we can fully understand the true demand for air travel, predicting widespread profitability for an industry subject to the every ebb and flow of the economy seems to be walking into a trap. A trap that sets off a series of others - I fear.

And we have not even started discussing what all of this might mean for some of the credit card issuers. The enabler of the consumer-led expansion. That too is for another time - I fear.

Prioritizing US Airline Industry Needs for 2009

With news being made on every move the President-elect makes during his first days in Washington, I think it appropriate to prioritize airline issues that Swelbar sees as important for 2009. I do not make resolutions. If I did, many of this year’s items would be nothing more than broken promises from years past. However, we have an incoming administration that promises change. Until proven otherwise, I will take Obama at his word.

This week, we began to get some insight into his ideas behind a stimulus plan. Infrastructure remains a key component. It is nice to see tax cuts comprising a significant component of his plan which promise immediate benefit; conversely, investments in infrastructure likely will serve the goal of long-term stimulus. Of course the Supply-siders will be quick to remind us that tax rebates are nothing more than borrowing from tomorrow to pay for potential benefit today. Isn’t this all that we have been doing over the past month or so anyway? And I digress yet again . . .

In setting airline industry priorities for the new year, my ranking criterion is based on my belief of what benefits the most industry stakeholders. These are airline employees, travelers, manufacturers, airport operators and their vendors and, of course, shareholders. Theoretically, the interests of these varied stakeholder groups combine to create a virtuous circle of prosperity. But it’s safe to say we have had a disconnect in that circle going back as far as 2001, if not before.

Few industries are as vital to the overall economic strength and vitality of the economy as the airlines. It is an industry in the headlines every day, and in its role in moving people, goods and services is one critical to America’s financial recovery as grease on the economic wheel. So Mr. President-elect, without a stimulus package that serves the airline industry there is no velocity in the new administration’s economic policies.

While some of the stimulus ideas may be nothing more than good money chasing a bad idea, the chief goal must be to reinvigorate the velocity of the money supply. It’s about speed. The airline industry sells speed. And the industry needs a visionary push to operate at its maximum potential speed.



Priority #1: The Air Traffic Control System

With flight activity expected to triple by 2025, there are few issues that impact stakeholders as much as our ability to achieve a robust, scalable and more efficient air traffic system. Mr. Obama has promised to review each and every line item in the federal budget. When it comes to the Federal Aviation Administration (FAA), there should be more than enough fodder to make a significant down payment on the estimated $40 billion necessary to implement the new air traffic control technology that does not rely on a 1950’s era cathode-ray tube.

Yes, there is more to making the system efficient than technology alone. It requires ridding the system of inefficiencies that have plagued the industry for much of the past 50 years. In this case the miracle of compounding does not produce a good result. We’ve already seen that play out in the auto industry. And it’s not unlike what the airlines have been (un)doing since 2002 in their efforts to improve operational productivity and efficiency– all the while fighting a grossly inefficient infrastructure.

There is not one major stakeholder group that would not benefit from a permanent fix to the aviation infrastructure.



Priority #2: Aligning Labor Interests with Other Stakeholder Interests

For decades, the industry giveth at the pinnacle of an up cycle only to taketh away on the way down. This repeated practice has not served any stakeholder group well. I am not suggesting ESOP-like arrangements that were negotiated in the early days of deregulation. But I do believe that performance-based pay structures that include some component of risk for failure to perform will prove essential to strengthening the industry in the future. It could come in the form of stock grants, warrants, or liquidating preferred stock plans that are paid down with earnings, each in conjunction with meaningful profit and gain sharing.

The first goal of airline contract negotiations should be to begin the process of realigning the interests of management and labor in a compensation system that works for the long term and escapes the volatility that has resulted from pattern bargaining. All executive compensation plans are based on designs that reward performance. If at-risk pay is good for executives, then so, too, should metrics be used to institute variable pay that will reward performance throughout the organization.

What makes this a very difficult task is that management will always have more total compensation at risk. That is the nature of the beast. One example of a plan that had some success was Eastern Air Lines Variable Earnings Plan (VEP) that was put in place in the late 1970s. Depending on Eastern’s level of profitability, earnings were adjusted between 96.5% and 103.5%. In a Time Magazine article in February 1977 (‘Moon Man’ Turns Eastern Around), Eastern CEO Frank Borman credited the plan as one way to break "the almost blind acceptance that annual raises are expected regardless of company performance."

Thirty-one years later, the industry has still not figured it out. Therefore it should be a top priority to break this pattern. Volatile prices are unsettling in commodity industries – and the US airline industry has become a commodity industry. Beginning in late 2000, volatility came in the form of decreasing fares. Today, volatility comes in the form of oil prices. In the future, continued volatility in labor prices could prove disastrous because there are no other areas on the income statement that can cross-subsidize labor costs that are above what the market will bear.

Stable and predictable labor costs benefit all stakeholders – even employees. Employees continually focus on downside protections. They should also be thinking about upside protections as well.



Priority #3: An Energy and Environmental Policy

I fear the oil story is far from over. An amazing ride up the curve and a hair-raising ride down in the span of five months time leads me to believe that this story’s final chapter has yet to be written. Oil’s stark and rapid increase made it very clear that the world has changed and will continue to change. Worldwide, new forces drawing from a finite oil supply led to a fundamental alteration of the demand for oil – one that is not yet fully understood.

Historically, a rapid drop in oil prices is at least partially explained by an increase in either the supply of oil or a meaningful increase in refining capacity. Neither explains the plummeting drop in the past few months. While capacity levels are increasing, refiners continue to operate in hurricane alley, vulnerable to political unrest and violent weather. We sit one storm away from spiking prices again. Consider the last two weeks alone, when the price of WTI crude oil increased from $30 on December 23 to nearly $49 per barrel on January 6.

Clearly, there are many other benefits to addressing our energy needs -- national security high among them. The President-elect has put new energy policies on the priority list for his administration. I only hope that he gives it the necessary focus so that the U.S. begins to be more self reliant for its fuel needs, through increased exploration and production and through developing alternatives that will help dampen the volatility that has characterized the oil market since 2004.

Obviously, improved fuel efficiency also promises significant environmental benefits -- an increasingly important issue in commercial aviation. Modernizing the air traffic control system will help, as will creating a durable and sustainable financial model that permits airlines and manufacturers to invest in “green” technology and more environmentally-friendly aircraft.


Priority #4: The Customer

To date, the consumer has been the only clear winner in the deregulation experiment, which lowered fares to the point of making air travel accessible to the masses. But in most cases, the customer’s travel experience has suffered over the last few years.

With the key to a healthy industry beginning with a healthy demand, airline customers stand to gain from the reforms I advocate. Clearly, travelers benefit from better dependability and reliability that ATC modernization will promote, as well as more stable pricing that would result from a continued focus on cost controls, efficiency and fuel savings. The intangible benefit, in my view, comes from the real prospect of a better travel experience for passengers that will only be possible when the airlines have the financial ability to invest in the improved planes, cabins, amenities and services demanding customers want.

That said, the industry sure as hell does not need the so-called “Passenger Bill of Rights.” The last thing the airlines need is another layer of legislation and regulation. Investments in infrastructure will go far to solve air travel problems associated with overcrowded airspace and inefficient controls. But only then, if then, should the government consider further burdening airlines with legislative “fixes” – many of them addressing problems outside the airlines’ control.

But as fares increase; customers pay more for the services they want through “unbundling,” and fuel surcharges become the norm, it is incumbent on the industry to make the customer a focus . . . a very sharp focus.



Priority #5: Foreign Ownership and Consolidation

As the new administration takes its seat, negotiations are underway on Phase II of the US – EU Open Skies Agreement, which could permit foreign carriers to take a larger ownership stake in US airlines than the current statutory limit of 25 percent. Look at virtually any industry that is forced to compete in the global marketplace, and foreign ownership is nowhere near the issue it is in the US – or Europe - or Asia for that matter. Hell, Anheuser Busch, a company with a much stronger US brand than any airline flying today, was sold lock, stock and barrel to Belgian-Brazilian brewer InBev.

Alliances are nothing more than Band-aid fix to a problem that requires a more lasting solution. The global airline industry is amalgam of regional brands. In truth, the global airline industry is an amalgam of sub-regional brands, because anti-trust laws have largely prevented the creation of true regional brands. Now, with the world’s geographic regions already harboring more carriers than the market can support – all in the name of competition – the industry is pursuing these alliances as a makeshift to do what market forces require.

Europe is quickly becoming a three-carrier continent with a couple of LCCs in support. The US is consolidating more through shrinkage than by sub-regional brands joining hands. Delta-Northwest was just the beginning -- and provided a damn good blueprint on how to deal with the thorniest issues from past mergers. The question remains, which combination comes next?



A Concluding Thought

The US airline industry is not asking the government for a handout or a bailout. But the industry must work with the government on the problems and priorities unresolved from years gone by. It will take a commitment to get it done, and the effort will only succeed by addressing each of the issues this short list of priorities outlines. Only then will the US airline industry be in the position to benefit each and every stakeholder – for the long term.

And Mr. President-elect, until the ATC and other aviation infrastructure issues are fixed to the industry’s satisfaction, you might want to relieve the airline industry of its disproportionate tax burden -- as long as you are printing money for others of course.

In Reality, There Was Only One Airline Story in 2008

Oil that is, Black Gold, Texas Tea.

This is the time of the year when many stories will be written on the top happenings in the airline industry in 2008. The economy is certainly an issue as well, but would economic conditions be what they are without the volatility in the price of oil and the transfer of wealth into the hands of a few that occurred as a result of the price rise? The volatility in the price of oil had a significant negative impact on the velocity of the global monetary system’s money supply. After all it is the combination of money in the system and the velocity of that money moving within, and throughout, the system that lies at the heart of the current economic crisis. But I digress……….

While the price of oil is some $110 per barrel off of its high set on July 11, 2008, the average “in the wing price of jet fuel (price of a barrel of crude plus the crack spread, or the cost to refine crude into jet fuel) will be on average $125 in 2008. That compares to “in the wing prices” of $90+ in 2007 and $30 in 2002 when the most recent restructuring began. Simply, it is not just the price of oil that was the story in 2008 but also the volatility in the price of oil. If anyone really believes that today’s price is tomorrow’s reality, then…..we probably do not have a lot to talk about.

I will go to my grave saying that $147 crude was the best thing that has happened to the US airline industry in the last three decades.

If not for the rise in the price of oil: #1

On the first trading day of 2008, crude oil trades at more than $100 per barrel for the first time. Consolidation chatter increased in volume among players in the US airline industry – Delta/United; Delta/Northwest; Continental/United; United/US Airways were just some of the many combinations being discussed. In each case, the price of oil was mentioned as a catalyst for consolidating the industry. Ultimately the only transaction that transpired in 2008 was the merger of Northwest Airlines into Delta Air Lines. United and Continental are working toward an alliance that they have promised to be different.

Consolidation within an industry typically occurs in one of two ways: either through a financial transaction or through financial attrition. Financial attrition has proven to be the more effective method for the airline industry as more bankruptcies have occurred in 2008 than at any time in the global industry’s history. In the US we lost Aloha, ATA, Air Midwest, SkyBus, Gemini Air Cargo, MaxJet and Eos to name some. We have Frontier, Midwest and Sun Country hanging on by their fingernails; any of which if were lost would not cause the US air transportation system to reexamine itself.

If not for the high price of oil and a nuance here or there, these smaller, undercapitalized, geographically limited and less efficient carriers would not have been pushed over the edge or to the brink.

If Not for the Price of Oil: #2

The US industry would not have unbundled its product and decided that ancillary fees should be charged. The first bag fee, the second bag fee, the soft drink fee, the pillow and blanket fee and the aisle or window seat fee all joined the change fee in airline lexicon throughout the course of 2008. Why? Because additional revenues were needed to be generated to offset the high price of oil. In the dark science of airline ticket prices - fares remain harder to increase than fees are to charge.


Southwest Airlines remains a holdout on charging its passengers fees for bags, blankets or sodas. This will continue to be a closely watched story in 2009. The concept of unbundling is proving to be a smart approach for an industry that historically has priced its product below cost with few exceptions. Yes Southwest is differentiating itself from the industry, and time will only prove if their strategy is right. The encouraging aspect is that the remainder of the industry is addressing the concept of cross-subsidization that has described this industry for far too long. Ultimately cross-subsidization means that you will pay the reaper.

If not for the high price of oil, we would not have had fare increases, ala carte pricing, unbundling and ancillary fees to talk about.

If Not for the Price of Oil: #3

The US industry would not have made the difficult decisions to cut capacity to levels not previously imagined. Or stated another way, the US industry would not be challenging the age old belief that you cannot shrink your way to profitability. Or stated another way, the US industry finally began to let the air out of its own “capacity bubble” by removing significant levels of uneconomic flying.

Discipline is not a word that can be used to describe past managers of the US industry. If not for the price of oil, the current group of managers might not have exhibited discipline as they are/have been when it comes to capacity, minimizing fixed costs and pricing either. But they are and it is encouraging that today’s managers recognize that the airline industry emulates other capital-intensive, commodity industries that grew too much in the up cycles and failed to remove uneconomic capacity in the down cycles. Even the low cost sector has been forced from its “growth for growth’s sake” posture.

If not for the high the price of oil, this industry would not have had the will to accept that the capacity bubble needed to be deflated.

If Not for the Price of Oil: #4

We would not be seeing the desperate grab for economic leverage by US airline labor as a new negotiating season approaches. We have seen corporate campaigns in the past, but this time we have seen labor reach a new low. Pilots at each American, United and US Airways have all decided in some way, shape or form to play the nuclear card. What is the nuclear card you may ask? It is safety. The use of safety by US labor, particularly pilots, is among the more disgusting tactics employed in decades.

Airlines do not knowingly compromise safety so it should not be hinted at, let alone put in lights. Honestly, competitors are never happy when a catastrophic event occurs at another carrier. In addition, this year’s corporate campaigns by US labor have also been unfurled with the supposition that labor’s fight with their airline companies is also a fight on behalf of customers as well. Surely you jest ALPA, USAPA and APA? Other than safety, air travel consumers and labor have very little in common. Consumers are not standing ready to pay even more for travel just to subsidize the $15 billion in concessions made over the past six years that labor believes they are entitled to be reimbursed.

I am continually drawn to statements by ALPA President John Prater made earlier this year when he suggested that the price of oil would have nothing to do with substantial increases that would be won by airline labor in the subsequent cycle following the industry's restructuring began in 2002. Prater, in a talk in New York earlier this year, warned Wall Street that labor is a fixed cost just like oil. At least Prater got part of it right: labor is a fixed cost. Fixed costs are what the industry must reduce if a sustainable and durable business model is to be found. Fixed costs are being removed and that is why headcount will continue to be reduced.

Another Prater comment I liked: “Don't try to use the price of gas," said Prater. "The industry is unstable, and the only way to add labor stability is through a solid contract." I am really not sure what the hell that means unless there is finally an ability for airlines to be flexible when countering the ebbs and flows of economic cycles and commodity price changes. In my mind, labor flexibility is among the most important issues facing every carrier in their upcoming negotiations. In my calculus, flexibility means durability and that is good for all.

If not for the price of oil, headcount would not have been reduced even further outside of bankruptcy over and above the levels achieved while in bankruptcy. With capacity cuts comes headcount reduction.

Pre-Concluding Thoughts

When we started the 2008 calendar, US consolidation was the talk. Don’t look now, but consolidation in Europe has stolen the headlines here. There is certain to be more M&A activity on the European continent as well as the loss of carriers unable to combat the global economy’s headwinds will continue.

China was the rave as a desired airline marketplace because of its emergence as a global manufacturing powerhouse. How quickly the post-Olympic economic issues are pressuring that country. The globe is now less a consumer of China-produced goods. As a result, China will be slower to develop as a consuming economy. India is worse.

The high price of oil should have been a catalyst to focus the US government on the air traffic infrastructure. Sadly, that was not the case. As I have stated here many times, I just do not get why this is not the penultimate issue where labor and management could join hands and pressure the incoming administration to make it a priority. Management would have to ask for fewer changes to collective bargaining agreements if minutes could be saved on each and every flight. Labor sells time to the airlines; and the airlines sell time to the consumers. This is the only indirect relationship I can conceivably come up with where labor and air travel consumers are joined other than safety - and in this case their interests are far from aligned.

Concluding Thoughts

Because of the high price of oil, hedge contracts will continue to be a story through the first half of 2009. The oil price pinnacle reached in July of 2008 was the absolute best thing to happen to this industry. Managements in the industry were presented with the single-biggest crisis in history. A crisis that promised to ground an industry unless immediate, necessary and legacy-busting actions were taken. The industry has found that new revenue sources could be tapped and fixed costs could still be cut.

The industry has little to cut in terms of costs other than capacity reductions. This is true going forward as well. Balance sheets are stretched thin and not every carrier is yet out of the woods. The airline model can now withstand $90 oil in a mild recession. The question remains: how high an oil price can today’s airline model sustain as we sort through the economic, credit, commodity, trade and geopolitical issues that will confront this industry over the next year?

Next to oil, the largest expense category is labor. So in addition to Oil price volatility; Infrastructure issues; Labor contract negotiations will begin to dominate the headlines in 2009. As an observer of the economics and finances of this industry, I feared for the industry as oil prices marched toward an “in the wing” price of $175 per barrel. I am just as fearful of the speed of the decline in the price of jet fuel.

I hope that we can maintain the same discipline that resulted in many hard decisions. Decisions that arguably have the US industry better positioned to confront the economic headwinds because of the immediate and decisive actions that took place in mid-2008. To revert back to same old ways of doing business - whether it is not charging consumers the "all-in" cost for travel on a going forward basis; ignoring the need to make labor more flexible/productive as the quid for higher pay; or relaxing the need to fix the infrastructure would be such a waste of energies expended since 2002.

We would not be this much closer to finding a sustainable operating model if not for the high price of oil. We really would not.

Happy 2009 to all, Swelbar

AA’s Labor Negotiation Scenarios Get Even More Interesting

I am thinking that we should consider changing the name of the NMB, National Mediation Board, to the AAMB or the American Airlines Mediation Board. Or the FWMB, the Fort Worth Mediation Board, because the docket at the Mediation Board is about to be anything but National.

Trebor Banstetter, at the Fort Worth Star-Telegram’s Sky Talk blog, reports that American Airline’s flight attendants represented by the Association of Professional Flight Attendants (APFA) have jointly filed with the company to the NMB to take over the talks. This one did catch me by surprise but as I think about it, this is a brilliant strategy.

If the application by American and APFA has indeed been made, it raises some very interesting scenarios. Terry Maxon asked on his AIRLINE BIZ blog the other day: Will TWU be first American Airlines union to impasse? Maxon’s question was spot on given that the company and the TWU, sans the mechanic group, had arguably narrowed their differences in a super negotiation session that concluded one week ago. I do appreciate that the starting point will be something other than the final issues remaining on the table, but the TWU and the company each made clear to one another what is important to each side in their negotiations.

We potentially have the majority of American’s employee groups in mediation. The one group not in mediation, the mechanics, is the one labor group at AA that have a sound platform from which to negotiate "gain-share" improvements given the outside work being conducted. This is not to say that there are not some difficult issues ahead in these negotiations given that AA is planning to park their older – maintenance heavy – MD80 fleet on an accelerated pace beginning in 2009. But the fact is this group has enabled AA to find new revenue sources.

Brilliant, Why?

Often, the NMB is forced to make a decision as to which negotiation on its docket has reached impasse first. Typically a decision is between airlines and not labor groups at the same airline. American now has an entire company in mediation. A release of any one group would certainly result in sympathy strikes from other groups with unresolved contracts.

How quickly would new President Obama agree to ground the nation’s second-largest airline? With nearly $2 trillion in economic stimulus to be injected into the economy during the early days of his administration, I am not sold that “labor’s savior” will be trigger quick to ground a company of American’s size in an industry that is inextricably tied to the health of the economy.

Another benefit is that the NMB will be able to truly gauge progress within each negotiation. This is particularly important when determining the “impasse pecking order”. With regard to the TWU and APFA groups, at least some movement has taken place in the non-economic areas. The APA cannot say the same as it has put itself into such a politically-tenuous position that it cannot move off of an opening proposal. A proposal that could not be afforded on the day it was presented – let alone now.

Mediation in this industry can be a good mechanism to work through issues but only after issues begin to narrow. That is how the process is designed to assist. Not to clear the underbrush from 30+ sections of a collective bargaining agreement.

I still think Maxon is right that the TWU group in mediation is number 1 on the “impasse pecking order” list. For the APA, you just moved to a distant third on that list – unless of course you get to participate in a sympathy strike. Or maybe, the APA will actually read the tea leaves and remove their opener and conduct a negotiation with the real world in mind and not the terms and conditions offered at Air Nirvana.

This really is fun to watch.

PRASM, TRASM and now FRASM? Oh My

We routinely discuss PRASM, or Passenger Revenue per Available Seat Mile. We also refer to TRASM, or Total Revenue per Available Seat Mile. I am now thinking that we will begin to talk about FRASM, or Fee Revenue per Available Seat Mile. PRASM, FRASM and TRASM – Oh My.

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Musing on Cars, Planes and Readers

I remain captivated by the auto bailout talks and have quickly become a big fan of Senator Bob Corker, the Republican Senator from Tennessee. His preparation for the hearings is evident each and every time

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Planes and Automobiles: Why?

Those that say that there are few similarities between the cultures and structures of the US airline and auto industries either have their head in the sand or refuse to accept the reflection in the mirror

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Stuffing Romy's Thanksgiving “Turkey”

Over the past month, news emanating from Wall Street has muted some of the stories taking place in the airline industry. So on this Thanksgiving morning, I thought I would stuff the bird with some stories that leave me scratching my head...

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