11.20.2008 Labor issues at many US airlines are emerging that underscore this blogger’s call that these upcoming negotiations will be the most important since the airline industry was deregulated in 1978. And we are not really talking about economics yet...
11.17.2008 The auto industry faces many of the very same issues that the airline industry faces, and faced, albeit the inherent inefficiencies were exposed by different exogenous events. Today’s credit crisis has exposed decades of leveraged inefficiencies...
11.11.2008 I wake up in Honolulu this morning to CNBC discussing the auto industry and the fact that General Motors’ market capitalization is roughly the equivalent to what it was in 1943. Talk of a pre-packaged bankruptcy filing is spewing. But can that really fix anything?...
11.7.2008 You would think that in a week with this much news, I could find something to write about. Obama is elected. General Motors' October sales fell by 45 percent. GM loses $2.54 billion in the third quarter. A legacy industry seeks government help. US Airways bolstering liquidity through deals with the same regional partners that...
10.28.2008 100 People, Companies, Concepts and Events that Have Shaped the Course of the US Airline Industry (and one man’s career in the business). To commemorate my 100th swelblog post and to cap off my analysis of 30 years of deregulation, I submit the list of the 100 most influential people, things and events that have shaped my views...
10.27.2008 This month, in honor of the 30th anniversary of deregulation, I’m focusing on where deregulation got it right; wrong; backwards; and indifferent. Today we look at what is right. In the most simple of objectives
10.23.2008 Earlier this week, I promised to write my views on 30 years of deregulation, with a focus on where deregulation got it right; wrong; backwards and indifferent. One area where the industry had it wrong and continues
10.22.2008 Second in a series on Deregulation
There cannot be a discussion on the morphing of the US airline industry over the past 30 years without a few words on Southwest Airlines. The presence of this one airline, and its unique model in the US market, has influenced everything from network development; to labor costs; to non-labor costs; to the fostering of an environment that screams “I luv my job,” – rare in the US airline industry.
As I said in Monday’s post, I believe the industry’s discussion of commercial aviation’s economic impact is backward, I am indifferent about the role of Southwest and the Low Cost Carriers sector in general. But I believe that Southwest has had profound influence on the industry, both good and bad.
Network Triangulation
In the late 1980’s and early 1990’s, the Dallas-based carrier was increasingly recognized as a potential force. In May of 1993, the US Department of Transportation published what is now a highly recognized piece analyzing that force: The Airline Deregulation Evolution Continues: The Southwest Effect. Many know Southwest’s storied beginnings, beginning with a napkin on which the initial route network was drawn: Houston – Dallas – San Antonio. As the name implies, much of its network was confined to west of the Mississippi River until 1995.
In addition to the obvious airport market attributes Southwest looks for before it enters a new city, the carrier employed a fairly rigid network strategy as well. One day, I sat down at a table and mapped out Southwest’s growth city by city over its history. Lo and behold, when the initial nonstop segments were announced from a new airport market, you could bet that new triangles were formed. For example, from Indianapolis, Southwest might announce Orlando and Kansas City service. Southwest made sure before announcing any two new segments from a new city that there was existing service between the two points, just as there was in the case of Orlando-Kansas City when Southwest began service in Indianapolis.
Airline observers often refer to the hubs of the network legacy carriers as “fortress hubs.” Southwest built its own fortresses of sorts through the use of its network triangle strategy, protecting its own flows no matter how small. Over time, the carrier took small hub airports and made them medium hubs – or nodes -- which like fortress hubs serve to protect Southwest’s primacy and discourage competition.
Southwest’s construction of its nodal network provides it with both the flexibility of being a point-to-point carrier as well as a carrier that connects traffic across its system at super nodes like Baltimore, Nashville, Phoenix and Las Vegas. While it serves only 64 of the nation’s 340+ commercial airports within the contiguous United States, Southwest impacts more than 90 percent of nation’s domestic origin and destination traffic.
This calculation is tedious but its methodology is simple. Draw a circle of two hours driving distance around each of Southwest’s 64 points – a clear visual of their strategy that aims to expand the catchment area, or reach, of the airport markets it chooses. Then, envelope multiple airports within the catchment area; each of them becomes a source of demand for the carrier’s lower fares. Southwest service has demonstrated clearly that the highway is an acceptable entry point to access the US air transportation system, but it also has had a negative and profound effect on small airports.
[Editorial question for policymakers: why is access to the air transportation system via the highway acceptable when Southwest is involved and not acceptable if a network legacy needs to close a market because it is not economic to serve a particular airport market?]
Earlier this month, Southwest announced it would start service to Minneapolis/St. Paul making the Twin Cities its 65th node. To give you an idea of the power of the carrier’s "no-connect network", it advertises that modest service between the Twin Cities and Chicago-Midway will provide access to more than two-thirds of Southwest’s entire network.
Great to be a Southwest Employee, Not so great for other airline employees
In recent years, Southwest employees have fared significantly better than their network legacy carrier peers in winning wage and benefit improvements. Today, Southwest workers are, on average, the highest compensated employees among the top dozen carriers. Their secret in providing industry-high average wages is simple. Their model incorporates and employs high productivity across a network of shorter stage lengths and smaller aircraft that should, by definition, make this achievement most difficult. And all of this is made possible through their unique network.
Keep in mind however, that Southwest did not enter the competitive fray burdened by labor contracts with provisions held over from before the advent of jet airplanes. It didn’t have a senior workforce or the labor costs bloated by seniority pay. And it didn’t have a network like those of its competitors that entered the market well before deregulation – in other words one designed by regulators who determined which cities, from which carrier, would get commercial air service with little regard for efficiency. Instead, Southwest got to draw its own lines and routes that define the company today. And they did so with an evangelical approach to labor and employee relations that many believe give the airline an edge in customer service and reliability as well.
Productivity is the Southwest mantra – whether it is labor, aircraft or facilities. Southwest’s non-labor costs have always been a competitive advantage. Many observers believe that unit labor costs are the airline’s most effective weapon, but I argue that is not the case. Instead, it is the relationship of productivity and pay that has provided Southwest with flexibility to pay relatively high wages as it negotiates with its highly-unionized work force.
This is the concept that the unionized work forces of the network legacy carriers struggle to comprehend. Traditional hub and spoke carriers with vast operations cannot achieve Southwest’s level of productivity. But there is a relationship, or an equilibrium, that can be found at each and every carrier. If the will to ”find it” could only be found.
Now, 30 years after the deregulation experiment began, Southwest has grown to be the largest domestic carrier in the US, with low costs and network scope that will continue to pose a significant competitive challenge to other airlines. Southwest may well be the best managed airline in the business, as most industry observers agree. But its success was also helped by the fact that Southwest did not enter the fray with a legacy noose around its neck. Instead, Southwest succeeded because it was small, nimble and could easily adapt and exploit opportunities as the competitive landscape evolved.
Triangulating Labor, Network, and Southwest
In an ideal world, an airline’s network would drive the labor and staffing decisions to achieve the best possible efficiency and productivity for the respective airline. In the real world, the legacy network carriers are often forced to create a network around the labor contracts that have put strict limits on productivity and constraints on how best to serve markets in its system.
Low cost carriers are most often cited as the primary driver of consumer benefits because low fares have opened the skies to the masses. But are they? Have they been? No. Consider that Southwest serves only 20 percent of the commercial airports in the contiguous United States. So how can they, and their low cost carrier peers, be considered the shining light(s) of deregulation? Yes they drove prices down in the larger markets – the only markets the low cost sector serves with few exceptions - and in some small markets indirectly, but the effect was to kill off many small airports in their wake.
Through its efficient and methodical approach to building a company, Southwest puts pressure on incumbents to be just as efficient. We see this most recently as network legacy carriers have reduced wages and increased productivity. But the process has been supremely painful and, in some cases, required a trip or two through the bankruptcy courts, in part because neither management nor labor leaders had the will to make changes necessary to adapt to new competition.
Today, Southwest’s network touches virtually every geographic market of size in the US. As the domestic market is now contested at each and every point, the network legacy carriers are left with two choices: 1) attrit and possibly exit the domestic space; or 2) negotiate a new labor construct that can cohabitate with the likes of Southwest. Neither choice is ideal. But one choice is better than the other.
Concluding Thoughts
Throughout my career, I’ve been engaged in some battles involving Southwest – but only on the other side. I can attest that they are a hard-nosed competitor. But I am a professed network carrier guy that fervently believes the low cost sector receives entirely too much credit for bringing the benefits this industry drives each and every day.
Southwest is often first to cry foul with claims of being competitively disadvantaged when it tries to enter new markets or protests paying for what it believes is its fair share of the air traffic system. But that so-called “disadvantage” has done quite well for Southwest’s leaders, employees and shareholders.
I applaud and admire the airline’s culture and competitive success. But before we give all of the awards, I ask that small communities and legacy carrier labor ask what good Southwest has done them? In fact, it is the network legacy carriers that deserve awards for keeping many small communities alive by continuing air service, even when some of these routes can’t be flown profitably. It is also true that ticket prices have been contained or even reduced by the hub competition that exists in the US domestic market today.
In the future, look to the horizon for the new competitive battleground. It will be more about Auckland than Amarillo. It really will.
More to come.
10.20.2008 First in a series on Deregulation
For the past couple of months I have been doing a fair amount of public speaking. Appreciating that this month/year represents the 30th birthday of the passage of the Airline Deregulation Act of 1978, most of my engagements have focused on the industry's evolution over the past three decades. Over the coming days on this blog, I will focus on where deregulation got it right; wrong; indifferent; or maybe even backwards. Today, I am going to start with one idea that just might be backwards.
Between Airlines and Airports: Who Really Creates the Economic Impact?
Do a Google search for the economic impact of aviation. The impacts on North Carolina, Oklahoma, Wyoming, Oregon, Nebraska and Texas will all populate the first page of that search. On the same page of the search you will find the Air Transport Association’s study of the economic impact of commercial aviation on state economies. As the ATA’s study and other studies say in their own ways: commercial aviation is inextricably linked to the health of the local, national and global macro economies.
The first page of ATA’s report quotes Pulitzer Prize winner Daniel Yergen:. "Every day, the airline industry propels the economic takeoff of our nation,” Yergen observes. “It is the great enabler, knitting together all corners of the country, facilitating the movement of people and goods that is the backbone of economic growth. It also firmly embeds us in that awesome process of globalization that is defining the 21st century."
My question: Are the airlines themselves enablers? Or facilitators? Yergen is probably right in suggesting a combination of inputs are necessary to create the commercial aviation industry. Any economic assessment of the impact of commercial aviation will measure direct benefits of the service; indirect benefits generated from the service; and induced benefits derived from air service on the economy as a whole.
In the most simple form, direct impacts are the earnings and employment generated by the service. Indirect benefits typically measure expenditures driven by the passengers who travel to the destination on the service. And induced economic activity is measured by related industries that benefit from the direct and indirect economic activity of the service – typically a multiplier of the direct and indirect activity.
Can Airlines Make Themselves Profitable on a Sustainable Basis?
Given estimates that the US airline industry will lose nearly $20 billion since deregulation, while local and national economies have expanded, could it be argued that the model is backward? Government policy is hell-bent on promoting competition in each and every market. The industry has delivered a network platform comprised of carrier-to-carrier competition, hub-to-hub competition, and the competition between network legacy carrier and low cost carriers. There is not a single airline flying for which the current revenue model works if only the fares charged passengers are counted.
In an article published in the current edition of Foreign Policy magazine, I note that US carriers of all ilks lose money per enplaned passenger when only passenger revenue is counted – a simple but telling analysis. Counting only passenger revenue, both the legacy and low cost carrier sectors have lost money per passenger since 2001. In fact the low cost carrier sector has only made money based on this metric three times since 1995. Thus the industry absolutely needs to raise fares, charge ancillary fees and/or continue its efforts to cut fixedcosts - or all of the above - as the loss per enplaned passenger calculations exclude interest expense and direct investments in the business.
Airlines have a long way to go before they find a sustainable operating model that manages to “feed” various stakeholders. In some circles there are calls for re-regulation. But this ignores the fact that the federal government already heavily regulates this so-called “deregulated” industry, so it is unlikely that further regulation is the answer.
Now the Question?
Maybe it is the communities that realize the economic benefits of commercial airline service that should subsidize the airline’s losses?
After all, it is not the airlines that are realizing millions– and in some cases billions - of dollars in economic benefits – profits that they would otherwise use to pay higher wages or invest in new equipment. Rather, most of the gains go to the communities in the US and around the globe that depend on air service to drive direct, indirect and induced benefits, even while many complain that air fares are too high. Some of these economic benefits go to support airports and the infrastructure around them, but most subsidize the local economy without direct gain for the airlines that generated benefits.
It Is All Local – Until You Have to Pay For It?
Let the Local Market Wet-Lease Service
If all politics are local; and local economies depend on airline service; then shouldn’t politicians in local markets explore ways to “buy” the air service they believe is necessary to support the regional economy while also satisfying the expectations of their constituencies on the price of that air service? In effect we already have a similar model in place in the practice of network carriers that purchase capacity from their regional providers that includes a cost plus arrangement.
If politicians and the communities they represent protest higher fares, fees and reductions in service, then the answer should be a simple matter of economics. Have the community pay the difference between the ticket revenue and the cost-plus of maintaining the air service, plus some reasonable profit for the airline to reinvest in its business. Already, politicians and community leaders boast about the the economic benefits of air service; alternately, those facing air service reductions are the first to cry foul based on their estimates of economic costs. The decades old airline-airport/community operating model of today could be reworked to meet the financial realities of tomorrow’s aviation market.
Economic activity stemming from commercial aviation service is already calculated every day. What is suggested should be a simple investment decision for communities. There is a price to pay for being a node on the global trading map and decisions to be made about what type of service best meets the need of a community. But it is not the responsibility of airlines to ensure your dot remains on the map.
Today many think that the low cost providers would be the answer to end all discussion. We would see, wouldn’t we?
More to come.
10.16.2008 Air Romo breaks his finger on the first play of overtime and is grounded for four weeks. American Airlines reports a profit for the third quarter of 2008; but only after accounting for the sale of American Beacon Advisors. Southwest Airlines posts its first quarterly loss in 17 years; but only after accounting for losses on certain hedge contracts. Had it not been for accounting issues, the news might have been much the same as American would have posted a loss and Southwest would have posted yet another profitable quarter.
But earnings are not “the” story for 2008’s third quarter given the volatility of jet fuel that occurred during a period when the passengers carried largely bought their tickets months ago. The story from the earnings announcements is more about the landscape on a going forward basis. Like many data points we assess and refer to, the Southwest loss deserves an asterisk.
The most interesting news thus far has been American Airlines announcing an order for 100 787-900 aircraft as part of its third quarter discussion. 42 of the aircraft are firm orders and are scheduled for delivery beginning in 2012. As the news came across the wire, I was preparing to give a lecture on networks. It was quite the buzz in the room as many of the students are like you and me and have jet fuel running through their veins.
There are many aspects of this announcement that I find encouraging. First, and simply, a US carrier announced a significant order for new technology as India's airlines consider cancelling orders. Second, and unlike many of the world’s carriers with orders for new aircraft, a US carrier is not ordering at the top of the cycle only to take delivery as the cycle turns down as will prove true with many carriers in Europe and Asia. Third, American did what it should do and make the delivery schedule contingent on a negotiated deal with the Allied Pilots Association.
Terry Maxon of the Dallas Morning News blogs on the APA’s reaction to American’s announcement that it is spending billions on new aircraft that will permit it to connect multiple dots on tomorrow’s global map. Of course the pilots are pleased that the company is investing in new equipment. Of course their reaction comes with the caveat that reinvestment in aircraft is only part of the necessary reinvestment in the airline. As the APA reminds us daily, restoring pay rates to some historical level in their current contract is also a necessary action.
I don’t know about you, but I am tired of the refrain of pay restoration. I am tired of the suggestion that these negotiations began in 2006. They did not. The negotiations began when the new rockers in the Metroplex, “Captain Lloyd and the No Planet Airmen”, took office and made a comprehensive proposal to management that was ultimately priced out at $3 billion dollars.
I have written here often of the need to change existing collective bargaining agreements as language just does not work. Well the APA rightfully points to a glaring reason why we need to rethink the entire labor construct. Pay rates have historically been based on the weight of the aircraft among other inputs. Well the weight of the 787 will be less as it made of composite materials. So now that does not work for the APA and there will have to be another approach.
I have been traveling and speaking again this week, so I missed Trebor Banstetter’s article on Tuesday in the Ft. Worth Star Telegram discussing the status of American's negotiations with its pilots. The APA seems to suggest that the NMB is partially to blame. Remember, as I have written here before: you have to clear the underbrush before a meaningful negotiation can take place on the economics otherwise - just put it on ice. The APA strategy to call for mediation still numbs this observer. I hope that they did not pay anyone for that advice.
But the real piece of information that I find most interesting as I catch up on my reading is a Banstetter blog post suggesting that there is a move on to rein in the national officers at APA. Lloyd and his band have become one song wonders and the membership needs more.
American has positioned itself to take a new narrowbody aircraft every 10 days beginning next year and to begin a growth and replacement strategy with the 787 beginning in 2012 all in managing the company for the long term. Hopefully the APA might begin to take notice from visionary pilot groups at Delta and Northwest that tomorrow really is different.
As always, this one is fun to watch. I wanted to post a piece I have been working on about autos and airlines again, but news here is so hard to resist.
10.7.2008 Will the legacy carriers today be the domestic providers tomorrow?
This post has been partially written for about six weeks. The US domestic market presents us with many things to consider as it evolves. “Darwinists” will say it will be the “survival of the fittest”, or the strongest competitor will be the last standing. In October 2002, Eric A. Marks wrote a book: Business Darwinism: Evolve or Disolve: Adaptive Strategies for the Information Age. Marks was writing on the critical importance of information technology in accelerating the necessary grab for global market share. He used the phrase the “survival of the fastest”.
Whether it applies to the US airline industry and its participants or not, the use of a phrase like “evolve or disolve” certainly applies to the current carriers of all ilk providing service to customers within the US domestic airline market. So as we move into the season of capacity cutting in a significant way, one could ask if we are dissolving or simply engaged in a practice of attrition of uneconomic capacity? No matter how we choose to refer to this period, it is an evolution of an industry structure that is unknown.
Republic Airways, SkyWest and Possibly Others
In the past weeks, Republic Airways, a “US Regional Carrier”, has made some aggressive financial plays at each Frontier and Midwest. Both carriers have strong local market followings and that could be described as an understatement. Warren Buffett likes brands. Are hub markets brands? And if these hubs are joined?
Pilots at Midwest might say that the current ownership is using the Indianapolis-based carrier as a stalking horse to win pay and productivity relief from current contracts. In Frontier’s case, Republic is part of the group that provided the “Debtor In Possession” financing necessary for the Denver-based carrier to construct its plan of reorganization.
Neither Frontier nor Midwest are vital to tomorrow’s US domestic air transportation system - as we know it - and they are joined in that regard by Sun Country in Minneapolis. Whereas this observer has been vocal of a need to consolidate carriers in the “regional space”, I am thinking that there just might be something more to consider. I refer from time to time to a piece I did in 2003 entitled: Low Cost Carriers: Thou Shalt Not Inherit the Earth.
Not so much that there is a need to consolidate carriers in the regional space as many of them will simply dissolve as hubs are closed in the face of high oil; an overall slowing of demand; and less reliance on domestic traffic flows for the network legacy carriers. But I am thinking that carriers like Republic, under it visionary CEO, Bryan Bedford (who should have been a CEO at a legacy carrier already – but then again why would you want to do that?), and SkyWest just might be tomorrow’s US domestic capacity providers. Carriers like Republic and SkyWest just might be the competition for the surviving “Low Cost Carriers” like Southwest, jetBlue, AirTran and possibly Virgin America.
It is Republic and SkyWest that are buying the right-sized aircraft for a market with higher prices and slowing demand. It is Republic and SkyWest that are building fleet scope that provides each of them with the economies of scale that are critical to manage any and all associated costs. It is Republic and SkyWest that have aircraft to serve communities of all sizes that will make "narrow-minded" lawmakers happy. It is Republic and SkyWest that will be looking for "natural partners" to code-share with as they will need international network scope in order to maximize onboard revenue. Republic and SkyWest have learned the lessons from Independence Air and ExpressJet (edited) that built failed models focusing only on the US domestic market.
SO……….
Hey Bill, what are you saying? I guess what I am saying very simply is that this labor negotiating period remains the most critical since deregulation – just as I have been saying for the past couple of years. As Aristotle first said, and was recently used by my dear friend Jon Abbet on the putting green when comparing the banking industries to the airline industry, “nature abhors a vacuum”. The US domestic airline system presents the greatest potential for a vacuum. Controllable costs have converged. But that will not last. Service from Lubbock to London would produce a vacuum if American were to leave and that will be filled. Lansing to Lagos would produce a vacuum if Northwest/Delta were to leave.
Carriers like Republic and SkyWest have the opportunity to take advantage of technology that ensures a “survival of the fastest” path. Remember the UPS whiteboard guy and the cargo industry - no real legacy impediments. Tomorrow they will be the carriers that deal more with an inefficient air traffic control system. STAR, SkyTeam and oneworld will only want to ensure that international connections arrive on time. Northwest and Delta have committed themselves to the US domestic market. But I am not sure that United, Continental, US Airways and American have. In the case of the latter two, they have more commitment today.
Whether it is seniority or a different compensation scheme for tomorrow’s "seniority" that works best for the future industry, never overlook a potential competitor - as it is present. That competitor is not the obvious but rather the well managed companies that have been tasked to adapt to the network model. Republic and SkyWest have.
So in this negotiation, labor will either figure it out or they will not. The US domestic network still provides the most jobs to the labor organizations representing the employees at the legacy network carriers. Will that be the case tomorrow? I am not sure. This is a time to negotiate a construct that rewards blood, sweat and tears. This is also a time to negotiate a construct that recognizes that tomorrow is different. And in the course of doing so, membership numbers can be protected, and possibly augmented.
So ask Boeing and the IAM if a strike is worth it? I am not sure. Ceding competitive advantage to Embraer and Bombardier and others in tomorrow's narrowbody market is the ultimate question. The same is true for airline labor. Domestic economics are different from international economics. Beware of the underdog as is it not the LCCs to fear, it is Republic and SkyWest. Attrit and dissolve; attrit and resolve. That is the question?
Never doubt that nature abhors a vacuum. For ALPA and pilot's unions this is a watershed issue as you represent both sectors. For the flight attendants, membership numbers might not grow but at least you will protect what you have. This is big. Really big.
More to come.
10.6.2008 Dow down 800 points only to rally in the last 45 minutes to close down 370 points to just under 10,000. The Dow rose above 10,000 in 1999. Here we sit in 2008 at the same levels. Of the 3,500 or so stocks traded on the New York Stock Exchange, 1,700 traded at 52-week lows today while 1 stock traded at a yearly high. On the NASDAQ, 1,100 stocks traded at 52-week lows and 3 traded at highs. Oil traded down $6 and change per barrel to $85 and change, and the dollar to euro ended at 1.35+. (The relationship of oil prices and the strength of the dollar is proving quite meaningful)
Back in July I wrote about Leverage Detoxification: Banks and Airlines. Today’s analysis of the market’s activity can only highlight the deleveraging/unwinding well underway with no real sense – yet - of where the bottom just might be found. The same might be said of what is going on in the airline industry. But, the airline industry’s problems pale in comparison to what is happening in the US and global financial markets.
Today I heard it said that deleveraging the markets could lead to disinflation. This would be a very bad outcome. It was not that long ago that we were talking about stagflation as oil prices were marching toward unimagined levels while the global economy was showing every sign of the slowdown that now appears on every continent’s doorstep.
So as we search for the bottom in the markets, analysts will say that heavy volume on the down side is critical before the real buying can begin. In Wall Street terms, capitulation is the term that market strategists refer to when all investors sell all of their stocks just to get out when it appears there is little hope of profiting by holding the instrument. We do not see this activity as of yet.
Wall Street observers are referring to the market’s current activity as a “Buyer’s Strike” – meaning that they are neither buying nor selling. It is a buyer’s strike for air travel that makes me very nervous right now as I cannot imagine just how many airline tickets have been bought over the past 5 years with proceeds from home equity loans and lines of credit.
So, on this Manic Monday, Sun Country files for bankruptcy protection with very little cash. They join Frontier in reorganization. I would not want to be in either carrier’s shoes. But then again, I would not want to be in any airline’s shoes that might be forced to file. In the case of each Sun Country and Frontier, both carriers have loyal local followings but add very little to the overall air transportation system. Just as Lehman Brothers was determined to not be vital for tomorrow’s Wall Street, neither Sun Country nor Frontier is vital to tomorrow’s airline industry.