What a Fine Mess We're In
(Originally published 9/28/2001 in Aviation
Daily; updated 12/14/2001,
and republished 01/03/2002 in PlaneBusiness Perspectives.)
What a Fine Mess We're In
by R.W. Mann, Jr.
While the problems are prickly, let's try to remember
that we're in this fine mess together.
We're going to need to rely on each other to help work through the challenges to a workable solution.
One can in no way minimize the crimes against
humanity that occurred on 9/11, nor their resulting
effects on the airline industry and economy. It is still simply unimaginable that a passenger aircraft
would be used as a weapon of mass destruction, or that the perpetrator would revel in the results.
Though the toll in lives would no way approach
the aftermath of 9/11, some among us are in denial
that to some extent, even greater carnage was inevitable -- not in lives, but in jobs. Hundreds of
thousands of jobs were at peril. The revenue trend was just that bad. Coincidentally, pay expectations
were rising in parallel with the UAL pilot settlement, and energy costs remained persistently high.
Absent 9/11, not all carriers would have ridden it out and survived, though not all would be clinging to
the lifeboats, as is now the case.
Layoffs Were Inevitable and is $15 Billion Enough?
Let's quickly review. Many on Wall Street projected
a near-record loss year for the industry, well prior to
the events of 9/11. A serious, but survivable, situation for most carriers. The furlough issue was being
widely discussed as a follow-up to announced asset impairment charges and accelerated fleet retirements.
Furloughs, down-gauging and service reductions
were only a matter of time, had RASM and CASM trends
continued as they were. The only questions were when, and how much. We may recall, one CEO claimed
in Congressional testimony on "The Deal from Hell" that his carrier was a failing enterprise. Others were, too,
but their CEOs didn't see the need to advertise.
As they are wont to do, Wall Street would have
rewarded the first CEO to react to the adverse revenue
and margin trend by cutting flying and announcing layoffs. No takers until after 9/11, but Gordon Bethune
of Continental gets that award. By standing up in his executive foxhole and calling in a capital and consumer
markets version of air strikes on his own head, Mr. Bethune managed to inflict collateral damage on his firm
and the entire industry, the thought, perhaps, "If I go, we all go", being an intended consequence.
Just to make sure the message got across, in a
never before seen act of Regulation FD-like bravado, Delta's
Leo Mullin on behalf of ATA and later, Doug Parker of America West issued wake-up calls to Congress and
anyone else who would listen, by proclaiming "the sky is falling" and later, "the business model is broken".
No kidding. And where were Stephen Wolf and Jim Goodwin during all this? (Well, we know about the latter.)
Following this, we saw a remarkable, some say
coincidental, parallel thinking process emerge, evidenced by
the industry's nice, round twenty percent capacity cut, and later, the public floggings at a Wall Street transportation
conference of those carriers that failed to toe the line. ("Daily competitive intel reports on my desk at 0700!
An objective recitation of the facts would have
shown that the sky was, a./ falling, and the business model was
b./ broken, not to mention, this was c./ well known, if not widely acknowledged earlier in the year, and
d./ something had to give, and e./ the tragic events of 9/11 broke the proverbial camel's back.
The only question is, will $15 Billion worth of lifeboats, grants and guarantees for the airline industry be:
- too little? (Marketplace/economy fail to recover;
hey, we need another trip to the trough, and cut the checks
faster next time, OK?)
- too much? (Yes! Snuck in coverage for "pre-existing
conditions"; high-fives, option gains and long-term
incentive bonuses to the max!)
- just right? (All sides leave mad, but life, economy, industry soldier on, hopefully, recovering and growing.)
And the answer is? We won't know for quite a while,
but it looks like colleagues in the consulting community have
been appointed the arbiters of good apps!
So far, with the Airline Stabilization Board,
we have a classic triage dilemma. The carriers with the best balance
sheets and liquidity don't need the facility, don't like its terms and as a result won't likely even apply, but will
actively argue against any of the most wounded from being granted guarantees -- thereby allowing them to
remain flying and pricing the industry in a vegetative state. We might term this squabbling at the trough, or
industrial euthanasia. By contrast, those carriers that are the most seriously wounded and in need of guarantees,
evidence terrible economic cases for being saved. Some of these, must be marked "F" for Fatal.
The bail-out committee gets to decide who is worthy,
who is not, how to divide the pie, and when to cut the checks.
A few years from now, peruse Long Term Incentive Plan payouts and gains on sure-to-be repriced option grants
as a proxy for who managed to hoodwink the Board, profiteer at a time of crisis, and by how much.
Remember that in those "$1 salary" years, Lee
Iacocca pulled down what Chrysler later reported was $90 million
in options gains, though in fairness he also managed to help save the company. At least "we the people" will
also participate to a small degree via capital gains on some carriers' warrants -- those that don't turn to wallpaper.
My sense is this is just an accelerated and sadly,
tragic, version of "the Savaging of the Boutiques", foretold in
October 1993 and then again (repeating the cycle) in June 2001. Only this time, the taxpayer gets to pick up the tab.
Travelers will, too, but $15 billion divided by 125 million tax filers is $120 per filer in grants and guarantees.
Make sure you get your money's worth.
Revenue Problem or Cost Problem?
Jim Goodwin's "gift to the industry" in the form
of his September 2000 pilot settlement hasn't even been applied
to all crafts and classes of UAL employees -- and its mechanics have voted to strike over this prospect, to a
quick and resounding "No way" from the White House -- let alone across all firms, though when it is, it stands to
raise the majors' costs by more than $4 billion annually, based on year 2000 metrics.
The problem that emerged in March 2001 was more
of an underlying economic, unit revenue (RASM and RATM)
issue than it was one of high labor costs. While it was not resolved amongst the dismal scientists until well after
September 11th that the economy had slipped into recession during the first quarter of the year, as far as the
airline profit equation goes, it was quite clear that from March 2001, the revenue term was under serious pressure.
The labor portion of the cost term, and the cost side as a whole, continued on its ballistic trajectory. Blame the
revenue problem on what you will, evaporation of the dot.com bubble, inflated corporate profits, corporate outrage
over rapacious pricing, inherent dis-productivity of the network business model, or a peak in the sunspot cycle,
but the revenue problem that was seeded early in the year accelerated to warp speeds prior to 9/11.
Prior to 9/11, there had been no major carrier
call for layoffs, but an economic "lights-out" had already been
announced for the most jurassic and least fuel-efficient of the US airline fleet. Sayonara, steam-gauge tri-jets,
we loved ya. As it turned out, many younger frames preceded and followed you to the desert.
The pace of the March 2001 problem and its resolution
changed dramatically, in the aftermath of 9/11. First, there
was the unprecedented total airspace shutdown. We've seen the grounding of the DC10 fleet, the distress of the
Desert Shield and Gulf War period, questions and quick action on B737 rudder actuators and MD80 jackscrews,
the tragedies of Pan Am 103 and TWA 800, and we may yet see action on composite primary structures.
All were shocks, but the total system shutdown set traffic and revenue run-rates on the peg at Zero, for all parts
of the global industry touching US airspace, while its expenses kept running in free spool.
A run on the (already factored) bank by ticket
holders canceling future travel plans, like nothing seen during the
Gulf War, at least in part due to those "Chicken Little"-like CEO pronouncements, exacerbated the industry's
cash flow crisis. Rapacious insurance cost increases, if it was available, drove the industry towards
Title XIII/Chapter 443 coverage as a last resort.
The events of 9/11 only exacerbated the revenue
side problem, while the shut-down caused a zero-divide error
on the unit cost side, to be followed by the usual unit cost bump that goes with retrenchment. Way beyond mere
domestic economic softness, the possibilities of a global economic downturn were magnified, with no apparent
end to the downward spiral.
9/11 represented a life threatening shock to industry
equilibrium, financial stability and service plans. This
triggered the overhanging avalanche of airline industry furloughs, with a multiplier effect in travel, hospitality
and tourism-related industries, economy-wide. Quantifying the incremental impact was at the center of a
Washington subsidy debate that at one point looked as if it would be concluded (if one was to believe the threats)
only after the first mega-airline filed for bankruptcy protection. It appears the only real arguments on Capitol Hill
were where to set the baseline, size and composition of an industry package, since the street forecast the
industry to lose money under any circumstance, and at the last minute, inclusion of a Chrysler-like equity kicker.
US carriers have nagged for years about government
subsidies given to foreign carriers. Thus, it was ironic that,
having over the past decade hosed down all its suppliers (including employees and travel agents) for discounts
and subsidies, the airlines and ATA finally succeeded in getting Congress to pull the subsidy lever in their favor.
In an odd turn-about, the EU continues to resist European carriers' similar pleas. The EU opines that failure
**is** an option, and it has occurred, taking Swissair and Sabena to the mat.
War on the Homefront
US carriers left no stone unturned, invoking "force
majeure" as a means to selectively re-interpret (an objective
assessment would be "abrogate") labor contracts. Interesting, in light of none having done so during fleet groundings,
or the run-up to or during the Gulf War. The closest anyone got was in the aftermath of Desert Storm, during a faltering
US economy, when one airline CEO complained to the Secretary of Transportation that "overpaid pilots are the single
greatest issue facing the industry". (No, this wasn't Jim Goodwin.)
Contract abrogration is a logical extension of
the "cliff walking" trend seen during 1999 and 2000, wherein management
began pushing, then suing its employees for their "loyalty" and "volunteerism", asking the judiciary for spot
interpretations of contracts that have decades of bargaining history and past practice, and continuing to ignore
problems with scheduling practices the subject of FAA and NTSB commentary, resulting in fatigue and placing
safety in the balance. With this sort of a record with the bargaining process, the judiciary, regulatory and safety
agencies, it begs the question, when, if ever, force majeure "ends".
And let's not confuse a series of symbolic but
economically hollow senior executive gestures -- people liquid enough
to "forego salary" (but significantly, not incentives, which dwarf salary) -- while in some cases gorging on tens of
thousands of equity shares at bargain prices -- with the challenges laid down on furloughed and remaining employees,
most of whom are living paycheck to paycheck and have few of the many executive benefits, including, amazingly
enough, Congressionally approved, multi-year parachute payouts. What's with that, anyway? As a taxpayer and analyst,
I'd suggest some of those folks get the hook, not a parachute. At least they relented and agreed to pay severance,
when the court of public opinion frowned on them.
What about concessions? Well, why subsidize a
failed business model? Network carriers have evolved into
boutiques that require a high-octane blend of ever-increasing full-fare business travel, to produce unit revenues
that can sustain what are largely structural and resulting high unit costs. Though they arguably should, none is
seriously considering a change to the network model, so why should employees throw bad money after good?
Since there are only so many high fare coupons out there (and P.T. Barnum having been proven wrong, there are
few indeed, right now), the inevitable result is fewer seats needed to carry fewer fares, and even smaller
equipment needed, if frequency is to be maintained. We know where this leads, directly to the small jet battle,
playing soon in a market near you.
The Savaging of the Boutiques
Just as we saw in the period leading up to and
following the Gulf War, we are watching the savaging of the 'boutique',
network airline model, the clear beneficiary being Southwest. Present economic conditions illustrate the fragility of this
high-cost, limited productivity airline business model, and the 'all weather' superiority of its structurally efficient,
low-cost, high-pay antithesis.
Despite present appearances, the airline industry
is less cyclical, as a result of a decade of outsourcing, alliance-building
and associated reductions in capital and operating risk. Capacity control, with a wink and a nod, has helped, as well.
But it is just as clearly not immune to a debilitating combination of the vagaries of the business cycle and a domestic
market in decline, an abrupt drop in RASM precipitated by a fall in business traffic, protracted high energy costs that
outlasted the longest duration hedge programs, and impending collateral damage from labor expectations
in the aftermath of the UAL pilot contract.
Why did RASM (and the air express business' parallel,
RATM) go over a cliff? Falling corporate profits, of course,
but the dot.com bubble contributed. In addition to billions in IPO proceeds being turned into hideously bad advertising
and "sock puppets", the Internet bubble produced a spike in demand for dot.com business travel and express shipments
at obscenely high, rapidly increasing and now clearly unsupportable prices.
The mantra "on internet time" frequently meant
"cost no object" and translated to increasing amounts of moment's notice,
"just in time" travel at full-fares, by people and express packages. This was great business, while it lasted, reinforcing
more flight frequency with smaller aircraft size, and corresponding, rapid growth in the express business. Unfortunately,
the bubble burst, as most do.
Since 1993 and the beginnings of the recent economic
expansion, network carriers' embracing "boutique" business
models has moved them to operating in an economic "coffin corner", analogous to that high altitude flight condition
where there is an extremely small margin between the speeds at which Mach buffet and stall buffet occur. It is also
the point of maximum aerodynamic efficiency, so it is a sought-after, if fragile, condition for long-range cruise flight.
In fairness, the industry cruised profitably,
undisturbed, for nearly a decade, in the coffin's cusp. More frequency
with smaller equipment, including commuter/regional aircraft, stimulated and served more business demand
at more times of day, producing less than proportional increases in by-product leisure seats. Business fares and
yields rose, as did overall load factors. RASM rose, but the use of smaller, less efficient equipment and small jets
drove higher unit costs. The margin between RASM and CASM narrowed, the profit envelope collapsed, and the
risks to the business model increased dramatically.
In the coffin corner's aerodynamic sense, the
aircraft can't fly faster for structural reasons and it can't fly slower
or it will stall and upset. So it must either maintain this precise speed or carefully maneuver out of the optimal altitude,
speed and efficiency flight regime.
In the coffin corner's airline pricing analogy,
the market won't accept present fare levels and carriers clearly can't
charge more. Faced with suddenly lower demand and load factors, unit revenues crater and the airline revenue
management suite is out of its "sweet spot". Due to their high structural unit costs, network carriers can't afford to
charge less. So, the profitability stall buffet hits, and airlines experience an upset, and rapidly move to losses.
Sooner or later, network boutiques face a need
to recognize the inherent limitations in their business models, and
restructure and re-engineer for a wider profit envelope, not limited to coffin corner conditions, which means
affordable fares and lower structural costs -- a la Southwest. Unfortunately for the network crowd, years of shedding
low-fare business to Southwest has made it the industry's fourth largest carrier in terms of passengers boarded,
as well as the fastest growing, highest margin, widest profit envelope and highest market capitalization air carrier,
which may within a few years surpass even the current number one Delta's boardings.
Also interesting are the effects of "Economic
Value Added"/alliance/code-sharing and low commission distribution
strategies on profit leverage. The former decrease fixed/variable cost ratios, while the latter gives the appearance
of doing the opposite. Since both of these structural evolutions were viewed by Wall Street as "positive", it's
interesting to note that they appear to push the industry further into the coffin corner in a declining demand environment.
These adverse effects illustrate unintended consequences
of theoretical efficiencies. Similar to the manner in
which the California power crisis and the Enron failure resulted from supposed economic efficiency run amok,
or that occasion when the plant must shut down the production line because the "just in time" supplier -- doesn't.
The parallel being the "just in time" passengers and express parcels that all of a sudden don't travel.
Where are those EVA, alliance strategy, ERP and
"lean production" consultants now that the stuff has hit the
proverbial fan? No doubt, tuning up for the next engagement: "re-engineering the airline boutique". Hello? Southwest?
The New Deal: Will Anyone Want to Fly?
So, how is this going to shake out? The way the system is being re-engineered, that's a valid question.
We're already seeing a total mind-set change in
the area of aviation security and related civil liberties. Some of this
is necessary, arguably overdue, but some approaches, if not properly thought through and implemented, will
radically diminish the desirability of air travel, especially on short hauls.
If there is a silver lining here somewhere, maybe
we will end up with the long discussed "Single Level of Safety
and Security". Hopefully, it will apply to express/cargo carriers, as well as passenger carriers. A 300,000 pound
cargo jet has at no time in the past been less of a risk than the passenger variety, yet cargo aircraft standards are
lax by comparison.
The desirability and competitiveness of short
haul travel by air could be severely challenged. Unfortunately, some
of the gains made by innovative airlines that successfully "gave time back" to frequent business travelers could
be lost. Gone for the moment are last minute show-up and check-in, for example.
While the reality may differ in the short term,
with few people using the system, the perception is one of slow, tedious
and invasive, federal security screening at airports, adding a perceived hour or more to all trips. We have passenger
compartments being locked-off, flight crew armed, meals eliminated due to cost or security concerns (likely both),
and that nothing sharp be allowed onboard.
One carrier has banned essentially all carry-on
articles, requiring all articles be checked and intensively scanned.
The 100% scanning is a needed change, but the idea of **gasp** a post-flight trip to the final frontier, dreaded
baggage carousel number 2, for your laptop and briefcase, is more than most business travelers will tolerate.
Another problem: most airlines won't take liability for checked laptops, cameras, prescriptions, etc.
Read your contract of carriage, and weep when your laptop turns up DOA.
Does any of this make sense? Maybe. From personal
experience, on those occasions where we have scanned
both carry-on and checked baggage for certain organic substances, we frequently found the contents of carry-ons
was far "badder" than what was being checked, and much worse than imagined.
So, to the hour or so perceived security delay
penalty, add another 30 minutes for the fastest bag delivery I have
ever experienced, likely longer, and the air traveler going ~250 miles or less will surely drive, video conference
or hop the Part 91/Part 135 business jet, to avoid the "new age" hassles.
I seriously question whether most short-haul business
travelers will accept the process that's being re-engineered,
as it is perceived and may in fact be (at full volumes, whenever that is, and whatever full volume represents going
forward). If this "stands", it's over for convenient, speedy, short-haul air travel, which volumetrically, represents a
sizable chuck of activity, and a key piece of certain carriers' franchises, such as the Shuttles and travel to DCA.
Let's quickly recap the New Deal:
I won't even go into the reality of "shoot down"
rules of engagement and trial balloons involving remote control "saves"
of errant aircraft. (That's a Control-X , "Land Me" to you Flight Sim junkies.)
As an industry, we've got to be able to do better
than this. The economy is depending on a robust airline industry
for support of its rebound, and the industry is depending on continued travel convenience, though with enhanced
security, at an understandable but affordable cost in dollar, convenience and civil liberties terms.
"Con Air" won't cut it, nor will the status quo.
We need the best and the brightest to solve this problem, through a
mixture of known, working technologies like PNR screening, inter-agency information sharing, carriers' own CRM
processes, and INSPASS-like trusted traveler credentials. "Knowing your customer" takes on new significance
as we move forward in the new environment. Keeping it convenient to fly will be essential.
Let's get to it, and start together on the road