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US regional aviation outlook: More than posturing to eliminating regionals

8-Sep-2010

After Continental Master Executive Council Chair Jay Pierce blasted yet another strategically placed shot across the regional industry’s bow last week in suggesting that the next contract for the merged United/Continental would rid the carrier of outsourcing to regional airlines, newly installed Allied Pilots Association President David Bates suggested much the same thing.

See related report: Continental pilots want regional flying abolished, or is it just posturing?

It seems the elimination of outsourcing may be more than a positioning strategy after all, according to The Street. “American [Airlines] pilots are also concerned about scope, which limits the number of regional jets the airline can fly,” wrote The Street columnist Ted Reed. “At American's Chicago hub, Bates points out that it's a lot of ‘trouble finding an American jet.’ The number of locally based pilots has declined from 2,200 in the mid-1990s to about 1,100 today. As airlines reduce capacity, American's fleet has fallen from about 900 aircraft to 619 today. The contract limits American to 47 70-seat jets, while the use of 50-seat jets is largely unlimited.

“A solution, Bates said, might be for American to buy hundreds of 100 to 120-seat jets, eliminate its American Eagle subsidiary and take over the routes flown by 50-seaters,” Reed continued. “American could then hire the Eagle pilots. The per-seat cost would decline and passengers would be happier with the bigger planes, but not so happy with the reduced frequencies. ‘I'm hoping that's part of the plan going forward, although I haven't yet broached it with management,’ Bates said.”

Bates certainly has chosen a propitious moment to make the suggestion as the only thing clear about American Eagle’s future is the fact that AMR wants to get rid of it. But it will also likely derail any efforts for the sale by creating uncertainty. Even so, the asking price is too high, it has too many 40 to 50-seat RJs which are no longer economic and then there is the Chapter 11 risk for the buyer should AMR reject CPA contracts after any sale. The higher costs and the consequent dramatic changes needed to turn Eagle around have no doubt kept suitors at bay. Likewise at Comair.

Regardless of labour issues, regionals face a tough future

The comments by Pierce and Bates as well as similar attacks against the sector by mainlines themselves seeking better contract provisions and lower CPA costs, aptly illustrate the upheavals the industry continues to face including the the long-overdue debate within the Air Line Pilots Association about how to resolve the conflicting interests of mainline and regional pilots. Bates’ solution of hiring Eagle pilots seems to accomplish that but at least one regional airline executive has called it a fairy tale. Even so, it does indicate the need to resolve this issue industry wide.

Even so, it seems the real question will be whether or not the entire issue will become moot, as suggested by Fltops.com President Lewis Smith, whose organisation is a pilot hiring clearing house. It also provides guidance for those wanting a piloting career. Indeed, he suggests that far from eliminating regional flying, they will be sucking up their pilots into their own pilot corps as a matter of course.

“The major US airlines are just beginning the longest and largest pilot hiring binge in history and the ‘wake turbulence’ will be very disruptive to smaller flight operations who feed them pilots,” he said. “During the last 20 years the US major airlines hired more than 46,000 pilots. The next 20 years will see that number double.”

Still, Smith thinks Pierce’s suggestion should be taken seriously. “The pilot union negotiator mindset is now:  If the passengers are willing to pay USD25 for their Samsonite, then surely they will pay a few extra dollars for a Sullenberger,” the former mainline pilot told CAPA. “So, I don't think the proposals to integrate the pilots from the feeder airlines with the mainline pilots is just posturing. It's a serious attempt to reduce the outsourcing of mainline flying and improve the career progression of mainline pilots. The recent proposals from unions to eliminate outsourcing was an inevitable development.  The question is: Are they willing to strike over it?”

Regionals more than just watch and wait

For their part, regionals can only hold their collective breath as they observe the proceedings. Even so, real changes are deemed highly unlikely because “major airline executives are too smart to let the unions draw them into killing off the flexibility of regional outsourcing,” according to a retired regional airline executive, who asked not to be identified. “They fought too hard and gave up too much to get the scope relief necessary to make the regional business what it is today. If they kill it off, they will inevitably have to pay a big price in the future to buy back the scope relief they have now.”

Still regionals are moving toward the future by consolidating and diversifying such as what Air Canada Jazz and Republic Airways Holdings are doing. Jazz is launching a new contract for Thomas Cook in November using 757s for the north-south charter service, while Republic diversified into low-cost carrier service with the acquisition of Frontier and Midwest Airlines.

The main challenge for regionals is lowering CPA rates. Thus the lower the regional cost structure the more contracts they will win. Consolidation is designed to do just that as mainlines put pressure on their regional partners and as low-cost carriers capitalise on the unpopularity of 50-seat jets by rolling out competitive services with mainline aircraft. That service is considered far superior since it not only offers passengers larger jets but goes point to point versus the regionals’ connecting service.

Plenty of pilot jobs expected along with major regional airline disruption

The former regional exec also pointed out the dire consequences of Bates’ suggestion. “While the thought of bringing regional flying in house may be appealing to mainline unions, it would mean thousands of regional pilots would lose their jobs as their airplanes went to the ground and the airlines shrank or failed altogether,” he said, adding he disagreed with the hiring scenarios. “The suggestion that this all works out for the benefit of those regional employees as the surviving majors would hire these displaced pilots is a fairy tale. They would be hired only after recall of the thousands of mainline pilots already on furlough and would be hired at the bottom of the seniority list.”

Indeed, Smith thinks the legacies are on the verge of a pilot hiring binge. “I don't believe the major airlines in the US will experience a pilot shortage, but that doesn't mean they won't be impacted,” said Smith. “Their primary source of pilots are the feeder airlines and operational disruptions are almost certain as the pilots leave the feeders for the majors. We expect the major US airlines to hire more than 40,000 pilots in the next 12 years but there are only 20,000 pilots flying for the feeders in total.” More importantly, the inevitable disruptions about which Smith is speaking could turn into reasons CPAs could be terminated.

But he doesn’t think massive hiring campaigns will breed peace between management and labor. “US airlines will experience several more pilot strikes and midnight showdowns,” he said. “Union negotiators want to charge all the market will bear and figure if another competitor is paying a certain rate and still making a profit, then their company can surely afford the pilot pay raises. Besides, in the union leaders mind, it’s good business to have the highest possible pay, to prepare for the inevitable pay cuts which are always around the corner in this feast or famine business.”

This means that, clearly, unions are not buying that this time will be different and the conservative business plans managements across the industry are pursuing will be successful. Indeed, they expect that past will be prologue when it comes to jobs and pay.

Smith explained two other trends afoot in the industry, pay at foreign airlines and the changing mindset of management. “The foreign airlines will need to modify their requirements and compensation considerably if they wish to continue harvesting pilots from the US market,” he said. “I believe one can expect serious shortages among the foreign carriers who can't afford to pay what it takes to attract qualified pilots.”

“In addition, after the 9/11 tragedy, harmony with front line employees took a back seat to survival,” he said. “Many CEOs are now re-evaluating the wisdom and profitability of more harmony with the pilot group, especially those that are unionised.”

But that does not sync with what United Chair Glenn Tilton was saying earlier this year. Tilton’s suggestion that there would be no sacred cows as airlines made fundamental changes in how they do business was clearly aimed at labour. “The industry has made expedient decisions, when it was seemingly affordable or comfortable to do so, and regretted them thereafter,” he said. 

Loss of frequency or loss of service

The only downside to the scenario outlined by Bates, is the loss of frequency in many of the markets now served by Eagle. But the regional airline executive disagrees. “The whole rationale for the idea is that the uneconomic, small RJs will be going away,” he said. “But so will the markets they were ‘right-sized’ to serve. The majors won’t replace that uneconomic capacity so those are jobs that will never come back. It also takes fewer pilots to produce capacity on bigger airplanes so even fewer pilots will be needed.”

He likened any progress made toward the pilots’ goals to in-source regional flying to the B-scale tried by American in the 1980s and suggested it would only be temporary. “The B rates were also temporary and the changes being suggested by the pilots now will ultimately go away with time,” he concluded. “This is a union sucker punch and any major airline executive who falls for it doesn’t have the scars that come with experience. Once the airlines have made the billions of dollars in investment in the aircraft and all the pilots have been hired on, the concessions will disappear and the operating costs will rise. That will be the future just as it has in the past.”

The regional executive who was instrumental in building his airline during the most rapidly changing periods of regional airline history, also pointed to the long-term capacity purchase agreements indicating that it would be a long time before regional airline outsourcing would end.

“That is so even if they wanted to do it and reached satisfactory contractual agreement with the pilot unions,” he said. “The regional airlines will quite appropriately and understandably assert their rights under the CPAs to continue the flying for the full CPA term.  After all, they invested in the airplanes and associated infrastructure and would have nowhere else to place their entire fleets.  As the CPA terms eventually run their natural course – some as much as 10 years – the majors will be free to drop uneconomic regional flying and bring what is left in-house; or drop some, bring some in and leave some with small niche players flying 50-seat jets and turboprops.”

The executive did point out, however, American, owning both Eagle and Executive Airlines and having no CPA agreements, have no such constraints. Thus, it could shut down Eagle at any time. “Obviously, while they are trying to sell Eagle, it would be a poor strategy to even think about bringing regional flying in house or killing off Eagle,” he said. “No one would invest in that future.”

Or, he suggested, legacies could do what Delta did with Mesa, terminate the agreement on the grounds of non-performance. “That is tricky and uncertain as we have seen,” he said. “Or they could try to buy out the contracts but that is unlikely as the cost would be very high. No matter how it is done, it would be bad news for the regionals as their industry would essentially disappear.”

Ironically, he also pointed out that the bigger-aircraft-fewer-pilots discussion is now being played out at Southwest over the 737-800. Thus the reason Southwest pilots are so concerned about the potential impact of larger aircraft.

Buying the 100 to 120-seaters, of course would be music to the ears of Bombardier and seems to lay a path forward for the likes of Embraer, Mitsubishi, Superjet and Comac, despite the fact that we are a long way off having a clear picture of the future.

Their regional airliner programs always relied on changing scope but this type of change was probably not anticipated. It makes Bombardier look rather prescient for having decided to tackle the mainline market against Boeing and Airbus because its CSeries will undoubtedly emerge a winner if Bates’ suggestion is taken seriously.

Labour trying to restore former glory

Despite the unlikelihood of the Pierce/Bates suggestion, it is clear that labour has been one of the biggest losers in the past decade but it cannot be said that management has emerged a winner given the losses, disruption and other dramatic changes they are now suggesting as industry strategy. The only difference being that C-Suite managers have enjoyed a lot more job security ... and stratospheric salaries, of course. And that is huge.

With pilots remaining on furlough, regionals are squarely in union sights it seems and thus, Pierce’s seemingly off-the-wall suggestion must be taken more seriously than putting it down to a strategic ploy. Still the suggestion defies the industry as we know it today and would mean really radical changes that, to date, cannot be supported by a cool, logical look at the numbers.

Indeed, American’s numbers show that 9.3% of its mainline passenger revenue comes from affiliate feed. For 2009 the amount of incremental revenues gained from that feed was USD1.4 billion, somewhat shy of the USD1.7 billion it reported in 2008. That money is in addition to the USD2.012 billion in American Eagle revenue posted last year even as expenses overwhelmed profits by about USD500,000. The acquisition of hundreds of jets and the disruption of a USD3 billion revenue stream comes at a time when American can least afford it. And a mere half million in losses will do nothing to ameliorate the USD600 million in labour cost disadvantages American has compared to its peers. But, then again, USD500,000 could buy a lot of CSeries jets.

In addition to the nearly 4,000 mainline pilots on furlough, there are 1,635 regional pilots Fltops.com says remain on furlough. No one knows the real number that will actually return to the US industry as many have moved on to other careers or are now flying for other airlines or overseas. For instance, Delta recalled all its 349 pilots and only 75 opted to return forcing the hiring of 175 pilots “off the street,” according to Fltops.com’s Smith.

“There are 3,951 furloughed pilots who have seniority numbers at the major airlines and subject to recall, mainly American and United, but many of them are working for other airlines,” he continued. “The implication they are unemployed is exaggerated.”

Future labour management relations still uncertain

Still, meeting labour and management expectations in a changing industry was the theme of The Street article, the new breed of union leadership and how they are tackling that hurdle. Reed places Bates and Pierce and United Master Executive Council Chair Wendy Morse in that new breed of leaders who “realise that for pilots to win, airlines must win too”. That can only mean tackling some of the harder issues that have been festering for decades. But it promises a healthier management/labour relationship, not to mention a healthier airline industry.

Certainly, labour has given its all in the past decade and airlines are a mere shadow of their former selves. With that new reality facing management and labour it is clear a new way forward is required. That new way will require more sacrifices by labour no doubt but it should also call for more sacrifices by management, the track record for which includes having traded away labour concessions for market share leaving labour angry and the airline just as sick as when labour conceded in the first place. Labour’s desire to restore previous compensation and work rules, flies in the face of today’s industry which still requires even more flexibility than management has already gained in work rules and compensation.

CFO Kathryn Mikells looks to other industries for a solution, specifically communications. She suggests the variable compensation model – compensation based on reaching performance goals linked to organisational strategies – should be considered as it has worked in other other highly cyclical industries.

Complicating the debate is the golden salaries for airline management which have increased the gap between management and worker pay to the size of the Grand Canyon. That will not likely be resolved as it is a topic for society at large, not just airlines, and management compensation now borders on the obscene. The Institute for Policy Studies reported recently “that the CEOs for the 50 firms that laid off the most workers since the onset of the economic crisis took home 42% more than the CEO pay average at the S&P 500 firms as a whole.”

While management often calls the argument a red herring preferring instead to point to the unemployment rate impact on worker compensation. But, labour counters saying that if management is serious about reducing wages to remain competitive, then that should include inflated executive salaries. Economists also report that while executive compensation has been rising, savings from labour cuts in workforce and wages has produced profits. Those profits are being retained on the bottom line rather than being reinvested in the business, technology or in improving workers wages or working conditions.

Efforts to resolve this issue at the societal level have gone flat in Congress even in the wake of the housing and financial crises. Even so, tempering management compensation should be put in management’s quiver as it asks labor for more sacrifices. Certainly, Continental CEO Jeff Smisek’s promise not to take his salary in 2010 unless the airline is profitable acknowledges that the gap is part of the problem. Given Continental’s results year to date, he isn’t expected to lose his salary.

Metamorphosis

The fact is, the last decade has pressured all constituents in business and airlines are not unique. Because of that, the airline industry is now morphing into what it will ultimate become -- at least that is the hope of everyone involved. But we won’t know that until at least mid decade. Certainly that is what is suggested by United Chair Glenn Tilton and his colleagues President John Tague and Mickells when they talk about the future of the industry.

See related report: US airline outlook: Fundamental restructuring is in the wind but will the industry revert to type? 

Tague noted the greatest sea change – managing the airline for the down cycle. JetBlue's David Barger suggests any capacity increases or route changes must earn their way onto the network and Tague seems to agree. Clearly the new mantra at United is: Can this work in the down cycle? That suggests that if the idea cannot work in the down cycle, the airline must be far more nimble to make the changes necessary when the bottom falls out of the market again, now expected in 2018 or 2019. That means more flexibility from labour.

Tackling these issues are merely the birth pangs of a new industry, one that will take new thinking on the part of employees and management and, as Reed suggests, is already happening with the likes of Pierce and Bates along with Morse. The sweet spot will come when management realises that investing in employees, as SkyWest has done successfully without unions, creates a tangible result in the bottom line.

But prospects of a new day for labour/management relations are cloudy indeed. The ascendancy of the three new labour leaders comes at a time when three aviation labour groups have joined to create the American Aviation Labor Alliance (AALA) to work on financial and competitive issues “workers care about in the airline industry,” according to Teamsters General President Jim Hoffa. AALA is a formal partnership of the International Brotherhood of Teamsters (IBT), the Transport Workers Union (TWU) and the Coalition of Airline Pilots Association, which represent more than 140,000 aviation workers.

But its goal is far more traditional and confrontational and, observers think, counterproductive to a healthy the industry. It could compromise the efforts of pilot union leaders of making progress on their new philosophy that if the airline wins, so do its employees. In other ways, however, they may be close as they both attack the outsourcing that have cost jobs in maintenance and the cockpit. AALA’s first mission is the not-very-likely passage of the FAA Reauthorisation Bill now that the mid-term election campaigns are in full swing. They are banking on its provisions concerning overseas repair bases and pilot training, despite the fact that the pilot training issue was already passed earlier this summer. The bill also covers bankruptcy reform.

While it is natural for the new organisation to focus on its traditional issues, there are many other issues that keep them at odds with management ideas on what constitutes what the Coalition of Airline Pilots Association describes as “a flight plan for a successful commercial aviation industry in this country” and makes any paradigm shift by both management and labour to be as far away as it ever was.


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