Oliver Twist
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I find this of great intrest to all of us at US. Sorry for the length, but it IS worth the read. My comments at the end.
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Why United''s Crisis Is Good for Flying
Waning hope of a rescue by taxpayers is forcing the airline leader in bloated costs to face reality.
FORTUNE
Monday, September 16, 2002
By Shawn Tully
The mayday came Aug. 14, but the crisis at United Airlines had been building for years. On that Wednesday, CEO Jack Creighton, the Solomonic 70-year-old who had been summoned from retirement to act as caretaker for the airline, set a draconian deadline. United is in such disastrous financial straits, Creighton declared, that it must wrest huge cost reductions from suppliers, lenders, and employees in just 30 days. Achieving those savings is the only way for the $16-billion-a-year giant to win what it desperately needs: a $1.8 billion loan guarantee from the U.S. government.
If the cost cutting fails, Creighton warned, United will probably file for bankruptcy by mid-November. The world has changed, he said dourly. Unless we lower our costs dramatically, bankruptcy protection will be the only way to ensure the company''s future.
Creighton''s mayday was less a cry for help than an ultimatum aimed at United''s unions. In an industry whose major players are hobbled by exorbitant union contracts, United, which employs 83,000, is burdened with arguably the highest labor costs of all. The problem is compounded because employees own more than half of United''s stock and thus have a strong say in setting their own raises.
Now, the challenge of guiding this ungainly contraption is shifting from Creighton to a new boss. On Labor Day, United''s board chose Glenn Tilton, vice-chairman of ChevronTexaco, as CEO. Tilton is neither a turnaround specialist nor an airline industry expert: He won the job chiefly because he was acceptable to United''s unions. At ChevronTexaco, Tilton built a reputation as an astute consensus-builder who nurtured an excellent relationship with workers. It was he who helped Texaco repair the damage from the infamous mid-1990s scandal over its alleged mistreatment of African-American employees. Though the shadow of bankruptcy is still his strongest lever, Tilton is already playing the peacemaker, stressing the need for a genuine partnership between management and the unions.
Tilton won''t have to reach far for an example of what can happen if the unions fail to come to terms--US Airways, America''s smallest major carrier, filed for bankruptcy on August 12. As part of its restructuring, US Airways agreed with the Air Transportation Stabilization Board, the federal authority dispensing post-Sept. 11 aid to airlines, to slash costs in exchange for $900 million in loan guarantees. The biggest cost-cut: 25% off the airline''s labor expenses.
Weirdly, the specter of a United bankruptcy is good for the airline industry. To begin with, United''s planes will keep flying whether it goes bankrupt or not--reassuring news for consumers, since United accounts for 17% of U.S. air travel and an even bigger share of the business market. Meanwhile, its crisis represents the first real possibility for the industry to break its disastrous spiral in labor costs. The major airlines--American, United, Delta, Northwest, Continental, and US Airways--are reeling from the recession and the aftermath of Sept. 11. Their revenues have dived 23% since 2000, while the costs of insurance and security measures have soared; analysts expect the six companies to lose $6 billion this year. United''s crisis may finally convince the unions of the need for change. Because of the threat of bankruptcy, I see lots of downward pressure on pay, says Sean Sullivan, head of the National Pilots Association, which represents the pilots at AirTran, a low-cost carrier.
This isn''t the kind of industry leader United was supposed to be. When the airline restructured in 1994, it began a bold experiment in employee ownership. In exchange for deep pay cuts, the pilots, mechanics, ground workers, and management received 55% of United''s shares. The dream was that those employees would moderate their future pay demands for the good of the company they mostly owned; the reward for their restraint would be a strong share price.
But the concept was flawed from takeoff. The unions, especially the pilots union, soon realized that they could extract more wealth from United by driving up salaries than by growing the stock. In United''s boardroom the unions wielded a big club: veto power over the choice of any new CEO. That ensured a series of pliable CEOs sympathetic to the unions'' demands. It''s good for labor and management to be adversarial, says Michael Boyd, chief of the Boyd Group, a leading airline consulting firm. Unions should not be picking CEOs.
The problem became obvious in the spring of 2000. In the midst of negotiating a new pilots'' contract, CEO James Goodwin, a career United executive who had been championed by the unions, became intrigued with the idea of acquiring US Airways. He pursued a deal in secret.
When the pilots found out, they became enraged, not at the exorbitant $4.3 billion price Goodwin wanted to pay but at what they saw as a betrayal: They would have to sacrifice many of the best-paying positions and perks to US Airways pilots with more seniority. In protest, pilots failed to show up for work, forcing the cancellation of hundreds of flights. The slowdown brought United to its knees. To win the pilots'' support for the acquisition, Goodwin agreed to an incredible 28% pay increase in October 2000, far more than the pilots had demanded earlier in the year.
Washington ultimately blocked the merger on antitrust grounds. But the United pilots'' settlement created an industrywide feeding frenzy. I was working with the American pilots on the day the 28% increase was announced, recalls Boyd. All molecular motion in the room stopped. The reaction of the American pilots was ''When do we get ours?'' In early 2001, Delta pilots won the same increases granted United''s, plus one percentage point. American pilots are now demanding at least the pay garnered by their United brethren.
Even Sept. 11 didn''t stop the labor insanity. When Goodwin left as CEO in October, with a strong push from the unions, United picked Jack Creighton, a longtime board member. The unions liked him because as CEO of Weyerhaeuser he''d had excellent relations with the International Association of Machinists, the same union that represents United''s mechanics and ground workers.
Creighton was sympathetic to the unions at first. When he told them that United needed big givebacks, the mechanics and ground workers responded that they''d think about concessions. But they felt they were already underpaid. So they asked Creighton first to raise their pay to industry standards. Incredibly, the CEO agreed. The union loved the wage increases, but its enthusiasm for givebacks quickly evaporated.
Such deals helped bring United to the brink. Revenues have declined 26% since 2000, in part due to substantial cuts in scheduled flights, yet United''s total costs have dropped less than 3%. A major reason the expenses are so stubborn is the pilots'' contract, which is costing United an extra $692 million this year over 1999. United captains with 12 years of seniority now earn $265,000--the figure at AirTran is about $100,000 less--and work around 12 days per month. This largesse comes at a price. Since 1998, United''s market cap has dropped from $6 billion to $180 million. The entire company now trades for less than the price of a pair of 747s.
The ATSB, whose loan guarantee United is seeking, was set up by Congress to help airlines recover from the financial shock of Sept. 11. But under executive director Daniel Montgomery, a tough former bankruptcy workout specialist from Bank of America, it has evolved to serve a very different purpose--instead of a lifeline, it has become a lever to help the industry force down its bloated costs at last. Montgomery says United needs to prove two things to win the board''s support: It must show that it can cut costs enough to become a viable, profitable airline. That''s what US Airways showed us. It must also prove that it can''t raise financing from private sources.
Neither hurdle will be easy to clear. United got off to a weak start. It first applied to the ATSB with nothing more than a proposed 5% pay cut from management and 10% from the pilots. And the pilots'' concession was even less than met the eye. After taking a dip, their pay was to shoot back up, so that by 2006 senior captains would be making $295,000 a year, even more than they would have made under their original contract. Where United started was borderline laughable, says a top government official familiar with the ATSB negotiations. They thought they could get guarantees by getting their Congressmen to call.
Now United is getting serious. For one thing, the arrival of Tilton, whom the unions endorsed as CEO, could smooth negotiations within the company. To win the guarantees, it knows it will have to come close to US Airways'' 25% labor cost cuts. The pilots, who have the most to lose in a bankruptcy because they have the highest salaries and own the bulk of the employee-controlled stock, are talking to management about deeper concessions. Says Paul Whiteford, who heads the United chapter of the Air Line Pilots Association: We''re married to this company. But United will need concessions from all its unions. The toughest customer is the IAM, whose mechanics still refuse to make concessions to US Airways. To make matters worse, the IAM is struggling with a rival, AMFA, to represent United''s mechanics. The IAM lost to AMFA in 1999 at Northwest. It doesn''t want to lose again at United.
The IAM, its leaders say, has already done its share: Last year it agreed to allow United to pay $500 million in retroactive wage increases over two years--with interest, of course--instead of demanding the full amount upfront in cash. Now the IAM is weighing a company proposal to cut pay. But attorney Harvey Miller, who tangled with the IAM during the Eastern and Continental bankruptcies, says, I don''t think United can get the givebacks they''ll need because of the IAM--it''s the toughest union.
United may also have difficulty convincing the ATSB that it can''t raise private funds. The company holds $3.4 billion in debt-free aircraft that could serve as collateral for hundreds of millions of dollars in loans, though at lofty rates.
Bankruptcy, on the other hand, could get United big concessions, including givebacks on the epic scale the ATSB is seeking. The loss of passengers in the event of bankruptcy would probably be minor--consumers have readily patronized bankrupt airlines in the past. In Chapter 11, management must first try to negotiate new contracts with its unions. But if United deems that the concessions the unions then offer aren''t big enough, it can present the bankruptcy judge with its own plan for achieving profitability, and the judge can impose management''s deep cuts. Even if management proves too timid, the judge can enforce cuts on behalf of creditors that want to get the company flying profitably. Bankruptcy would have another healthy effect: Once employees'' shares become worthless, the unions lose their hold on the board.
A good guess is that United will gain a 20% reduction in its labor costs and a 10% reduction in total expenses, either in bankruptcy or in a deal with the ATSB. That would place United wing to wing with the lowest-cost majors, Continental, Northwest, and US Airways, and well below American. Most important, it could start something revolutionary in the industry, a ripple effect of lower labor costs. This will change the direction of compensation, says analyst Philip Baggaley of Standard & Poor''s. Conceivably the cuts at United could send high-cost American scrambling for bankruptcy. More likely United''s example will allow American to win better deals with its unions.
Pay cuts won''t end the major airlines'' travails. Even Continental and Northwest have costs about 40% higher than cut-rate carriers like JetBlue and Southwest. The majors collect more revenue per seat than the Southwests because they attract business customers with lavish frequent-flier programs, more frequent flights from big business hubs, and creature comforts like extra legroom. But the majors'' hold on the road warrior is weakening. Says Douglas Weeks, travel manager for Booz Allen Hamilton in Washington, D.C.: Our consultants drive to Baltimore to save money on AirTran and Southwest flights. They can save $1,000 flying to the San Francisco Bay Area on Southwest, vs. the cost on US Airways, United, or American, from Washington.
In the long term, the major airlines will have a hard time charging the sky-high business fares they need to make money in good times and bad. The low-cost airlines will continue to win market share. The question is how fast the erosion proceeds. But that''s next year''s crisis.
-------------------------------------------------
The authors take on UAL problems is not unusual to me. I have seen it coming for quite a while, not just at UAL, but at US as well and does not bode well for any major airline.
The old saying goes well here. Wolf in charge of the hen house???
Your comments??
------------------------------------
Why United''s Crisis Is Good for Flying
Waning hope of a rescue by taxpayers is forcing the airline leader in bloated costs to face reality.
FORTUNE
Monday, September 16, 2002
By Shawn Tully
The mayday came Aug. 14, but the crisis at United Airlines had been building for years. On that Wednesday, CEO Jack Creighton, the Solomonic 70-year-old who had been summoned from retirement to act as caretaker for the airline, set a draconian deadline. United is in such disastrous financial straits, Creighton declared, that it must wrest huge cost reductions from suppliers, lenders, and employees in just 30 days. Achieving those savings is the only way for the $16-billion-a-year giant to win what it desperately needs: a $1.8 billion loan guarantee from the U.S. government.
If the cost cutting fails, Creighton warned, United will probably file for bankruptcy by mid-November. The world has changed, he said dourly. Unless we lower our costs dramatically, bankruptcy protection will be the only way to ensure the company''s future.
Creighton''s mayday was less a cry for help than an ultimatum aimed at United''s unions. In an industry whose major players are hobbled by exorbitant union contracts, United, which employs 83,000, is burdened with arguably the highest labor costs of all. The problem is compounded because employees own more than half of United''s stock and thus have a strong say in setting their own raises.
Now, the challenge of guiding this ungainly contraption is shifting from Creighton to a new boss. On Labor Day, United''s board chose Glenn Tilton, vice-chairman of ChevronTexaco, as CEO. Tilton is neither a turnaround specialist nor an airline industry expert: He won the job chiefly because he was acceptable to United''s unions. At ChevronTexaco, Tilton built a reputation as an astute consensus-builder who nurtured an excellent relationship with workers. It was he who helped Texaco repair the damage from the infamous mid-1990s scandal over its alleged mistreatment of African-American employees. Though the shadow of bankruptcy is still his strongest lever, Tilton is already playing the peacemaker, stressing the need for a genuine partnership between management and the unions.
Tilton won''t have to reach far for an example of what can happen if the unions fail to come to terms--US Airways, America''s smallest major carrier, filed for bankruptcy on August 12. As part of its restructuring, US Airways agreed with the Air Transportation Stabilization Board, the federal authority dispensing post-Sept. 11 aid to airlines, to slash costs in exchange for $900 million in loan guarantees. The biggest cost-cut: 25% off the airline''s labor expenses.
Weirdly, the specter of a United bankruptcy is good for the airline industry. To begin with, United''s planes will keep flying whether it goes bankrupt or not--reassuring news for consumers, since United accounts for 17% of U.S. air travel and an even bigger share of the business market. Meanwhile, its crisis represents the first real possibility for the industry to break its disastrous spiral in labor costs. The major airlines--American, United, Delta, Northwest, Continental, and US Airways--are reeling from the recession and the aftermath of Sept. 11. Their revenues have dived 23% since 2000, while the costs of insurance and security measures have soared; analysts expect the six companies to lose $6 billion this year. United''s crisis may finally convince the unions of the need for change. Because of the threat of bankruptcy, I see lots of downward pressure on pay, says Sean Sullivan, head of the National Pilots Association, which represents the pilots at AirTran, a low-cost carrier.
This isn''t the kind of industry leader United was supposed to be. When the airline restructured in 1994, it began a bold experiment in employee ownership. In exchange for deep pay cuts, the pilots, mechanics, ground workers, and management received 55% of United''s shares. The dream was that those employees would moderate their future pay demands for the good of the company they mostly owned; the reward for their restraint would be a strong share price.
But the concept was flawed from takeoff. The unions, especially the pilots union, soon realized that they could extract more wealth from United by driving up salaries than by growing the stock. In United''s boardroom the unions wielded a big club: veto power over the choice of any new CEO. That ensured a series of pliable CEOs sympathetic to the unions'' demands. It''s good for labor and management to be adversarial, says Michael Boyd, chief of the Boyd Group, a leading airline consulting firm. Unions should not be picking CEOs.
The problem became obvious in the spring of 2000. In the midst of negotiating a new pilots'' contract, CEO James Goodwin, a career United executive who had been championed by the unions, became intrigued with the idea of acquiring US Airways. He pursued a deal in secret.
When the pilots found out, they became enraged, not at the exorbitant $4.3 billion price Goodwin wanted to pay but at what they saw as a betrayal: They would have to sacrifice many of the best-paying positions and perks to US Airways pilots with more seniority. In protest, pilots failed to show up for work, forcing the cancellation of hundreds of flights. The slowdown brought United to its knees. To win the pilots'' support for the acquisition, Goodwin agreed to an incredible 28% pay increase in October 2000, far more than the pilots had demanded earlier in the year.
Washington ultimately blocked the merger on antitrust grounds. But the United pilots'' settlement created an industrywide feeding frenzy. I was working with the American pilots on the day the 28% increase was announced, recalls Boyd. All molecular motion in the room stopped. The reaction of the American pilots was ''When do we get ours?'' In early 2001, Delta pilots won the same increases granted United''s, plus one percentage point. American pilots are now demanding at least the pay garnered by their United brethren.
Even Sept. 11 didn''t stop the labor insanity. When Goodwin left as CEO in October, with a strong push from the unions, United picked Jack Creighton, a longtime board member. The unions liked him because as CEO of Weyerhaeuser he''d had excellent relations with the International Association of Machinists, the same union that represents United''s mechanics and ground workers.
Creighton was sympathetic to the unions at first. When he told them that United needed big givebacks, the mechanics and ground workers responded that they''d think about concessions. But they felt they were already underpaid. So they asked Creighton first to raise their pay to industry standards. Incredibly, the CEO agreed. The union loved the wage increases, but its enthusiasm for givebacks quickly evaporated.
Such deals helped bring United to the brink. Revenues have declined 26% since 2000, in part due to substantial cuts in scheduled flights, yet United''s total costs have dropped less than 3%. A major reason the expenses are so stubborn is the pilots'' contract, which is costing United an extra $692 million this year over 1999. United captains with 12 years of seniority now earn $265,000--the figure at AirTran is about $100,000 less--and work around 12 days per month. This largesse comes at a price. Since 1998, United''s market cap has dropped from $6 billion to $180 million. The entire company now trades for less than the price of a pair of 747s.
The ATSB, whose loan guarantee United is seeking, was set up by Congress to help airlines recover from the financial shock of Sept. 11. But under executive director Daniel Montgomery, a tough former bankruptcy workout specialist from Bank of America, it has evolved to serve a very different purpose--instead of a lifeline, it has become a lever to help the industry force down its bloated costs at last. Montgomery says United needs to prove two things to win the board''s support: It must show that it can cut costs enough to become a viable, profitable airline. That''s what US Airways showed us. It must also prove that it can''t raise financing from private sources.
Neither hurdle will be easy to clear. United got off to a weak start. It first applied to the ATSB with nothing more than a proposed 5% pay cut from management and 10% from the pilots. And the pilots'' concession was even less than met the eye. After taking a dip, their pay was to shoot back up, so that by 2006 senior captains would be making $295,000 a year, even more than they would have made under their original contract. Where United started was borderline laughable, says a top government official familiar with the ATSB negotiations. They thought they could get guarantees by getting their Congressmen to call.
Now United is getting serious. For one thing, the arrival of Tilton, whom the unions endorsed as CEO, could smooth negotiations within the company. To win the guarantees, it knows it will have to come close to US Airways'' 25% labor cost cuts. The pilots, who have the most to lose in a bankruptcy because they have the highest salaries and own the bulk of the employee-controlled stock, are talking to management about deeper concessions. Says Paul Whiteford, who heads the United chapter of the Air Line Pilots Association: We''re married to this company. But United will need concessions from all its unions. The toughest customer is the IAM, whose mechanics still refuse to make concessions to US Airways. To make matters worse, the IAM is struggling with a rival, AMFA, to represent United''s mechanics. The IAM lost to AMFA in 1999 at Northwest. It doesn''t want to lose again at United.
The IAM, its leaders say, has already done its share: Last year it agreed to allow United to pay $500 million in retroactive wage increases over two years--with interest, of course--instead of demanding the full amount upfront in cash. Now the IAM is weighing a company proposal to cut pay. But attorney Harvey Miller, who tangled with the IAM during the Eastern and Continental bankruptcies, says, I don''t think United can get the givebacks they''ll need because of the IAM--it''s the toughest union.
United may also have difficulty convincing the ATSB that it can''t raise private funds. The company holds $3.4 billion in debt-free aircraft that could serve as collateral for hundreds of millions of dollars in loans, though at lofty rates.
Bankruptcy, on the other hand, could get United big concessions, including givebacks on the epic scale the ATSB is seeking. The loss of passengers in the event of bankruptcy would probably be minor--consumers have readily patronized bankrupt airlines in the past. In Chapter 11, management must first try to negotiate new contracts with its unions. But if United deems that the concessions the unions then offer aren''t big enough, it can present the bankruptcy judge with its own plan for achieving profitability, and the judge can impose management''s deep cuts. Even if management proves too timid, the judge can enforce cuts on behalf of creditors that want to get the company flying profitably. Bankruptcy would have another healthy effect: Once employees'' shares become worthless, the unions lose their hold on the board.
A good guess is that United will gain a 20% reduction in its labor costs and a 10% reduction in total expenses, either in bankruptcy or in a deal with the ATSB. That would place United wing to wing with the lowest-cost majors, Continental, Northwest, and US Airways, and well below American. Most important, it could start something revolutionary in the industry, a ripple effect of lower labor costs. This will change the direction of compensation, says analyst Philip Baggaley of Standard & Poor''s. Conceivably the cuts at United could send high-cost American scrambling for bankruptcy. More likely United''s example will allow American to win better deals with its unions.
Pay cuts won''t end the major airlines'' travails. Even Continental and Northwest have costs about 40% higher than cut-rate carriers like JetBlue and Southwest. The majors collect more revenue per seat than the Southwests because they attract business customers with lavish frequent-flier programs, more frequent flights from big business hubs, and creature comforts like extra legroom. But the majors'' hold on the road warrior is weakening. Says Douglas Weeks, travel manager for Booz Allen Hamilton in Washington, D.C.: Our consultants drive to Baltimore to save money on AirTran and Southwest flights. They can save $1,000 flying to the San Francisco Bay Area on Southwest, vs. the cost on US Airways, United, or American, from Washington.
In the long term, the major airlines will have a hard time charging the sky-high business fares they need to make money in good times and bad. The low-cost airlines will continue to win market share. The question is how fast the erosion proceeds. But that''s next year''s crisis.
-------------------------------------------------
The authors take on UAL problems is not unusual to me. I have seen it coming for quite a while, not just at UAL, but at US as well and does not bode well for any major airline.
The old saying goes well here. Wolf in charge of the hen house???
Your comments??
