CAL 757-300

Excellent article to follow up on some previous threads on this board. And it's written by a UA pilot!

By Vaughn Cordle
Financial Analyst & Senior United Airlines Captain
(flycordle@aol.com)

Airlines and unions are in trouble

As more people realize that the yield bubble of the late 90s was an anomaly, and that the network airlines have unsustainable cost structures, more people will focus on and write about the need to reform labor contracts and the behavior of airline unions in general.

Lets not dance around the real issue: Unions are too powerful in the airline industry and no airline can take a strike. Reform of labor contracts means rationality in labor costs as they pertain to the airlines' ability to pay. Capital spending is being dramatically cut in order to cover the negative cash flows and customer service quality will not improve when airlines are forced to cut costs and leverage up. Labors' slice of the revenue pie is now too large given the economics of the industry. Industry fundamentals and the economic environment will improve because we are emerging from a recession. However, a recovery of traffic and yields will not return to the levels of the 1996 to 2000 bubble years any time soon, if ever. Moreover, real (inflation adj.) yields will continue to decline as traffic climbs over the next decade.
Over the last full business cycle the US airlines destroyed $32 billion in capital. In economic terms this includes all sources of capital including equity costs and all off-balance sheet liabilities. Under funded pensions plans are a form of borrowings, from the employees, and is considered a source of capital.

During the bubble years, industry income was overstated and balance sheet liabilities understated due to the 24% a year gains in the stock market. This phenomenon provided above sustainable long run returns on pension assets, which in turn lowered expenses and liabilities for the airlines unrealistically. The bubble years provided actual pension plan returns above expectations which in turn lowered funding requirements and the difference between plan assets and plan obligations. This came to an end in 2000 with the downturn in the stock market. Many airlines are still using unrealistic assumptions, in terms of expected returns on plan assets and discount rates, which are much too high. When these assumptions are too high, earnings for the airlines are overstated.

CAL 757-300

High cost, mature and heavily unionized companies like the network airlines are disadvantaged in the marketplace because of the very large pension and post-retirement obligations. These plans really should be classified as "unconsolidated" subsidiaries. These subsidiaries must be fed ever-increasing dollars from the parent company, and the numbers are huge.

As an example, UAL's pension and post-retirement (service and interest) recurring costs in 2001 were $1.3 billion with actual plan returns of a NEGATIVE $464 million. Total plan obligations were reported at $12.5 billion as of December 31, 2001.

These plans are under funded by $2.7 billion, which means the company's reported book value of equity is overstated by $2.7 billion. Total plan assets: $7.7 billion. Plan asset returns were negative last year because of the negative return on the broader stock market.

The real economics of the pension and post retirement accounts plans reflect the difference between the reported (accrued) obligation on the balance sheet and the "economic status" of the plans, which is simply the difference between projected obligations and the fair market value of the plan assets.

For a company like United, this means that the book value (equity) of the company is really a negative $223 million if you knock off the $952 million in intangible assets and the (off-balance sheet) value of the under funded pension plans. UAL's true equity position is vastly different from the reported $3.4 billion in the latest 10K filing. Intangible assets on the balance sheet have no value in a bankruptcy.
What does this mean? It means that several major airlines are headed for bankruptcy without major reductions in aggregate labor costs. Anachronistic work rules and a bankrupt ideology, in terms of how the unions value labors' input, are at the core of the industry's capital destroying problem. Inflexible work rules and the unions' drive for ever increasing "industry leading" wages and benefits are simply bankrupting the industry. The airline unions' business practices and unrealistic demands are out of whack with today's highly competitive and revenue challenging environment.

CAL 757-300

Mature high-cost airlines with older and heavily unionized employees are at a distinct competitive disadvantage because of the very large pension and post-retirement obligations and poor (airline) asset utilization. Negative returns on equity, assets, capital AND poor customer service does not make for a viable business model. Unless returns improve dramatically, capital spending will be inadequate to support the asset base and customer service quality will not improve, in fact it will continue to deteriorate.

So what is the solution? Bankruptcy, or at least the threat of bankruptcy, appears to be the only way out for several of the airlines. USAir is basically already there and United is only a quarter or two away from a chapter 11 filing. The stabilization board provides a backup source of capital and would provide the liquidity required to avoid a bankruptcy filing -- at least in the short run.

Why does it take a threat of bankruptcy before labor backs down from unrealistic wage demands? Perhaps it's a function of the unions' political hierarchy and their socialistic nature. Clearly they do not concern themselves with the cost of capital (required rate of return) or the risk profile (which impacts the cost of capital) of the airlines in which they control. I say control because contract rules dictate what the airlines can or cannot do competitively. Scope clause limitations and outdated work rules result in poor asset utilization and poor returns on capital (equity and liabilities). Labor actions (i.e., slow downs, threat of strikes) drive up the volatility of earnings and the risk profile of the company, this in turn drives up the required rate of return for the investor.

Higher required returns on capital means less capital, which in turn means fewer resources for customer service and asset growth -- and less resources to pay labor and to support the large and ever growing obligations represented in the pension plans.

Without labor contract reform, the industry -- in terms of the high cost network airlines -- will continue to destroy large sums of capital and will continue to provide a level of service quality that will continue to deteriorate. In my opinion, it will take an actual bankruptcy or two to break the strangle hold that organized labor has on the industry.

Considering that the airlines with the most militant unions have the poorest customer service rankings and the poorest returns on assets, it would be fitting for those airlines to go out of business. If labor unions cannot step up to the plate and provide leadership on needed labor contract reform, they deserve to go down with the ship. Nothing wrong with having competent representation, and unions do have a valuable role to play, however when they squeeze the golden goose to the point of where it can barely breathe, let alone grow, we have a problem. It's an imbalance of power problem and it's a union problem.

More specifically, the problem is the inability of the unions to properly value the input of labor, and it's a problem of unions not understanding the need for the airlines to cover the cost of capital over a full business cycle. Until union leaders understand the cost of capital concept, and the need to be competitive over the longer run, more than a few airlines will continue down the path of Eastern, TWA and others who were unable to adapt to a dynamic and very cost-competitive marketplace.

Scott

For the record, there is a kernel of truth in the synopsis offered by Capt. Cordle. Lest you believe he represents the average line pilot, let me assure you his name resides in the ALPA "scab" book, millennium edition. "V. Cordle" has a serious disdain for ALPA, as he will forever be villified as a "fleet-qual", hired off the street to replace striking UA pilots on 5-19-85. Chances are he was previously rejected during pre-employment screening, only to be ceremoniously hired at the rate of $50,000 per year as a first officer. In those days, this was a princely sum acccorded to the few with "corkscrew soul, a waterlogged brain, and a combination of backbone made of jelly and glue." (credit to Jack London in "Ode To A Scab", 1915) Did he dispense a significant value to charity?
At any rate, I have no desire to "shoot the messenger". As a 12 year ALPA member, my views of reality are tempered by education in business academia. To cut to the chase, the average UA line pilot would gladly offer concessions to re-energize UAL, but the management credibility gap has yawned chasms until recently. Jack Creighton has re-instituted corporate communication, offered some hints at a youthful business plan, and exudes great integrity. Old business models of revenue and expense are essentially trashed. Pilot compensation must be based on rational standards. Before you accuse me of being overpaid and underworked, try riding in the jumpseat of CO (if you are entitled by reg) with a crew during a 3 or 4 day trip with typical weather and equipment constraints. Live the entire experience once or twice and you'll realize our drive. Most of us dearly love our jobs and will greatly sacrifice when justified. I just cringe at concessions to a management rife with corruption, greed and general incompetence. I'm counting on Jack Creighton to clean house at the mid-level and he will be my hero!

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Fly the Friendly Skies of United

uniTED takes wing Feb 12, 2004

Scott

Part 2: Phil, your pedantic potshots at UA and US ought to be tempered by the creaky state of your own CO. UA retains 2.6 billion cash and 4.0 billion in unencumbered assets. It is my understanding that CO has not one aircraft available for collateral. True? Forgive me, I'm possess a lowly BBA degree, but your analysis of pension liability is a bit suspect. Retirement is a negotiated benefit - do you suggest abrogating such trivialities when the going gets rough? Is this forum dishonored by the presence of frank lorenzo, or are you simply an anointed pupil? Just remember your extremist views shall be humbly tempered by those at the pointy end of the aluminum tube.

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Fly the Friendly Skies of United

uniTED takes wing Feb 12, 2004

CAL 757-300

Thanks for your replies Scott. Unfortunately I can't take any credit for what I posted. All three posts are part of the same article, so the only one taking pot shots here is your very own pilot. I had to post the article in three parts because it was too large to post as one article.

However, I have to agree with Mr. Cordle in that wages are indeed spinning out of control. If you read some of the other posts I've put on here, especially the recent ones regarding US Airways, you'll quickly learn that I am not anti-labor, but that I am merely presenting rational ideas in an irrational industry. If you can sit behind your computer, take shots at me, and honestly say that the UA pilot contract signed last year was rational and good for the industry, then I guess it will be impossible to have an educated and rational discussion. There are a lot of industry people on this forum, union and management alike, that like to discuss this in a respectable and intellectual manner.

Sorry, Lorenzo isn't pull the strings on this marionette. Is Charlie Bryan pulling your strings?

Sentinel Chicken

I'm probably WAAAAY in over my head on this discussion as I'm not in the airline industry, a pilot, or labor scholar (but then I stick my finger in people's ofrices to make medical diagonses, so what do I know?), but it seems to me that what you guys are both discussing is a problem afflicting organized labor as a whole. The industries that organized labor once was a powerful force in are no longer the industries that drive the economy. Labor membership across the nation is growing gray and losing clout in key sectors.

To me, it's not that the days of organized labor are over, but there has to be (at least in the airline industry) a rethink of the relationship between labor and management. My read of the news in the industry is that BOTH management and labor are using negotiation methods and tactics that are woefully outdated.

It seems to me that in recent airline labor disputes the Railway Labor Act (which was applied to the airline industry in 1935) and it's differing provisions for conflict resolution are used by the respective parties be they management or unions to drag out negotiations- I've read about negotiations lasting YEARS under the provisions of the Railway Labor Act at some airlines. As a result, we're seeing some of these "work-to-rule" actions, sickouts, and so on that prove to be just as disruptive to the industry and the travelling public as a general strike would be.

If I'm not mistaken, there has only been one serious legal challenge to Railway Labor Act in the airline industry and that was with the FAs union versus Alaska Airlines back in the early 90s and that lawsuit concerned work stoppages as a form of "self-help" during labor negotiations. I'm no legal scholar, but it sounded like a conflict between the standards between the Railway Labor Act (which applies to airlines) and the National Labor Relations Act (which I think applies to everyone else).

I got a serious headache trying to understand this sh*t and I'm tempted to say that there probably needs to be a better way than the RLA in resolving airline disputes.

Scott is right, there is a credibility gap between management and labor at the airlines and I think in some part that's built into the relationship thanks to the Railway Labor Act.

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Piss on noise abatement!

Scott

Phil, after reading your earlier posts and recognition of the 3-part segmentation of Cordle's article, allow an apology for my ill-directed dart! I'll send you a case of the Chicken's "shine" as a testament to my willingness to participate in rational discourse.
The RLA is a significant impediment to mature and fruitful negotioations from the perspective of labor and management. The rancor of twice a decade duels certainly poisons the well of mutual trust and respect. The spillover to the travelling public is distasteful and degrades my profession. Yet it is often the ONLY method available to compell management to join timely discussion.
Yes, I have mixed emotions regarding our (UA) recent contract. Our industry leading agreement was artificially enhanced relative to what was sought during initial negotiation. Jim Goodwin earned the scorn of fellow ceo's by offering a generous settlement. And yet, we are a bit of a special case. During the grand experiment of our 5-year ESOP (employee stock ownership plan) my personal wage and benefit contribution was nearly $100,000. UA earned record profits attributable to concessions and a booming economy. As majority stockholders, UA employees entered negotiations keen to prop up wages well below industry standard - and recoup the benefit of long-term sacrifice. But do you know what the greatest failure of the ESOP really was? Lack of culture change at all levels. Ideally, a level of trust inculcated during the past few years would permit a frank analysis of the year 2001 and post 9-11 reality. Sadly, the lesson was unlearned. We are now faced with impending contraction and years of potential stagnation. Our collective best hope is heeding the ghosts of lorenzo, borman, ferris, wolf, and yes, bryan. Stay tuned!! Uh Doc, hope you are not allergic to latex!

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Fly the Friendly Skies of United

uniTED takes wing Feb 12, 2004

Sentinel Chicken

Okay, I'm going to play village idiot on this thread here, but some questions come to mind regarding labor-management relations in the airline industry:

Why a five-year contract? I see "five-year" and I think of the infamous Five Year Plans by the Party Central Committee of the old Soviet Union. It seems risky to my birdbrain to set wages for the next five years when who-knows-what can happen. Just look at what 9/11 did to the already beleaguered industry. Or are the contracts built with provisions for economic changes? It seems that's what United's ESOP was after, right? Financial flexibility based on airline performance.

Do the unions and management HAVE to negotiate by the rules set down in the Railway Labor Act? Is it possible for a union and management to sit down, agree that the RLA sucks ass and hammer out their own agreement their own way? Yeah, I know, that's probably a pie-in-the-sky way of looking at it.....

Release the hounds....I think.....

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Piss on noise abatement!

CAL 757-300

Both you and Scott have good opinions Doc. I don't think current labor negotiations in our industry are tied to the RLA. Part of what Scott said I agree with 100%: there is an inherent feeling of mistrust between labor and management that is partially due to the manner in which contracts are negotiated. One side gives their opening bid, the other side responds, and off they go for months on end. In the end each side concedes certain points but builds in a "poison pill" at the same time. Unions put in specific work rules. Management will insert clauses relating to fleet and growth. In the end the clauses cause inefficiency, higher costs, and mistrust between the two parties.

The two parties cannot sit down and talk about financial responsibility for one major reason: monopoly. ALPA represents every major US carrier (except AA), so if they start talking about incentive based pay and establishing trust with one carrier they are going to have to do that with all of them. And to agree with Scott once again, some carriers should NOT be trusted. I wholeheartedly believe that CO negotiates in the best interests of the company, not management's wallets. They realize that costs cannot rise too much in this environment or financial failure will follow.

I would love to say get rid of ALPA and have each labor group negotiate their own contract at each carrier, but I know that won't happen. However, that is exactly what must happen. Each airline is different: some are well managed (WN, CO, AS to name a few) that enter negotiations in good faith and should have a good relationship with their labor as a result. Others (I won't point fingers) deserve the situation they're in because management are idiots or act in dishonest manners, and their labor groups are pigheaded and hell bent on punishing management for their behavior, even if it means ruining the company. Let those guys die and get some rationality in this industry.

Wingman

[quote]Originally posted by Sentinel Chicken
[b]I'm probably WAAAAY in over my head on this discussion as I'm not in the airline industry, a pilot, or labor scholar (but then I stick my finger in people's ofrices to make medical diagonses, so what do I know?),

Then you are probably qualified to work in labor negoiations.

Scott

Doc's analogy to the old Soviet Union's "5-year plan" and the frequent need to renegotiate labor contracts is valid. In fact, airline agreements do not expire, they become amenable on a specified date. Union labor tends to seek wages independent of the business cycle. This philosophy stipulates "a days pay for a days work" and seeks to imbed the expense in operating costs akin to relatively fixed items as aircraft leases, real estate, etc. Linkage to operating profits or stock valuation is generally seen as a ploy to "shortchange" labor equity contribution. Would I agree to a modified compensatory system of a base pay and profit sharing? Conditionally yes, though ALPA has long fought such schemes. Phil is correct that the unions are wary of establishing precedent to spread throughout the industry. Ideally contracts would be negotiated cognizant of the strengths and liabilities of individual airlines. And no, I don't agree with the current mentality of successive "industry leading" contracts. Just why did DL feel the need to supplant the UA agreement? Simple greed; they had no organizational equity (esop) or significant wage gap to bridge.

But enough of history... where to from here? If the post 9/11 realities cannot usher a new beginning, we shall surely lose a few carriers, either to bankruptcy or merger. Low-cost operators will inherit the future.

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Fly the Friendly Skies of United

uniTED takes wing Feb 12, 2004

Scott

BTW Phil, where would you be had the sentiments expressed in the last paragraph of your previous post come to pass? CO enjoyed the protection of chapter 11 bankruptcy twice, due in part to corrupt egotistical management and recalitrant labor. Dare I say the long-term employees of the "other guys" who "deserve to die" beg to differ with your prescription. Fortunately CO has morphed into a great carrier worthy of the name. Although Ch. 11 rules have toughened, perhaps future entrants deserve a second chance. Food for thought?

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Fly the Friendly Skies of United

uniTED takes wing Feb 12, 2004