Holding Pattern: United Airlines

TOM BEARDEN:

The customary turmoil at the airport curbsides this year was dwarfed by the turmoil experienced by the airlines themselves. United, the nation's second biggest carrier, is scrambling to cut its high costs to avoid a Chapter 11 bankruptcy filing that may be only days away. USAir, already in bankruptcy, is struggling to cut costs as well. Both are symptomatic of an industry that lost big money this year, continuing the financial roller coaster the industry has been riding for the last decade. Losses in the early '90s were followed by record profits in the second half of the decade. In the last two years, though, accelerated by 9/11, the profits turned to record losses.

The industry's current crisis began sometimes in 2000, when airlines noticed a substantial shift of business passengers away from the big hub-and-spoke carriers to the discount carriers such as Air Tran, Southwest, and Jet Blue. These were fliers who once willingly paid the very high fares airlines typically charged for last minute fliers such as business travelers. No more.

J.C. PHILLIPS:

The bottom line is "I can't afford it," you know. The difference… this flight today, the difference is $300 and for me that's fairly important.

TOM BEARDEN:

Is that the difference between making a trip and not making a trip?

J.C. PHILLIPS:

It does.

TOM BEARDEN:

The result has been a small windfall for discount carriers, which typically have much lower costs through a combination of lower pay scales and more efficient operations. So the discounters can charge lower fares and make profits. Joe Leonard of Air Tran is confident he can compete successfully with much bigger carriers.

JOE LEONARD, CEO, Air Tran Airlines:

We expect when we go into anybody's hub that they're going to add capacity and they're going to match our fares. But, again, if you've got anywhere from a 25 percent to a 70 percent cost advantage over the competitor at the end of the day there's not much they can do about that.

TOM BEARDEN:

The large carriers are now trying to figure out how to cut those high costs that make them uncompetitive. Delta Airlines recently decided to create a new low-fare subsidiary to begin next year operating more like the discount carriers, with all-coach cabins and shorter ground times. American Airlines saved money by spreading out the schedule of arrivals and departures at its big hubs in Dallas and Chicago. Neither American nor Delta has tried to reduce its high labor costs, which many say is the hub carriers' biggest disadvantage. At USAir, for example, the labor costs involved in flying one seat one mile is twice what it is at Southwest. American's labor costs are twice those of two-year-old Jet Blue. In August, USAir filed for Chapter 11 after losing $2.5 billion in the previous year and a half. The airline recently negotiated billions of dollars in pay cuts from its work force in hopes of winning a final okay for a loan guarantee from the federal government. The same process of negotiating worker pay cuts is now underway at united, which is currently losing more than $7 million a day.

JIM LEHRER:

Margaret Warner has more on the situation at United.

MARGARET WARNER:

United Airlines has been trying to put together a $5.2 billion package of wage concessions from its various unions. If successful on that score, the company hopes to win backing for a $1.8 billion federal loan guarantee. The airline's pilots, flight attendants and some smaller unions approved wage cut packages, contingent on every union doing the same. But last Thursday, the mechanics balked. Their decision today to reconsider that vote this Thursday offers the world's second largest airline its last chance to avoid bankruptcy. Here with more are Peter Cappelli, professor of management at the Wharton School of Business at the University of Pennsylvania; and Thomas Leritz, aviation analyst with banc of America Capital Management in St. Louis. Welcome to you both.

Mr. Cappelli, beginning with you, explain why, what's changed, why are the mechanics willing to reconsider essentially the same package they rejected last week?

PETER CAPPELLI:

Well, maybe it makes sense to back up and say why did they turn it down in the first place. A lot of people would wonder, particularly an employee owned company, why the mechanics weren't agreeing to help save the company when the other unions did earlier. And I think there are a couple reasons for that. The main one is that the mechanics believe that their wages are pretty much the same everywhere. The IAM, their main union in the industry, has similar contracts across the entire industry. And they believe, I think rightly, that if the United failed, they would end up doing similar work some place else at roughly the same rate of pay. So they don't quite see the same need to do it, to make the concessions. They're also under some pressure from other unions who they'd like to represent. The mechanics at United and other unions claim you shouldn't make concessions. Similarly, USAir, the mechanics there went through two votes, turned down the concession deal at USAir the first time, so they're under a certain amount of pressure to show that they're as tough as the unions elsewhere, at USAir in particular.

So the question, why are they agreeing to do it now, why are they going to go back try again, turns on the fact that the alternatives look pretty grim. The alternative if they don't agree to these concessions appears to be that United would be heading towards bankruptcy. If they go to bankruptcy court, the bankruptcy judge could change the labor contracts, the unions might end up with worse arrangements than they would have if they negotiated something now. And it might also be the case, because this is an employee-owned company, that the ownership gets restructured after going through bankruptcy. And the union might find, for example, that it no longer has seats on the boards of directors if its shares ownership of the company falls by enough, it could lose those seats on the board, which are very important to the company. So I think the union agrees to go back because they stared the alternatives in the eye, they don't look good and they're going to try to persuade the members to make the changes.

MARGARET WARNER:

Mr. Leritz, if the mechanics go ahead and say yes this time, what does that really buy for this company that is hemorrhaging $7 million a day?

THOMAS LERITZ:

Well, I think when you look at the company, yeah, they are hemorrhaging $7 million a day, they do need to address that cost structure and they need to do the wage concessions. When you look at the proposal they have, what United Airlines has done is they've come up with a $14 billion package, and they presented it to the ATSB –.

MARGARET WARNER:

The ATSB is this federal air transportation.

THOMAS LERITZ:

It's the Air Transportation Stabilization Board. So United Airlines has brought forth this proposal, which includes about $9 billion in revenue enhancements over the next five and a half years, in addition to that they're looking for 5.2 billion in wage concessions from labor. So they're going to present this to the ATSB over the next couple days and the ATSB is going to consider whether or not this is a viable economic plan. And even if they do get the wage concessions from labor, there still is the possibility that the ATSB looks at the plan and they say $9 billion in revenue enhancements over the next five and a half years is very challenging, given the challenging pricing environment in the industry, and they might say we can't do and it they could subsequently go into bankruptcy, and that scenario as well.

MARGARET WARNER:

And, Mr. Leritz, following up on our earlier piece we just ran, are the executives offering any wage concessions here along with all the other unions?

THOMAS LERITZ:

None that I'm aware of. But if you look at the equity holder base, it's all the employees, including the executives. And I agree with the other gentleman. When you look at who's going to lose, labor is going to lose in either situation. If they do go to bankruptcy court, I think what the judge will do is they'll have wage concessions. So they're going to have wage concessions either way. If they do it before bankruptcy, they'll have more control, if they're able to stave it off, labor will have more control.

MARGARET WARNER:

Mr. Cappelli, some bankruptcy experts have actually suggested that it would be better for United to bite the bullet now, declare bankruptcy, end the uncertainty, and restructure in a really dramatic way. Is there do, they have a point?

PETER CAPPELLI:

Well, I think there's certainly an argument that you could get more dramatic restructurings not just from labor, but creditors and suppliers if you went through bankruptcy. You know, there's also a concern that if you go into bankruptcy, will you come out the other end. You lose the confidence of the investor community, and it's a pretty big risk to take. But it's a gamble. And I think certainly it's reasonable to think you could get some significant changes if you go through bankruptcy.

MARGARET WARNER:

Mr. Leritz, what's your view on that request, about bankruptcy and whether it might actually be better for United?

THOMAS LERITZ:

It depends on wake stakeholder you are. If you're an equity holder in the stock right now, it will go away. But I think what, they need to address these issues. When you look back to the summer of 2000, United Airlines increased their pilots' salaries by 28 percent, that started the ball rolling. A lot of the other airlines followed suit, they increased their wages as well. In the meantime, the industry's revenues have dropped from about $100 billion in 2000 to about $80 billion today. So the costs have gone up and the revenues have gone down. They need to address these issues, and it might take bankruptcy for them to address all these cost issues in a significant way, which would help the industry over the long-term.

MARGARET WARNER:

And is United, why is United in this fix when the other big hub carriers around quite in such desperate shape, American and Delta, in other words, are its costs more excessive than its big competitors?

THOMAS LERITZ:

When you look at United Airlines relative to American and Delta, they're pretty similar. However, American and Delta have a better liquidity situation today, and if you get an economic improvement, if you get Iraq behind us and the economy begins to pick up, air traffic begins to pick up, the Americans and the Delta probably would weather the storm a little better. It's become more of a liquidity situation for United Airlines, but their cost structure is high, relative to Southwest it's very high, it's probably 50 percent higher, the cost structure is 50 percent higher at United Airlines relative to Southwest. And on the labor side it's about 63 percent higher.

MARGARET WARNER:

And Professor Cappelli, if these concessions come through, if the federal loan guarantee comes through, what's your view on whether the whole package of cuts, including they're going to cut some cities and they're going to cut some routes, that's enough to put United on a firm financial footing?

PETER CAPPELLI:

Well, of course it's difficult to say. And the big bet is what happens to the entire industry and what happens to the economy. I think if the industry doesn't pick up, it's hard to imagine that it would be good times even if all these changes were made. I think probably more has to do with the changing in route structures and changes in the type of planes that they fly and how their competitors react. This is really a game of strategy, where they're trying to figure out some way to compete against other competitors; and the big carriers, Northwest and Delta, which are doing more or less the same thing that they're doing, and then you have these other carriers like Southwest which are nibbling around the edges. Southwest actually now is the largest carrier in the United States domestically, flies more passengers, doing it in a very different way. It's not clear that United could become a Southwest. They have a big hub structure, they have a different infrastructure, different set of planes, different route structures, so I think a lot of it depends on what their competitor dos and we just don't know.

MARGARET WARNER:

And, Mr. Leritz, final word from you: If United were to go to bankruptcy, what would be the impact on the rest of the industry?

THOMAS LERITZ:

What I think would happen is they would probably emerge as a lower cost producer. And the other airlines, especially the one was the high cost structure, would have to adapt to that new environment. They're already trying to adapt, they're already trying to get wage concessions, they're reducing capacity, et cetera, but I think they'll have to do a little bit more than that to survive. So it could change the entire industry. And like I was saying before, in the summer of 2000, United produced this situation where you have high labor costs. And it might be ironic that in the end they're going to change it in the other way.

MARGARET WARNER:

Thomas Leritz and Peter Cappelli, thank you both.