Saving United Airlines: A Labor-Intensive Proposition

Is United Airlines destined to go the way of other extinct species, like the dodo bird, the passenger pigeon and Eastern Airlines? Or is it destined to rise, phoenix-like, from the ashes of Chapter 11 of the U.S. Bankruptcy Code?

 

Experts on the airline industry at Wharton and elsewhere say there are two indicators that can provide clues about how United’s future may shape up: the behavior of its labor unions and the health of the U.S. economy. If UAL Corp., United’s parent, is to survive, it will have to convince its workers to accept job and wage cuts to help bring the company’s costs down. At the same time, the economy will have to recover at a brisk-enough clip for United to enjoy an increase in demand for its flights by travelers.

 

“I’m hoping the workers really will [cooperate with the company to reduce costs],” says W. Bruce Allen, professor of business and public policy, regional science and transportation, and director of the Wharton Transportation Program. “I’m amazed workers can be so recalcitrant in situations like these, but what else are they going to do?”

 

Management professor Peter Cappelli, director of Wharton’s Center for Human Resources, says he expects United’s unions “to be difficult” when it comes to company requests for wage reductions and job cuts.

 

Cappelli and Allen say United’s 13,000 mechanics, represented by the International Association of Machinists, may be the most reluctant group to accede to company overtures to reduce costs. The reason: Skilled mechanics are equipped to find good-paying jobs with all sorts of companies outside the airline industry. By contrast, pilots and flight attendants may be more willing to give management what it wants because the nature of their jobs makes them more “captive” to the company.

 

“The bankruptcy court will make the parties negotiate to cut costs,” says Cappelli, “and if the pilots and flight attendants have to go somewhere else to find work, they’re unlikely to get as good a job as they have with United. United’s mechanics don’t see mechanics in comparable jobs elsewhere taking lower pay.” Cappelli adds that job cuts are inevitable at United because labor accounts for the company’s single biggest cost – 40% percent of its expenditures.

 

Allen says United’s employees have to recognize the seriousness of the situation. “It’s totally possible United could disappear. If no other airline had disappeared before, United’s employees might not believe that it could happen. But the reality is that Eastern and Pan Am and other airlines have gone away.”

 

George W. Hamlin, senior vice president at Global Aviation Associates, a commercial aviation-consulting firm in Washington, D.C., says if the relationship between United and its unions continues to deteriorate, the bitterness could rival the legendary animosity between labor and management at Eastern Airlines, which ceased operations in 1991.

 

“At Eastern, labor-management relations became so bad that the two sides were at war,” says Hamlin, a former executive with Airbus Industries, Lockheed Aeronautical Systems and TWA. “United has that potential, but it’s not there yet. That’s my fear, but it doesn’t have to be that way.”

 

Hamlin points out that UAL has fresh leadership in its chief executive, Glenn Tilton. “He does not have a significant track record, pro or con, with a large organized labor group. And he came [to United] with the unions’ blessing. If Tilton is to succeed, he’s going to have to do things the union won’t like. He may have to cross his benefactors at least to some degree to get the job done.”

 

UAL went to bankruptcy court seeking protection from creditors on Dec. 9, 2002, listing assets of $22.7 billion and liabilities of $21.5 billion as of Sept. 30. The company had been burning as much as $22 million a day in cash. United is the nation’s second largest airline, but has the highest costs of any carrier.

 

The bankruptcy filing took place less than two weeks after United’s mechanics voted to reject $1.5 billion in pay cuts that the airline said were essential to its request for a $1.8-billion federal loan guarantee. (Separately, two other groups of workers represented by the machinists’ union voted to approve the cuts.) On Dec. 4, the Federal Air Transportation Stabilization Board turned down the $1.8-billion request, saying United’s cost-cutting plan was not financially sound and was based on unreasonably optimistic revenue projections.

 

Some observers have blamed the mechanics’ rejection of the pay cuts for the stabilization board’s decision. But Cappelli says that the board was unimpressed with United’s overall proposal and that it was likely the plan was doomed even if the mechanics had approved the wage reductions.

 

United has said it expects its reorganization under Chapter 11 to take about 18 months. During that time, the company – which employs 83,000 people, about 80% of whom are in unions – can take any number of actions to lower costs. But some ideas may be better than others, according to Allen, Cappelli and Hamlin:

 

Job and wage cuts are essential, but expect workers to balk. According to information posted on the web site of the Association of Flight Attendants on the weekend of Dec. 14, United wants its unions to agree, by mid-February, to accept $2.4 billion a year in annual wage concessions to satisfy conditions established by lenders who put together a financial package to keep United operating.

 

It was unclear how the unions were expected to divvy up those concessions. But, as part of an earlier proposal, the flight attendants had agreed to concessions in wages, benefits and work rules of up to $412 million.

 

Both the flight attendants’ union, which represents 23,000 employees, and the 8,600-member Air Line Pilots Association were taken aback by the size of the company’s request. One pilots’ union official said he was “stunned” by the amount, while a spokeswoman for the flight attendants called the figure “staggering.” Hamlin says the remarks simply represented “posturing” as workers sought to stake out “wiggle room” to negotiate.

 

Job and wage reductions are not enough. “It’s not just a question of letting people go,” Hamlin says, “but a question of a smaller United.” Hamlin suggests that United operate smaller planes with fewer seats in regional markets to cut capacity by one-half to two-thirds. Revenue in these markets tends to be “bimodal” – that is, business travelers pay high fares, while other passengers pay cheap fares. If United cuts its capacity while managing to retain its more profitable travelers, revenue would rise relative to the cost of operating each aircraft, according to Hamlin.

 

Do not try to become a no-frills carrier. The New York Times reported on Dec. 10 that United had hired consulting firm McKinsey & Co. to help it develop a strategy to become profitable. The Times said that McKinsey is “likely to push United toward adopting at least some of the techniques of low-fare airlines that have managed to be profitable while United has been losing billions.”

 

But Cappelli says it would be a mistake for United to “twist itself into knots” to try to emulate the success of Southwest Airlines. One alternative United could consider is to offer a certain number of no-frills fights, perhaps by forming a discount-airline subsidiary. But United may not be able to pull off either option.

 

“United may be given advice to copy Southwest, but the company doesn’t have the competence or the culture to do that,” Cappelli says. “If United wants to consider starting up a brand new airline, that’s probably a better bet to try to capture the low-fare market. But there’s still a question of whether United would have the competency to do even that.”

 

Sell some lucrative routes. Allen suggests that United sell the rights to its Pacific routes to raise much-needed cash. The rights to fly these routes are negotiated with other countries by the U.S. government and the routes are not open to competition. Other airlines, including freight carriers like Federal Express, may find these routes attractive.

 

United also has routes spanning the Atlantic, Allen notes, but European airlines would prefer that United hold onto those routes because United feeds planeloads of passengers to those airlines via European hubs.

 

Cutting back or eliminating unprofitable routes is one way to save money, but that course of action is easier said than done. “A sensible restructuring strategy is to trim back the routes not making much money,” according to Cappelli. “That would involve cutting back people, canceling leases on planes, and selling overseas routes. But it’s impossible for airlines with a hub-and-spoke model to tell which routes are profitable and which aren’t.” By contrast, airlines with routes that are all point-to-point, like Southwest, have a much easier time figuring out which routes are worth cutting.

 

Employees own 55% of UAL and have veto power on the board of directors. It has been suggested that one reason UAL is in such dire straits is because of the amount of control employees exert in managing the company. Hamlin of Global Aviation Associates supports this view. He argues that UAL “is not so much employee-owned as employee-governed. Southwest has significant employee ownership but has no board seats allocated to employees’ groups.” Hamlin calls UAL’s “experiment” in employee-ownership “a failure.”

 

Cappelli, however, says employee ownership did not “kill” UAL. In an op-ed article published on Dec. 11 in the Financial Times, Cappelli wrote: “The carrier was in trouble before then. Indeed, the company may not have survived without labor concessions.” But he went on to say that employee ownership “may have delayed more fundamental restructuring, because the temporary concessions appeared to do the trick and because some necessary cost-cutting would have hurt employees.”

 

Cappelli also noted in the op-ed that the employee ownership at UAL took an “atypical form” for a U.S. firm. “It was more like the German system of co-determination, in that there was no individual employee share ownership scheme but workers through their unions had substantial influence on board decisions. At a time of great concern about passive corporate governance, United had an activist board that looked after the interests of its shareholders, who were also employees. In fact, it may have been too active, tossing out so many executives so quickly that it was difficult to run the company.”

 

Aside from UAL’s own strategic decisions and the actions of its unions over the next 18 months, the U.S. economy will play a key role in whether the company survives – and whether other airlines run the risk of seeking protection under Chapter 11. Allen says all airlines are suffering from reduced demand as a result of the recession and the slow recovery.

 

“The question is whether [the Chapter 11 filing] is just buying time for United,” Allen explains. “If the economy doesn’t come back soon and demand doesn’t increase, it’s going to be hard for United. But if the economy comes back, I don’t think other carriers will face bankruptcy. When people have discretionary income, they like to spend it to travel.”

 

Barring a lengthy war with Iraq, Hamlin says he does not expect other big carriers to file for bankruptcy. “While the other large majors, including American and Delta, will have to conform to the new economic realities coming from United’s reorganization, I think that they have better leadership, and will come to recognize that there is greater flexibility in adapting to changes outside Chapter 11 than in bankruptcy.”

 

Cappelli is “reasonably optimistic” about UAL emerging from Chapter 11 with a bright future – if it can control costs. “But the problem with restructuring a company is that the restructuring takes place in a competitive environment,” he explains. “Even if United makes changes, it’s not certain that everybody else is standing still.”

 

Other major airlines mounted lobbying efforts in an attempt to prevent United from getting the loan guarantee from the stabilization board, Cappelli notes, ostensibly because they figured one fewer competitor would open up new markets for them. But, in hindsight, it looks like that lobbying campaign was wrongheaded because under the discipline of reorganization United could very well reemerge with a much lower cost structure than its rivals and be much more competitive than it had been.

 

“Eastern did just that in the 1980s and the company did a lot of damage to the industry,” Cappelli says. “Eastern reduced costs, slashed fares in everybody’s markets, and things got ugly.”

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