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C. Gopinath

Can United Airlines restructure and take off?

THE turmoil in the airline industry in the US has claimed another victim. United Airlines, ranked second largest in the world, filed under Chapter 11 of the Bankruptcy Code so it can restructure and make another attempt to become a profitable carrier.

The airline tried to avoid this situation by seeking government guarantees for its loans but the request was rejected early this month. It needs about Rs 7,200 crore in financing and is likely to get that from bankers now.

Under Chapter 11, the court provides protection from creditors while allowing incumbent management to restructure the organisation (with the approval of a debtors committee). Moreover, any new debt incurred receives superior standing so when a firm is under Chapter 11, lenders are less reluctant to provide funds.

The weak US economy had resulted in a significant drop in air travel for business purposes and when the terrorists used commercial aircraft as their weapon in the World Trade Centre attack in September 2001, vacation travel by air also began to suffer.

It really has not been happy times for the industry since 1978 when the industry was de-regulated. Since then, 10 major airlines (that is, those with revenues exceeding Rs 4,800 crore) have, at different points in time, filed for bankruptcy protection.

It is estimated that net losses of the airline industry would reach Rs 38,400 crore this year. Last year, it was about Rs 33, 600 crore and, that is, after taking into account the cash aid of Rs 24, 000 crore the industry received from the government to compensate them for the terrorist attacks.

In the last decade, of those who filed for bankruptcy protection, two have gone out of business, one was bought by another, two are independently operating and one is still under bankruptcy protection.

United's turnaround plan will include attempts to reduce its debt load, shrink in size by giving up some routes, and cut labour costs. It has a huge network with 80,000 employees and 1,800 daily flights. It accounts for about 20 per cent of all flying within the US, apart from valuable routes to London and Tokyo.

United's costs certainly need to be reined in. Its labour cost per seat-mile is about Rs 220 and its total costs Rs 528, the highest in the industry. Most of the major airlines suffer from high labour costs due to wage and benefit agreements entered into with their unions. Moreover, the seniority system and restrictions on job transferability give little room to manoeuvre. When United applied to the government for loan guarantees, its rivals — Continental and American Airlines — opposed it in their representations to the government.

Their argument was that bailing out United with its high labour costs will lower their negotiating ability with their own unions in efforts to reduce labour costs.

Other airlines have won Federal Government loan guarantees in the recent past. The failure of United to obtain the same facility reflects that the major stakeholders are not yet convinced that it has a viable plan for a turnaround. And that includes labour costs.

Employee-owned

Listening to all these woes, you would wonder what the shareholders feel about the high labour costs leading to bankruptcy filing. They must be upset that some of the employees are not taking the pay-cuts to keep the business going in these difficult times. Although pilots, baggage handlers, and flight attendants had agreed to wage concessions, the mechanics union was holding out. But the irony is that employees own 55 per cent of the equity. They are the dominant shareholding group.

The workers in such a situation face serious conflicts of interest. When an employee also owns stock, does he behave as an employee or as an owner? With the employees as a group owning a controlling interest, the problem gets confounded. The value of their stock has fallen so low that their retirement funds that are invested in the company stock have lost almost Rs 19, 200 crore in value. Thus, with no dividends on their shareholding, and their retirement accounts under assault, they are clinging to their jobs.

It was under similar trying circumstances that the employees became owners. In 1994, as part of a negotiated deal between the unions, representing pilots and mechanics, 55 per cent of the stock came into employees' hands (ESOP or Employees Stock Ownership Plan) in exchange for wage concessions amounting to about Rs 23, 520 crore. Workers also got representation on the board of directors. However, flight attendants, being another employee group, did not participate. There were several flaws in the plan, which many attribute to having caused the present set of problems.

It did not allow for permanent employee ownership, and also did not allow for new employees being offered shares. Thus, the spirit of the original plan was more like a short-term fix rather than a true transition to employee ownership.

News reports suggest there was no change in the culture of the company to reflect the new role of the employees. Structural rules also prevented employee participation in decision-making.

Employees could not access their shares until they were 55 years old and have met the vesting requirements, such as years of service. Thus, the employees are only nominally shareholders, but cannot use their shares like other stockholders. Meanwhile, with the slump in the economy, in general, and their sector, in particular, United's share price has fallen from Rs 6,144 in 1994 to about Rs 48 now. Bankruptcy need not be the end of the story for United. US Airways, another major airline which went into bankruptcy protection in August this year, is still in the air and making progress towards sustainable growth and profitability.

Airlines need to deal with the major changes that have taken place in their industry. Thanks to the Internet, customers now have the ability to search for cheap flights with their finger-tips, while sitting at home. The days are gone when a travel agent gave you a couple of alternatives and you picked one.

Now, the customer has access to the information directly and can make the compromises between price and convenience: In terms of time of the day to depart/arrive, direct flights versus one with stops, or an airport close to the city being visited or far away, while searching for low-priced tickets. Profit margins are getting squeezed in the process.

Some airlines, like Southwest, are already following a strategy of operating with a tight handle of costs. By buying only one kind of aircraft, Southwest keeps its maintenance, training, and inventory costs low. By scheduling its routes on a point-to-point system rather than a hub-and-spoke system, it has much less downtime and keeps its planes in the air longer and more fully utilised. By avoiding major airports and flying into smaller airports at the outskirts of big cities, it keeps its landing and other charges low.

It has also built a culture whereby employees share jobs and help each other out to keep the planes in the air and not on the ground. Finally, the philosophy of the company is to view road and rail travel as its competition and not other airlines. All these have combined to keep it in the black even in these difficult times while all its competitors are struggling with red ink.

United will have to be creative in its search for a new strategy, rather than think that all it has to do is to cut costs.

(The author is professor on international business and strategic management at Suffolk University, Boston, US. His Internet address is cgopinath@Suffolk.edu)

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