Printable Version
America’s Air Transport System In A Time Of Accelerated Change
A CNP Panel Discussion With Dan Kasper, Mark Kahan, Jim Wilding, and Duane Worth
July 25, 2002
Summary
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Transcript
Maureen Steinbruner: Very interesting, timely, I think very useful discussions over this summer, over recent months on things like pension reform and welfare but I really can’t think of anything that could be more timely and important to the United States overall than this discussion this morning.
First of all, just a couple of quick comments. I think the central importance of the air transport system to the economy and way of life in the United States is something that we all take a little bit for granted and I just, I think it’s something we need to focus on and reflect on. It’s a big country and so air transport’s particularly important in a country like the United States. Moreover, the industry is a high technology driver. It’s central to the U.S. international competitive position. It has a highly skilled and therefore relatively highly compensated work force. Some people will dispute the details of that. That’s true generally. And also, I think it’s important to remember that this industry is important to other industries. Obviously, air craft and components manufacturing, but also it’s a big wire of communications, information processing, computer software. It’s important to tourism and travel. It’s a hybrid system with private and public components and therefore big and unusually complicated demands on policy makers.
So, there’s a lot going on in Capitol Hill today. There’s a lot going on in the Administration. There’s a lot going on actually in the world, that policy makers are having to focus on. So this discussion is going to be very, very important. After deregulation we are at a point where inevitably I think we wouldn’t be talking about what’s happening to the airline industry, but of course, after September 11th, there’s a whole new set of concerns and now in a complex and challenging economy, there’s a third layer here.
Which brings us to today’s discussion. I would like to thank the staff, some of the staff who are actually not staff anymore. Marta Tellado who’s moved on, was very important to bringing this discussion together this morning. Our staff, Emily Cooney, David Hunter and others who worked hard, very hard to pull this off and especially would like to thank Mark Gerchick who’s serving as a Senior Fellow with the Center and who really inspired this opportunity. Mark, I think most of you know, is a partner in the firm of Gerchick Murphy Associates here in Washington, providing strategic consulting and representation for aviation, airport and other transportation interests. He’s served from 1993 as Chief Counsel, the FAA and from 1995 ‘till 1998 as Deputy Assistant Secretary of Transportation and the Department. He was also Acting Assistant Secretary for Aviation and International Affairs and of course before that, coming to the Department of Transportation, he was with the FAA. He’s very knowledgeable and has pulled together a great discussion and I want to thank him very much. Mark? I’ll turn it over to you.
Mark Gerchick: Thank you. Thank you very much, Mo, and thanks to everyone who came here today. It’s one of those end of the session days, a Thursday morning and there’s a lot going on and your presence attests to your interest in what I think is really a very interesting, timely and important subject. We’re very glad to have a very extraordinary group of creative thinkers about aviation today and the effort here is not to do an after lunch speech, which we’ve all heard many of or to have a series of speeches and people talking at you but hopefully to engender a bit of dialogue and discussion among people who have experience and have really thought about some of these issues hard. I must say regrettably Shelly Longer called last night to say that in light of the announcement, the dramatic announcement made last night at the United U.S. Air Coach share arrangement, that she’s unfortunately not going to be able to be with us this morning. As one can imagine that she needs to be running around Washington as these things go and Sam Buttrick called this morning. Unfortunately he’s had a family problem. A difficulty. He will not be able to make it. Nonetheless, I am very pleased with this panel that we have. I think if you’re looking at people who really know what’s happening in this industry, you see four of the best here. And let me introduce them briefly and then set the stage for the discussion we hope to have today. In alphabetical order, Dan Kasper. Dan is the managing director of the Cambridge Massachusetts office of LECG. He’s really one of the country’s leading airline economists. He previously served at the CAB as the Director of International Aviation. He worked closely I believe with Al Katon (phonetic sp.) in that capacity. He was responsible for formulating and implementing the CAB’s policies, prospective fares and rates, international aviation negotiations, competition and regulatory policy. He’s also served as a member of the U.S. National Airline Commission, which is a very important and influential commission. He is a graduate of the University of Chicago, where he has his BMA and JD.
Mark Kahan has one of the longer titles. I don’t know how he accumulated all these titles, but he’s Vice Chairman of the Board, Executive Vice President, Chief Operating Officer and General Counsel. That’s a lot to do. Of Spirit Airlines. Previously he was in the private practice of law in Washington and was the co-founder of Air America, which is a posted regulation passenger and cargo airline. Before that, Mark was a director, Associate Director of the CAB, Deputy Solicitor of the U.S. Department of Energy, and Staff Counsel to the New York State Public Service Commission.
Jim Wilding, who many of you know, is the President and CEO of the Metropolitan and Washington Airports Authority. That’s the independent authority that operates Washington National, Reagan Washington National Airport and Washington Dulles International Airport. Jim is one of the really world’s leading authorities on airports, although he’ll modestly say he isn’t. But he was the President, Chairman of the Airports Council International which is a leading airports group and is currently on the Board, I believe, of the parent organization in Switzerland. And Jim is also past president of the Arrow Club.
Captain Woerth, Duane Woerth is the President of the Airline Pilots Association. And we’re very pleased to have him. He is also a Northwest Airlines pilot and previously served as ALFA’s (phonetic sp.) Director for International Federation of Airline Pilots Association. Captain Woerth also served for five years as a member of the Northwest Airlines Board of Directors, and that’s a very interesting area which we’ll talk some more about. Previously he was with the U.S. Air Force for six years and retired as a Lieutenant Colonel, from the Air National Guard. Captain Woerth is a graduate, has an MA from the University of Oklahoma.
Now, just a few facts as background and then we’ll have some (discussion), we’ll start in to some questions here. Civil aviation, as Mo pointed out, has a huge impact on the U.S. economy. It’s roughly 9% of GDP, by some estimates. $900 billion and aviation directly or indirectly supports some 11 million jobs. Last week the CEO of Boeing was asked about the current state of the aviation industry at Farnborough and Boeing is of course always optimistic about these matters since it’s in the business of selling aircraft and his comment was that "We now face the worst decline the aviation industry has ever seen." The numbers unfortunately confirm this. After a horrible 2001, the industry is looking at a $5 billion net loss for this year and another losing year next year. Over the last year, airlines overall lost $12 billion. That’s essentially what they earned over the previous four years. And over 100,000 jobs are gone. Airline traffic is stubbornly staying down. It’s down about 10%, year over year. We’ve had several months of declines, despite earlier optimism that we would see a big rise in traffic at this pont. And worse than that for the airlines, passenger revenues are down even more. Down 15% or so. Passengers just aren’t flying like they did before and when they are flying, they aren’t paying. A couple of big carriers are now talking about bankruptcy and the aerospace industry is looking to defense not civil aviation to stay successful.
So obviously something has to happen here. The question now is, what will it take? We’d like to explore that today. Some of the issues we’d like to touch on is, do we need to see a fundamental shift in the airline business model or will the situation recover with cost cutting and incremental revenue enhancements? There are really two schools of thought. Are we incremental fixers or are we paradigm shifters? Who’s right in that debate? Second. If the post deregulation model isn’t working, what alternatives are there? Do we have too many airlines in this country? Do we have too few smart airlines in this country? What’s the answer there? Third. What’s the role of government in this situation? Will helping weaker carriers hurt or help the sector? What about regulatory policy and a whole range of regulatory policies? And finally and ultimately. What about consumers and the communities and airports that are deeply and immediately affected by the situation? After all, if that’s the object of the enterprise. So, with these questions in mind, let me turn it over to our participants for their initial thoughts. I’ve asked them all, each to offer a few thoughts and then we’ll move into a discussion and then we’re going to have some time for audience questions and comments. This is an extremely erudite audience. I know a lot of you and we really hope that you’ll be involved here. Why don’t we start with Dan. Starting from the left.
Dan Kasper: Sure. Thank you very much, Mark, for the invitation. Glad to be here and see so many faces of people that I used to work with, including Mark Kahan at the Civil Aeronautics Board. It’s always good to see Mark. I was talking to Duane Woerth as we came in and he said he had skipped the chance to testify about guns before Senator Gunson, the cockpit before Senator Hollings ... I will resist the temptation to say any more than to call him Wyatt Woerth. I did notice, however, that there’s a picture there. It looks like a group of pilots getting ready to board aircraft here in the back of the hall. Let me respond in very, 30,000 foot level to the questions that Mark has raised and asked us to discuss and I won’t go into any detail but would be happy to follow it up either in exchange with other panelists or questions from the floor. First, the question that I suppose is on many people’s minds, what are the financial prospects for the airline industry and I think in a word, grim. There, it’s quite clear that there is excess capacity and this is an important caveat, at existing cost levels and the result is, airlines are earning sub-par returns. And are likely to until they can fix the underlying situation, or the underlying situation can be fixed.
In my view, there are only three legitimate ways to fix the situation. One is to disinvest. That is, to reduce the amount of invested capital by cutting capacity, grounding it, restructuring, financially restructuring which would, by reducing the amount of invested capital drive up the return on investment. The second way, obviously, would be to reduce costs and I think it’s quite clear that if, particularly I want to talk here about the large network carriers. If they were able to reduce their costs significantly, more of them would be viable than is currently the case. So one way is to cut capacity. Another way is to cut cost. A third way is simply to sit tight. Wait for the economy to drive up traffic and hopefully revenues and if you’re a major airline, hope you’ve got enough cash that you’ll be one of the survivors of that process.
There is a fourth alternative that is raised and I’m sorry Sam Buttrick is unable to be here today because I’ve yet to get a straight answer from any of the people in Wall Street who push this approach, and that is consolidation. Which I think is typically read or is a code word for mergers. In my view, that is a false solution. First of all, it won’t reduce capacity. Because the largest airline in the country has about 20% of the available capacity. If that airline were to buy another airline and ground its capacity, 80% of the benefits would go to its competitors who paid nothing for that. So it’s a bad deal for the stockholders of that airline and for that reason I think it’s unlikely to happen. Secondly, the only way that, it probably won’t reduce capacity anyway because one of the ways they would cut cost is to push the aircraft back on lessors. Well, lessors have the airplanes. They’re not going to park those airplanes in the dessert. They’re going to try very hard to put them in the market place and will probably succeed in pushing out low cost equipment, which means low cost airlines, which means continued financial pain and unless and until underlying economics of major network carriers are addressed. So the only way that consolidation works, and I put that in quotation marks, is by reducing competition.
And I think, my own somewhat cynical view is, that’s what a lot of people on Wall Street, and I’m not picking on Sam because I don’t know what his views are on this, but a lot of people on Wall Street talk about consolidation. That’s really what they mean. And frankly I see no reason why consumers should pay for the mistakes or greed, if you will, of airlines, investors and labor groups that have gotten the industry into this situation. Now, what should government, that is the Administration, Congress, DOT and the FAA do about it to respond?
Well, having been around this industry for a long period of time since before it was deregulated, one gets a little bit of perspective on this and I guess my first suggestion would be to follow the Hippocratic Oath and do no harm. That is, first and foremost avoid putting additional burdens on airlines and airports by ways of fees, new fees, new costs, new mandates. That will only worsen the financial situation and possibly by taking revenue out of the system, we’re driving traffic away and taking it out indirectly. Secondly, I think it would be useful to rectify some previous mistakes, and by that I would be very explicit. What I mean is to address the totally unrealistic, in my view, deadline for the baggage screening and the tremendous expense that that’s going to put airports and airlines to for a system that by all reasonable accounts is not reliable. The second thing I think would be important is to focus on those things, first that only government can fix, and secondly that are likely to improve things in the future if not the present. And I think it’s unrealistic to think there’s a whole lot can be done in the short term. One of those areas is air traffic control. We’ve got to upgrade faster, smarter and better, in my view, and new organizational structure is needed to do that. I’m happy to talk more about that. But that’s a critical bottleneck. We bought a little bit of time with the drop off in traffic to fix the system. We ought to take advantage of it.
Ditto for airports. We ought to take advantage of the hiatus, the stretch out in the traffic forecasts that are now coming on and take the opportunity to address the capacity issues at airports. You know, the ironic thing is that we focus a lot, there’s a lot of government attention now being focused on demand management when in fact, at most of the airports where demand management would even be contemplated, clearly the most economically rational and efficient solution and the one that would maximize societal welfare is not to manage demand, it’s to add capacity because you’ve got willing payers who will pay for the access to that capacity. And yet that’s not an option that we’re addressing in any kind of a systematic way. Third, I think we need to revisit the issue of foreign direct investment and foreign ownership to raise the limits and authorize DOT to negotiate reciprocal investment, foreign investment. Fourth, I think we need to re-look at the labor management relations issue. We really need, in my view, a new model. As most of you probably know and Duane certainly does, the industry’s been operated from its inception under the auspices of the Railway Labor Act. That model is slow, it’s acrimonious, it provides poor incentives to the parties on both sides to reach agreement and increasingly requires too much political intervention by the President and Congress. I think that’s an opportunity to revisit and see if a better model can be made. Finally, in the longer term, I think it would be important to either encourage or at a minimum not discourage the evolution of new technologies that might have significant promise to make air transportation better, safer, less congested.
Here there are a number of possibilities. The one I would highlight is the potential being that is arising now as a result of the introduction of this development of a very new light weight engine that promises the ability to make much smaller aircraft commercially viable. If you think about it, the model of airports and air transportation that we’re working on, is a highly centralized model. The theory is you aggregate a whole bunch of people and a whole bunch of equipment into a very narrow space which by definition is going to create congestion on the ground, into the airport, on the ground, at the airport and in the air. If you look more broadly at what’s happened in other technological areas, you actually see that the tendency has been entirely in the other direction, towards decentralization. And there are some technologies that appear to have some promise. No guarantees but a promise to decentralize demand and I think this, that’s one that has some real interest. Finally, let me say a word about the implications of the present crisis for the current business model, the subject Mark started with. I think the hub and spoke system is quite likely to survive and that’s for a very simple reason. Low cost carriers cannot economically serve most small city pairs. And most city pairs are small in terms of the amount of traffic they generate. Only hub and spoke carriers by combining those traffic flows can serve those low traffic routes. So I think it’s some variation the hub and spoke system is quite likely to survive.
The pricing model that we currently have is much more problematic. There’s not enough high fare traffic to make these services profitable at their current cost levels. Part is a demand problem, related to the economy which presumably will take care of itself in time. Part is due no doubt to the security hassle that’s made travel, (a) more of a burden, and (b) and here’s where it really starts to hurt, more time consuming. Particularly in short haul trips which is diverting traffic from airplanes to cars or trains where the wait for security is less and the predictability of travel times is greater. But it seems to me, and I think to most in the airline industry now, increasingly unlikely that enough business passengers will be willing to, when they do come back, will be willing to pay the kinds of fare differentials that grew up in the late 1990's. Hence, something has to give. The most likely outcome would seem to me to be a shift away from the kinds of frequencies, the high frequency services that airlines have offered because that is really what high business fares paid for. You weren’t paying for a seat when you paid those. You were paying for an availability of a flight practically any time you wanted it. That availability is very expensive. If business travelers aren’t willing to pay for it, presumably it’s going to go away. The unknown in all of this is how, in my view, how it’s going to effect RJ operations, which is a subject we can talk more about. Basically those are operations that exist today in large measure, not entirely, but in large measure because of the very preferential labor rates. And if labor cost and operating costs of the big network carriers go down, the question is how much room, and the frequencies go down, how does this impact the market for RJ’s.
Mark Gerchick: Thank you. Thank you very much. For that fulsome discussion, really. Duane, Diana suggested we need a new labor management model. Do you have some words you’d like to start off with?
Duane Woerth: Well, I’ll get to that but I think one of the first things we should address is that this industry’s always been cyclical. I mean and we’re doing it again but we had a bigger bubble this time so that the good times were greater and faster and the growth was spectacular. Even record profits from 1994 to 2001, was maybe the best set of years we had. And so when that bubble popped the fall was equally as dramatic. I was just looking at a chart in front of me ‘cause I have a lot of members furloughed right now. But I was happy to remind them not, this didn’t comfort a lot of people, but the period for 1981 to 1987 we had a far higher percentage of pilots furloughed and it lasted for six years. So that was just a fairly shallow recession of the early 80's and some bankruptcy, the Continental troubles. I mean it all ended up in an awful lot, a very long period of depressed profits. It wasn’t this precipitous but we’ve had this problem in this industry for a long time.
So our questions I think for public policy is, what is different about this, is it just another thing that everything’s going to be okay again. I do not think so. And let me get to the principal difference. Of all the things that have changed in this recent one, that aren’t just pure economically driven, most people in this audience are usually comforted if I can agree with anything with Leo Mullen (phonetic sp.) and Gordon Motune (phonetic sp.) Air Transportation Association, that’s usually a good thing and the one thing I do agree wholeheartedly with them, that of all the things that are hugely different this time, as opposed to even 10 years ago when we had a special President’s Commission. Everybody remember the Clinton Blue Ribbon Commission and the airlines was in crisis. And is it the end of the airline industry and we had recommendations that addressed some of the questions Dan was bringing up. But then what happened, we had low fuel prices which was a wonderful thing in this business and we had a world record economy that grew and everybody all seemed to go away. Well, what is different than this, than in the 1993 when we also had terrorism driven, a Gulf War, a problem that really had to be a drop off certainly in international traffic and even affected our economy in a different, the biggest difference is now.
We have $7 billion in security costs that have been put on the airlines and they’ve been unable to pass it off. And I’ll just quote the Air Transport Association, this is (indiscernible) analysis. This is what ATA said, what Gordon Motune said and Leo Mullen said. They said this year we’ve made $3.3 billion if it wasn’t for the security cost increase. So that is a huge difference so it’s important to have a public policy that you cannot avoid a public policy decision. As Mo said, this is a hybrid industry. It’s not pure private sector. The public is hugely involved in infrastructure and in the taxation policy where we’re going to have to come to grips, what is a legitimate thing for airline consumers, whether it be cargo shippers or passengers. Are you supposed to bear all by yourself the cost of defending the nation? How much is legitimate issue for airline passengers or the airline or airport and how much of it is defense of the nation from guided missiles which are now airplanes? So somewhere in there we’re going to have to have a tax policy that makes sense or the airline managements are right. This is like a sin tax. Liquor and tobacco aren’t’ taxed at these rates. And this can’t, it’s not sustainable to have this tax policy and have a private sector business who simply cannot pass this on to consumer and meet the needs of this nation’s travel.
You add that $7 billion to security and for the previous couple of years prior to me becoming Wyatt Earp and Sky King at the same time, prior to that I know I testified at least 11 times in front of Congress on air traffic control. That’s another $5 billion that is insufficient infrastructure that is not, that the consumers are eating or the airlines are eating. It’s just not working. It’s unbelievable delays that have not been fixed and a lot of the fixes that are achievable both in aircraft design and point-to-point service, a lot of things can be different, but not with this air traffic control system, it can’t be different. It has huge infrastructural limitations and costs that are just massive. One of the things that I agree with Dan on is that, and like a lot of other industries, what the consumer wants and what the system can support are often two different things. And they’re conflict goals. Let’s just take a different industry. We found, let’s take the automobile industry, and as to gasoline prices and environment and everything else. After 1973, that’s it.
We know we need fuel efficient cars. We need smaller cars. We need to do a lot of things differently. As it turns out, consumers wanted bigger cards and we all wanted SUV’s that weight 50,000 lbs. and are stronger than Humvies. But we still want fuel economy. These are two divergent things. And if manufacturers built what we now, environmentalists and consumers say they want, they’d all go out of business. What you want is not what you really want. ‘Cause you are telling the market what you’ll pay for. With that we went through is frequency. What is all related in here, the things throughout our industry that allowed us to be efficient, that got the lower costs (indiscernible) was economies of scale.
From 1930's until about the mid ‘80's, we had a philosophy that said, we’re going to have bigger airplanes, we’ll have more people on them, we’re going to lower unit costs, we’re going to ... the growth of the industry and passengers was accommodated by larger and larger aircraft. The DC-2 to the 6, to the 8, to the 707's and now, one of the things we’ve learned as the business model changed, it’s not just that RJ is one symptom of a thing that we’re downsizing the fleet. The smaller, and smaller in gage, more and more airplanes required to fly the same number of people because the business model says high frequency is what wins. And somebody tries to take out capacity and how fewer frequencies and their city fares or their hubs, it’s pretty quickly who wins. The high frequency airlines and their hubs are point-to-point is the one who wins. Southwest doesn’t sneak up on you with one flight a day. They only show up with eight. It’s only the big business market. So again it’s a conflict in need. If somebody as a universal independent competitor says I see the nation has a problem. I see air traffic control is crowded. I see we have this issue. I’m going to voluntarily be the, I’m going to unilaterally withdraw some capacity in the terms of frequency. Looser. He’s done. So, I mean, that’s what happens. And now what we’re having is all the airlines, and it just reminded me a little bit of OPEC as in the sheiks accusing each other of too much capacity and lowering prices. I mean but that’s what’s going on right now and anybody who unilaterally withdraws is punished on one side of it.
They’re selling their future but in the meantime they can’t with all these seats out there, they can only going to get so much money for the product. But we have, that’s going to come as I think some of the public policy concerns as to infrastructure is that are we going to have a model that is what the consumer wants to reward is small airplanes with high frequency, which are a lot higher cost to produce. You know, this is in conflict with what is going to get us a stable industry, solve the capacity problems and get prices people are willing to pay for and those are something we’re going to have to resolve. But it’s a good reason why we have a public policy discussion on it because one of the things is again, this isn’t, I think one of the things we have to say, we get dogmatic about, we can get real religious about our economic philosophies but we have to understand this. If you believe this is an infrastructure industry, I believe it is. Believe me, I’m not trying to re-regulate. I don’t want anything to do with re-regulation in the forms of price controls or wage controls or any route controls. But by this system, we’re going to have some chaos. Especially when it collapses and some chaos means people are going to go out of business. Some people are going to shrink. U.S. Airways is a perfect example. U.S. Airways, if there’s too many hubs, Pittsburgh is down to 50% load factors out of, U.S. Airways has been picked apart, not just by Southwest, American and Delta with their services have just killed the northeast. Jet Blue really isn’t responsible.
They’re like insult to injury here. But U.S. Airways is shrinking back to what Allegheny and Piedmont used to be. A major regional airline in the northeast focusing on short haul, the smaller airplanes. That’s what’s happening to U.S. Airways. What that will do with the United and the rest of it, that’s another question. But we are seeing some fixes in here. The capacity is being put in in smaller airplanes which helps in the near term but again it’s a business model airplane. It’s RJ is the business jet. Those bombardiers and (indiscernible) cost almost as much for 50 seats to buy the airplane. Its capital costs are almost equal to an airbus A319 or 350 with 125 or 150 seats. So the capital cost for (indiscernible) huge which drives some labor things, the only way this airplane works with its cheap labor. Now we’ve had some conflict with that and also it has to be high fare. And how many, have you ever noticed, if you’re flying around in one of these, you’re now flying for a hundred and twenty-five bucks. I do this. I fly around or my staff’s flying around. It’s usually, the main plane I go to is to Ottawa. It’s all Air Canada. And I say I’d like to go to Ottawa. That’s fine. It’s $198.00. I’ll stay Saturday night. That’s wonderful. It’s $198.00. I’ll book 3 months in advance. That’s fabulous. It’s $1,000. We’re raising ticket prices. I mean, it’s, RJ is a business airplane. And it’s got a great use but it’s limited. It’s not all things to all people. And ...
Mark Gerchick: Duane, let me take up that point and actually ask Mark about, ‘cause I know the issue of point-to-point, high frequency or low frequency is the point-to-point model that Spirit I take it is operated. Tell us a little bit. Is that a model that you think this industry’s going to go toward? Can the major airlines coexist with the Spirits and the Jet Blues and the RJ operators?
Mark Kahan: Okay. Can I just say hello to everybody before I answer because I’m very pleased to see Dan and also we have some old-timers from the CAB. Regis I see. And John Kaiser and Jim Cron and any of the, any old-timers around?
Male: Nobody’s going to volunteer. Any seasoned experienced ...
Mark Kahan: Okay. I’m okay with the question. I was saying to myself that Duane an Dan have stolen most of my thunder and I’m glad I didn’t write out an extensive opening set of remarks. Your question goes to a, let me come at it from this direction. Let’s go back to first principles. One of the abiding intellectual presuppositions of airline deregulation goes back to the work that Jim Miller did in the ‘60's. Is that there were no economies of scale in the airline business and we believed that for a long time. And that was, that permitted a lot of people to get comfortable with the idea that we could have competition. Open competition in the airline business to begin with. And in 1979, after we got a little bit more understanding of the industry and did a little bit more work, and I remember working with Dan and Bob Frank and some other people on this, we discovered that lo and behold, that’s completely wrong.
There are lots of economies of scale in the airline business and the notion was the bigger the airplane, the lower its seat mile costs and that was used for an extremely important innovation in pricing. It took what people would otherwise think of as rank price discrimination, at that time it was two chair pricing for leisure passengers and price insensitive passengers. That got us comfortable with that and I believe that that idea of economies of scale and also economies of scope that underlie much of the literature about the growth of this industry in the 1980's and into the 1990's and that gave a patina of respectability to a fare structure where some people on the plane were paying 10 times more than another person, right? I think as Duane pointed out and as I was going to talk a little bit about, we know that’s wrong.
So far as I can tell, the low seat mile cost airplane, at least as reported in statistics, is the 737 and 700 as operated by Southwest. I think that depending on changing some assumptions, reasonably one could say that the range from A319 737, 700 all the way up to a 757 300, any of those planes under certain assumptions could be the low cost producer, right? Okay. You have to fly a 777 about 4,000 miles before the possible seat mile costs get even remotely close to the kinds of costs that you have in that area. And what that tells you is that the cost paradigm of the industry has fundamentally changed and I think that probably started changing in the mid-80's. I think that that’s a lot of what’s going on. You know, with all the ink written about the power of networks and I agree with Dan that there is a place for network carriers, nobody has demonstrated that a network can compete in markets where the stand alone costs of an efficient competitor are lower and that’s basically what’s going on. And that’s basically why low fare carriers in the absence of barriers to entry and predation, things like that.
That’s why they are gaining and that is part of the challenge that probably most of the challenge, faced by the network carriers. Now, they’re obviously at the crossroads and indeed we’re all at the crossroads. I don’t have, I can’t add much to financial analysis of the major carriers. It’s been very well reported. I think that Duane and Dan have both touched on important aspects of it. I certainly can’t disagree that security is a huge challenge and absorbing those costs and maintaining a product that will be attractive to the consumer, these are huge challenges. But I do know that the network carriers will have to resolve the fact that the cost paradigm of the industry is changing.
Mark Gerchick: Let me pick up on that. Ask Jim, if the cost paradigm is changing and if networks, there are questions now about the overall net efficiencies of networks and hubs, one of the core issues is whether airports can continue to be effective and efficient hubs and whether the way that we’re looking at capacity and capacity growth now for the future makes sense. Jim, I wonder if you have some thoughts on it?
Jim Wilding: Sure. Well, I guess you, you know, for starters, you can’t sort of paint all airports with one brush. We tend to be very well positioned here in the Washington area, principally because of the existence of Dulles that has enormous potential to expand its capacity to roughly three times to what it’s doing right now. So if that’s kind of one extreme, down at the other extreme you have a lot of major metropolitan areas in this country that have put their marbles on a single airport that is now very constrained by the urban area around it and where they, you know, invest enormous amounts of money for a 5% capacity gain over a 10 year period and they put all their energy and investment and everything in that, think they’re doing a very good day’s work and indeed they are. But I mean they’re really, if they lift their head up and look long term, and if you believe as I tend to, that aviation is fundamentally a growth industry and has an enormous amount to offer, you sort of say, wow! You know, they have no longer term strategy. It’s really just a short term strategy. But let me add one other thought to just as an opening thought. No (indiscernible) that the business is in a heap of trouble.
But it’s been in some pretty fair sized heaps before and let me visit that just for 30 seconds. In the 1950's we had an absolutely electrifying mid-air collision over the Grand Canyon that gave birth to the Federal Aviation Administration. Absolutely paralyzed commercial aviation. The 1960's saw engines falling off of Electras. That had sort of the same sort of you know, can civil aviation survive this, kind of feeling. The 1970's saw the advent of hi-jackings. An entirely new phenomenon that was absolutely terrifying to people. The 1980's began with the bankruptcies and going out of business of a lot of the marquee brands in airlines and ended with the Lockerbie bombing. Again, those things you know, these very same questions, can we get beyond this? Can we survive it? In the 1990's as Duane mentioned a few minutes ago featured the Gulf War and the catastrophic financial losses of the carriers in the early 1990's. I would probably go back and take any two or three of those put together and rather try to deal with them rather than what we’re dealing with right now. I don’t suggest they are on the same scale, but I would suggest there are two common denominators of what got us beyond all that and what I think will get us beyond this if we play our cards right. Number one, people in the aviation business in each of those instances, and here I mean the government, the industry, everybody put togther sort of harkened to the old adage, don’t just stand there. Do something.
There was a level of activism that said we’re not just going to watch this and think that time will work us out of it. It was a hands on, grab it, shake it, mold it, make it, make it get better. And number two, underlying all of this I think, is an incredible, incredible fascination and love that the people of this country have with aviation. The simple fact, wonderful fact of the matter is, that we are able to lead much, much more interesting lives with aviation. With the mobility that aviation gives us and I think there is a resilience to that. I mean you can kill anything if you work at it hard enough, but I mean there is just an underlying love of aviation and a love of the things that aviation gives in our lives that I think we have to recognize is a very, very important resource that is available to us and we just have to do everything we can to capitalize on it.
Mark Gerchick: I appreciate that. That’s a broad perspective and I think Duane was suggesting some of the same things. I, we have a situation where the polls are showing that people are not quite there yet. It may be a matter of time. There had been expectations that everything would spring right back and I guess that hasn’t quite happened but I guess we’ll have to see. It does seem that people are getting on airplanes but they don’t want to pay as much but they’re willing to get on airplanes, so maybe that’s the first step here. I did want to turn to, since I think it was Dan who raised the issue of the government’s role. I do want to get back to what the airlines can or cannot do, but in terms of government, we ought to just ask about that. Government has waded in a little bit now in a couple of areas. One is the loan guarantees. Second, there are suggestions that I think that we ought to see a tax moratorium, like 10 years ago. There was a fuel tax moratorium I believe. I think, Dan, you raised the issue that regulatory policy shifts on foreign investment or increasing capital. I know your view is we don’t need more capital. We need less capital, but that differs. I wonder if you could talk to the issue of what government should do very specifically now.
Dan Kasper: All right. Let me take a shot at a couple of those. First of all, I think, let me take the last one you raised first which is the foreign direct investment. I want to be very clear. The last thing this industry now needs is more capital. You know, they can’t just economically justify what they’ve got. Having said that though, I do think that there is a very strong, indeed a compelling case to be made for liberalizing our policy on foreign direct investment which in the aviation industry is fundamentally inconsistent with policy we follow in virtually every other major industry. Now, that is not to say that there aren’t some significant issues that have to be addressed. There are. I believe those issues can be addressed. There’s some national security issues. There are some sticky labor issues. I’m confident those can be addressed and I think it would benefit not so much immediately but in the future when the question comes up, you know, is an airline, where does an airline that may have some potential but is not making it turn to for capital sources.
It might well make sense to turn to a foreign airline, just as it might well make sense for some foreign airlines to turn to U.S. airlines to look for capital and management and guidance in those times. In terms of the other areas, I guess the loan guarantees are ... I’m not a big fan of loan guarantees but the fact is they’re there. And so, I think rather than crying a lot about them, the best one can hope for is that the loan guarantee board, the ATSB exercises its discretion in a way that makes the loan guarantee process something it can do what I might call Chapter 10 and a half, which is to say, a bankruptcy reorganization without actually going into technical legal bankruptcy and that basically would entail the imposing of very strict conditions, including cost reduction conditions and hair cuts for creditors, etc., and maybe grounding capacity, etc., that that is the kind of thing that hopefully would have been close to what would have emerged from a bankruptcy. I’m not saying it’s a match, but it’s close.
Mark Gerchick: Let me just ask Duane about that. Do you think that the loan guarantees are going to be used, that you guys are going to take a haircut? Is it a labor concession cudgel? Some people have suggested that?
Duane Woerth: Well, there’s only been so far one approved. America West. I mean it’s already in the bank and they have some of the lowest labor costs in the industry and even management said we’ll give you a business plan that has modest increases but nobody even (indiscernible) suggested cuts because they’re almost at the bottom of the industry in labor cost. But nonetheless they did put a cap on what you could expect for raises which are again modest. They put an eight year business plan out. Eight years in the business, that’s like, airline years are like dog years. It looks like them. Project 50 years out what it’s going to look like if you’re talking about eight years but nonetheless, that’s what happened there. And I think anybody that read the newspaper on U.S. Airways is getting 1.2 billion, most of it’s out of labor and some creditor stuff and that and only that. It is a free package. ... ... you want a pre-package Chapter 11 this is what it would look like. So that’s in effect is what is happening and I’m not really surprised about it. So I think that’s what is going with the loan guarantee program and a lot of people decided not to apply.
They either didn’t want to give up any stock in terms of warrants or if they were smart they would be left to these devices and anybody who did have access to the capital markets, some are complaining, well, we tapped ourselves out. I’m fairly covered with Northwest formally on the Board and so they pulled their revolver and they hocked everything and they got all the cash in the private sector then they said, well I guess that means since we’ve done what we’re supposed to do and paid higher prices and have a big amortization schedule, five years I guess we’re out of the running since we exercised all of our free market wells, so we’re going to have no access, so they didn’t apply. But I think that is what is going. They have decided you’re either going to be saved, you’re going to go through a pre-package bankruptcy process.
Mark Gerchick: And where do you come out on the foreign direct investment?
Duane Woerth: One of the things we’ve always said, we’ve never been enamored with or caught up in 25%. I’ve always been about control and what does that mean. And you can control it less, you can control it more and is there a difference in our mind and I think there is, yes. I accept Dan’s concern that if they don’t need any more capital, if that’s true, if mergers don’t make sense, we usually punish people. Not the chairman, you know. But I wonder if there’s any real difference, if we’re discouraging we think just doing mergers for mergers sake is probably stupid as (indiscernible) but let me just outline what have been our historical concerns. First of all, most of the airline business around the globe is not a private enterprise. I mean overwhelming it is a huge amount of government action around it. Ownership or certainly they treat it as an agent of the state. When we were having trouble with the British Airways for example negotiation trying to get an open skies, does anybody think the government of the United Kingdom doesn’t look at British Airways as an agent of their born policy or what have you and so we’ve always viewed, who’s against capital?
Nobody’s against capital. I mean, insurance companies want it, investment businesses, all kinds of Deutch marks, yen, or anybody wants to go around. Our concern has always been, has almost always been other airlines who have a social program, who have an employment program that is all geared to their citizens, not our citizens and so we’re always looking at investors differently. And if this is going to be free market, we didn’t want anything to do with foreign owned airlines or airlines who are, would have, even if we were cheaper, as you might, let me give you a specific example. I was on the Board with the Northwest KLM. We had all of our differences that were fairly publicly aired but one of the things that became clear and when I have discussions with a lot of my friends here in KLM, one of the things we were worried about was that U.S. employment law and Dutch law are 100% different.
If a Dutch, if they were going to contract Northwest KLM, they have a joint venture or we’re going to contract it, and we’re going to get rid of employees, some employees have to go. The fact is in Dutch law, it’s almost impossible but you have to pay them three years almost full. If it’s a huge social (indiscernible), if you’re a Dutch citizen, you don’t just get laid off, here’s your two weeks severance, see you. It’s a big, big cost. So in the United States it’s kind of not that way. Here’s your check. Hit the road. See you later. So, if you’re management and if I’m a Dutch manager, I say I have to lay off somebody. I can lay off a United States citizen, which costs me nothing or I must pay this person for three years, I think I’d lay off the United States citizen. These are issues that we have to resolve. So, we’ve been going to change or address in a pragmatic way, the different investment limits. We do want our issues looked at as to control and what it means as to different rights of labor law and what the consequences could be. So we’ve engaged in those discussions.
Male: Mark, could I quickly respond? And I agree that with Duane that he in particular has been very I think responsible in dealing with this issue of foreign ownership. I think the issue of the lay offs though is not completely but in large measure a red herring for the following reason. Changing foreign direct investment laws will not change the immigration laws and rules of the country and therefor the employees of U.S. airlines who work in the U.S. airline industry internally are still going to be U.S. citizens or people who hold green cards to do that. And they’ll be subject to U.S. labor law. So foreigners are not going to flood in and take U.S. jobs. It does become a bit of an issue on the over water segments. And that’s a particularly sensitive issue for the pilots and that’s an issue that will need to be dealt with but I think the concern about employment in the internal U.S. market is not a particularly compelling one in this case.
Duane Woerth: I don’t disagree where the real threat is. I don’t see British Airways or Air France setting up a hub in Charlotte with French pilots. That’s not what’s going to happen but it is a fact that our, of our large carrier like Northwest and United and Delta and whoever, the best jobs, the highest paying jobs, the jobs your retirement is based on, are all those North Atlantic and Pacific jobs and who does that flying. It doesn’t matter whether you start the trip in Paris or you start the trip in Atlanta. You’re just going back and forth to where your base is. It’s a purely ... our business like no other, it’s not like a manufacturing job where you have a factory closings. Where you’re domiciled and how you fly is pretty easy to change. Those problems could be dealt with if people want to address our issues ...
Male: I think that’s fair. They’ve got to be addressed up front.
Mark Gerchick: Let me just, the role of government is also not necessarily intervention or direct in terms of loan guarantees but also may be forbearance and we have the security issue. Particularly acute now with the December 31 deadline for baggage screening at airports and, Jim, I wonder is this a doable deadline? Is it possible to achieve this? What’s going to happen on December 31st? I don’t mean to put you on the spot.
Jim Wilding: I think there’s a form of utter madness sort of amuck in the land on this issue right now. The deadline is not in my view realistic. Wasn’t the day it was set. Has become increasingly less so as time goes by. The new Transportation Security Administration, who is over there working 20 hours a day, seven days a week, I mean and my hat’s off to them in terms of their commitment. But it took them, they had about 13 months to work on this and it took them seven of the 13 months to get under contract with Lockheed, well in this case, Boeing, but Lockheed on the passenger screening, leaving six of the 13 months to get the work done. What is going on now, is this frenzied activity around the country where teams from Boeing are coming in and talking to airport operators, (indiscernible) first visits with them and National and Dulles were done earlier this month and they, everybody agrees that this technology belongs down in the bag processing areas of an airport but there are hundreds and hundreds of millions of dollars and many, many months of construction activity necessary to put it down there, so the tendency is to plop them in the lobbies. And there are literally billions of dollars being spent putting the machines where the people are supposed to be because the people aren’t standing there when the study team looks at it.
They say well, what’s the problem? And you say well when the people show up, you know, they’re going to be standing out in the street. And the tendency is to say, well, we’ve got to get this in because of the deadline. We’ll come back and fix it later. Well, it’s clear there’s not going to be a fix later. After you spend billions of dollars putting it in the wrong place, you don’t then come back and spend billions of dollars putting it in the right place, at least the federal government isn’t quite up to that. So, I think if the deadline was given some flexibility, there would at least be a sporting chance of making these billions of dollars of investment in something like the right way. But you know, it’s a very, very difficult political thing. When somebody puts their hand up and votes for that, on the face of it, they would seem to be doing something that’s sort of un-American or certainly adverse to the security interest. I think the truth is exactly the opposite of that but it’s a very, very difficult tricky political issue.
Mark Gerchick: All right. Thank you very much. You know, also in terms of government regulatory policy, we have the whole issue of competition and consolidation and we have today, we went through a merger issue and now we have a code share raised. There have been suggestions that notwithstanding Dan’s views on this, that consolidation and reduction of capacity is the only way that this industry’s going to survive and be able to rationalize its revenues. What do you think about that?
Mark Kahan: Well, I was actually trying to think what life would be like if Dan and I and our friends were back there trying to run the CAB again. You know, it’s quite remarkable that nobody has raised re-regulation as an answer to the problems and I think that’s a wonderful testament to what we did. That at the end of the day I think we can still expect a minimal, as minimal as possible government intervention in terms of basic economic decisions of airlines to be the best course out although I don’t think anybody knows exactly what lies ahead on that road. Certainly if we were back and we were regulating, well on the plus side, the guys from American, United, Northwest and United would be in my office treating me with some respect. But what would actually be happening? We would probably be talking about some mergers and I agree with Dan that that’s, there’s no reason to believe that mergers would help solve fundamental problems. I’m sure there would be recourse for anti-trusts. I mean you’ll need to have some capacity agreements. Yuk! I’m sure that somebody would like to see some price discipline in the market place. Yuk!
So, I don’t think that there are any silver bullets out there. I don’t think that, so I think I’ll ultimately agree with Dan that the do no harm approach is probably the best way to go. I think that the folks in government are working as hard as they can to try to deal with problems. I think everybody in the industry is doing that. I think that there are some issues where government has to be, perhaps take a hard look. How many people here think that we need a third shuttle, using RJs between LaGuardia, DCA and Boston or that that’s an effective use of scarce airport resources? Okay. I have a big problem with that and I think that that ought to be looked at. So I think you have to look at things on a case-by-case basis but that kind of problem arises itself from a regulation. From the high density rule and the buy/sell rule and I actually, we actually have somebody who is prepared to defend the buy/sell rule I think here to my left. Over there. You know, I think that’s a discussion that we have to have because I don’t see that one the way Dan does. I don’t think we should spend all our time talking about that but ...
Mark Gerchick: The buy/sell rule. I going to draw a line. That’s a little archaean but if you want to raise that in questions, we’ll do that. One thing I want to get to before we turn to some audience questions though is this question about costs and I, two silver bullets have been offered for the airline industry. One is let a few folks go bankrupt and consolidate around three airlines, which we just discussed, a little bit. And the other is, do something about labor costs. They’re the biggest costs and the whole paradigm, the labor management structure has got to change. Duane, what do you think?
Duane Woerth: Well, first of all, I want to return my first premise. The big change here hasn’t been an increase in labor costs. All of a sudden it wasn’t this gigantic $7 billion increase in labor costs which is causing this. I mean, I’ll just take ATA at its word, taxes and particularly security costs are just skyrocketing. Incidentally, and labor has responded like we have in every situation. Let’s look at U.S. Airways. $1 billion per year, $7 billion worth in labor concessions can buy about five airlines right now. If it was real cash, I suppose but, so we’ve always responded up and down. I’ll just take pilots, for example. We have, used to be a higher percentage of costs than we are now. We used to be about 12% or 13%. We’re down to 8% to 10% of operating costs and even in our biggest contracts, and if that was a loan ,you should be the fastest growing, most successful airline in the world ‘cause I represent Spirit as well as United and it’s about 1/3 of the contract.
So it’s the labor, if you just have cheap labor, that’s not all your answers. And even our best contracts for example, we always hear about United and Delta. After six or seven years of no raises, they got some which average out to 3.2% per year and that, I mean most people in this room would say, my God, a 3.2% raise, I wouldn’t exactly be apologizing to the nation for it. So, and then we looked at the Comairs and (indiscernible) growing segment is what, it’s a regional industry. Starting pay is about $17,000. It maxes out about $50,000 with no pension. So if you’re looking for the fastest growing segment or even a stable thing, if you’re looking over there, there hasn’t been hardly any increases there and even where we haven’t we’re still making concessions and will. We’re tied to a seniority list. Our guys don’t go into union hall hiring. I mean we know we’re lashed to an airplane or to a company and you watch our guys respond individually as to how they respond to ....
Mark Gerchick: How does the ESOP process look to you. Do you want more stock? Do your members want to have more equity airlines right now or what?
Duane Woerth: Well, I think at these prices probably yes. I think if you believe it’s going to come back, there won’t be ...
Mark Gerchick: Dan’s going to mortgage his house and buy United.
Duane Woerth: Well, United pilots are agreeing to this thing to take 13 million more shares and first thing to take, but I think one of the things I think obvious you’re asking what is the United experiment mean? And I don’t, I think it’s going to take a lot of people to take a look at that for a long time. I think more to your question, I think more, do we want stock? Obviously we’d rather have cash, but we’ll take stock instead of just giving up for nothing. If you want us to invest in the company, I think people, there will be equity deals. Some will be warrants. Some will be options. Look at the Southwest model, which everybody praises. They’ve got a big portion of their compensation all the time is in stock but a Southwest model which always makes money is a different investment, isn’t it? But we will definitely look at it. But I think United, I mean, I think the expectations were too high for United. I think, and I talked with both their management and their directors and certainly their employees and there was this karma that was all going to change if we just had a majority ownership, everything was going to change. Well, it didn’t. I mean, and maybe it’s going to be, one of the things we’re going to have to ask and maybe only studies of really respected institutions who really don’t have so much emotional attachment to it can look at it and say, can you do an ESOP with these multi-billion dollar global conglomerates or then you can get an ownership culture where everybody’s so diverse and don’t feel like they have a piece of the pie. Or in particularly in one of the typical things, let’s contract to Southwest and United.
When I talked to employees at Southwest or United, there’s two hugely different phenomenon. At Southwest Airlines, if you’re an employee of Southwest Airlines taking stock or giving, whatever you’re doing. Exchanging what could be wages for a stock, Southwest Airlines is the old, Southwest doesn’t co-chair. They don’t have relationships with 15 other airlines who are doing their flying under the code. Employee says, whatever I give to Southwest Airlines, that’s my company. There’s no confusion about who this is. Contrast that with United who says, well, about 17 different airlines call themselves United Airlines and you’re investing in this. We’re actually buying airplanes for other airlines that just co-chair with us. There’s so many complicated transactions that the cynicism of the employees. Wait a minute. What is that airline anyway. Or Northwest or Continental or American for that matter. Who is, who are we? We have all these co-chair deals and made it very hard for employees to say I give you something and you give it to somebody else.
Mark Gerchick: That’s interesting. The concept of corporate culture in a global economy. It’s very interesting. I wanted to just, I know that there have been some talk about a new paradigm for, I hate using that word, for labor and management negotiations. Some discussion of a sort of a best and final offer approach. A kind of a maybe revision of the Railway Labor Act even. Could you discuss that a little bit?
Mark Kahan: Well, let me, yeah. I’m happy to. I think the first thing to recognize that and a lot of people I think outside the industry don’t realize that the airline labor relations are not governed by the same rules that govern the labor relations in the steel industry or the auto industry or any other industry but the railway industry for that matter. And the process set up by the Railway Labor Act of which Duane on my right is expert at after having done it for many years. Basically says that the existing agreement will remain intact. There’s a long bargaining process. That it invites almost interminable bargaining and doesn’t really provide any strict deadlines or strong enough, in my view, incentives for the parties to reach agreement quickly. Now, this is just built in the institutional structure of the Act and at the end of the day, if after all of the mechanisms are exhausted and then there’s either an attempt to lock out or a strike, the President at that point can invoke a cooling off period and the parties have to go back and try again and ultimately a settlement can be imposed by Congress. Usually when the President acts, the parties find a way to reach an agreement. And sometimes perhaps because the unions may not want to go back and tell the union leadership, may not want to go back and tell the members that, you know, we agreed to this. They can go back and say we were forced to do it and sometimes management may want to go back to its constituents and say, look we tried but the President forced us to do it. Well, that’s kind of a perversion of the labor relations process in the NLRA, which is the standard approach.
The question though, the concern has always come up in the rail industry and the airline industry, that you know, you’re talking about firms that have a very significant share of the output. The industry. American has 20% of the ASMs. If American gets shut down by a strike or a lock out, that’s a huge impact on the broad economy and I think it, my own view is, that it’s unrealistic of labor and management to think that either of them is going to get away with doing that. I think it’s increasingly less likely to be the case. So the options then are can we come up with some set of incentives in the law that encourages the parties to reach agreement and keeps politics out of it to as great an extent as possible and leaves it in the bargaining between the two parties. One suggestion for that, and I stress only one, is what’s called the last best offer. And each party puts its best offer on the table and then a neutral arbiter picks the most "reasonable" one. Now, that one has some problems. Both sides are somewhat uncomfortable with it but I think there are some things that could be done short of that in terms of deadlines, targets, incentives, that would move the process along a lot faster because the way it goes now, it just festers unhappiness.
Mark Gerchick: I don’t want to get too much in the weeds on it but do you have anything you want to add before we turn to the audience?
Duane Woerth: Well, actually on that, I think before we attempt to modify a lot of the action, it’s been the Dunlop Commission views and all the parties have