FT: The death of a golden goose

The death of a golden goose
By Caroline Daniel in Chicago

Financial Times
Published: December 27 2004 20:34

Amid the worst downturn in the US aviation industry, representatives from
AMFA, a mechanics' union, and a leading US airline met this month to discuss
a critical issue: uniforms.

After nearly three months of talks, the two sides were still fighting over
an employees' clothing allowance that awarded staff different garments up to
a total "value" of 10 points. The tricky issues of shirts and big boots had
been resolved (assigned values of half a point and two points respectively).
But now there was an impasse. "We argued about the points value of
turtlenecks and parkas. It was just insane," says one executive.

For US airline executives this duelling over trivialities is more evidence
that unions are not facing up to the radical change in their industry's
circumstances. Focusing on contract minutiae, they say, will do little to
staunch expected losses of $4.5bn for US airlines this year, on top of $23bn
lost since 2001.

Even though they have some of the most dominant unions of any US industry,
airline workers are paying the price. They have made concessions worth $6bn
over the past three years. Since 2000, the six largest US airlines have cut
more than 100,000 jobs, or about 25 per cent of their workforce. US Airways
has cut its staff numbers by 38 per cent. For the first time, two bankrupt
carriers are ending defined benefit pension plans (see below). Even
Continental, whose wage structure has long been envied, says it needs $500m
in annual cuts.

With airlines demanding more cuts, there are signs of growing militancy. At
US Airways, hardline pilots stopped a less lucrative contract being put to
members in September, triggering the airline's second bankruptcy. On
December 30, the Association of Flight Attendants (AFA) will conclude a
strike ballot at United that could be used to authorise a strike if United
imposes new contracts.

"United is the most likely place for a strike. Management is incredibly
arrogant," says Pat Friend, president of the AFA. "We recognise this was an
economic crisis. But over the past three years we have seen that no matter
how much we give [airline management] they blow it. They act as if we are
the lenders of last resort. They are attacking our middle class benefits and
there is a systematic ratcheting down of income."

This erosion is a more extreme and accelerated example of what happened to
employees in the steel and textile industries. "It was blue collar work yet
they were getting white collar pay and benefits," says Michael E. Levine,
professor at the Yale Law School and former airline executive. It is also
emblematic of wider trends in corporate America. The benefits once provided
by companies are being replaced by what President George W. Bush calls the
"ownership society", in which individuals bear responsibility for their
healthcare and pensions.

How airline unions react to the industry's financial crisis will dictate
whether any US airline emerges from bankruptcy in 2005. It will also
determine whether non-bankrupt carriers, such as Delta and American, return
to profitability.

As unions across the industry consider their response to the next round of
airline demands, the AFA's answer is on display outside Ms Friend's office,
on a sign used at a candlelit protest outside the White House on a freezing
night earlier this month. "No more concessions," it reads.

The mood, but not the message, was very different on June 28, 2001. Duane
Woerth, president of the Airline Pilots' Association, the most powerful
airline union, gave a speech to the International Aviation Club. In it, he
was frank about how he saw his role.

"The union presidents shall fairly be judged on how they raised, protected
or lowered our shareholders' value," he said. His definition of shareholder
value? "The number of jobs multiplied by contract value."

On the conventional definition of shareholder value, the industry has a
terrible record - systematically destroying capital. Airlines have now lost
$6bn more than they have earned since 1947. Mr Woerth's shareholders in the
union have fared much better - especially in the years that preceded his
speech, from 1995 to 2001.

"We had the biggest pilot hiring and the biggest contracts we had ever
signed. We were getting back to the parity of the golden years of the 1960s
and 1970s. We thought if [a pilot was not] earning $300 an hour for the
biggest planes, we were not close to living as we did in the 1960s," Mr
Woerth recalls.

That union strength could be traced to the Railway Labour Act of 1926, which
was extended to airlines 10 years later. Under the act, contracts did not
expire after a fixed term as they did in other industries. Archaic work
rules were often perpetuated. The side with the upper hand had an incentive
to delay ratifying a new contract.

The act limited the ability of an airline's management to prepare for the
threat of strike. "No airline can take a strike of any duration, so you take
the lesser of the two evils and agree to demands, and the RLA enables it and
puts power in union hands," says one senior airline executive. "Unions have
no risk of getting thrown off the property. There are too many safeguards -
contracts never expire and you can't have replacement workers."

Until deregulation of the US airline industry in 1978 there was little
incentive for management to be disciplined about pay. "They could go to the
government and get fare increases to cover it," says Frank Lorenzo, who is
vilified by unions for his role in the turbulent restructuring of
Continental in the 1980s, when there were attempts to take on labour unions.
"Our 2004 came in 1984," Mr Lorenzo says.

In the 1990s, however, strong economic conditions "lifted all boats,
allowing for some of the most generous benefits the industry had seen for a
long time", according to Mr Lorenzo.Management caved in to union demands.
Rick Dubinsky, then head of Alpa, summed up the prevailing ethos, telling
United's management: "We don't want to kill the golden goose. We just want
to choke it by the neck until it gives us every last egg."

The result, noted Bob Crandall, former chief executive of American, was that
"airline employees were compensated at a level nearly twice the average for
all US industries. The two highest paid professions were doctors and airline
pilots. However, doctors averaged 41 hours of work per week while pilots
averaged 22 hours per week."

Flight attendants enjoyed part-time jobs with full-time benefits. Unions
secured work rules that created jobs and made sure employees were paid for
dead time. A United bankruptcy filing included 35 pages of work rules, from
limits on how many hours a pilot could fly to payments for first class
travel. United paid for any pilot's relocation even if it was not the
airline's choice, including in one case paying for the cost of a piano to be
retuned.

Labour forces became bloated and inflexible. According to Vaughn Cordle,
analyst at Airline Forecasts, United had 173 employees per aircraft,
compared with 86 per aircraft at Southwest, a low-cost carrier. When the
downturn came, the mainline carriers were unable to respond quickly.
Low-cost carriers, unburdened by unproductive work rules (JetBlue's pilot
contract is just 16 pages) made money even with lower revenues.

Another airline executive says: "The challenge for airlines that have
emerged over 75 years is to compete with companies that have entered the
industry with a different cost structure."

Chapter 11 bankruptcy has provided the only way to overhaul these legacy
costs. Section 1113 of the bankruptcy code gives executives the power to rip
up labour contracts. Mr Woerth notes: "In bankruptcy, union leverage is
gone. We never had this high percentage of airlines operating in bankruptcy.
And the loss of leverage is evident."

United has already gone through one round of cuts two years ago and is now
proposing a second, more aggressive round of cost cutting. US Airways is now
trying to make its third round of cost cuts, warning that if staff do not
agree it could impose new contracts by mid-January. Delta and American
secured labour concessions only after invoking the threat of bankruptcy.
"There has not been a concessionary negotiation not brought on by dire
circumstances . . . It is always either in bankruptcy or on the court house
steps," says one executive at a bankrupt airline. "I do not see any
long-term change in behaviour."

For employees the cuts' impact is severe. Flight attendants at US Airways
have seen a 21 per cent interim pay cut.Ms Friend says: "The first payment
arrived this month. One four-year reserve flight attendant's net pay for the
month was $639 . . . We are getting reports of personal bankruptcies and
mortgage foreclosures . . . and one suicide."

Gro Holm, a single mother with 21 years as a United flight attendant, now
works 15 days a month, up from 12before the industry downturn began. "I have
taken a 30 per cent cut in wages and benefits. The industry was something
you could make a career out of. You were covered for insurance, medical,
dental, guaranteed a pension after 10 years and wages went up every year. It
is becoming a job, not a career."

At US Airways, some pilots have seen salaries fall from $150,000 in 2002 to
$70,000. "The average airline employee used to be solidly in the middle
class and pilots were upper-middle class. Now that has all ratcheted down.
There are junior flight attendants who can barely sustain their lifestyles,"
says Tim Baker, US Airways 737 captain, who also has to work more days.

Unions have struggled to respond to bankruptcy court powers. Union democracy
can make it difficult for officials who support concessionary deals to get
re-elected, as Mr Baker, ousted as a member of the Alpa "master executive
council" at US Airways, learnt. His replacement was one of four pilots -
dubbed the "gang of four" - who refused to put the contract offered by the
airline to members, calling it "voluntary rape". That hardline response
gratified egos but did little for employees: US Airways filed for a second
bankruptcy.

At the national level, however, Alpa has earned a reputation for pragmatism.
Pilots lose most in a bankruptcy filing. Mr Woerth has emerged as a reformer
on pensions. "The right to strike is the only ultimate leverage. But that is
like committing suicide while in bankruptcy," he says.

Instead, the union is playing a longer game. The maxim they abide by is:
"Pay cuts come and go but work rules are forever." At United, pilots
accepted a 15 per cent pay cut in a preliminary agreement this month but
rejected 16 work rule demands, such as a request to increase their flying
time to 95 hours per month. "This agreement cannot be sugar-coated," Dave
Zapp, an Alpa union leader, said, "but it concentrates the concessions on
wages rather than work rules and benefits."

One bankruptcy lawyer says: "They chose [to give ground on] wages, as they
will try to get it back later."

Mr Levine says: "[Mr Woerth] wants to live to fight another day. [He and the
union] understand the fundamentals are on their side. It may be a long
cycle, and they may have to take wage and work rule changes, but the one
thing they do not want to do is end up with non-Alpa airlines."

Not all unions are taking a long-term view. In November, flight attendants
warned of a nationwide strike and threatened US Airways with more sporadic
action.

Behind the threat is weakness. Militancy is more likely from those who feel
they have little to lose. Randy Babbitt, president of Eclat Consulting,
says: "This is the first time where wage rates are heading to levels where
people are willing to say they will go elsewhere."

That level is getting close for United's flight attendants. In a document
filing for United, Michael Wachter, a professor at the university of
Pennsylvania, says wages would fall below those of low-cost carriers such as
JetBlue and Frontier.

United's flight attendants used to enjoy monthly benefits of $1,987, 77 per
cent above the average for a similar job in other sectors of the US economy,
according to Prof Wachter. United is proposing to reduce this premium to 20
per cent. On retirement benefits, the flight attendants' ratio of retirement
benefits to wages would fall 38 per cent below the average for similar
workers elsewhere in the economy. Combined monthly pay and benefits would
fall to $2,999, below the private sector average of $3,252.

While that will fuel support for a strike vote, it is difficult to see how
the flight attendants would benefit from accelerating the airline's demise.

And yet, while personal lifestyles have certainly been hit, how bad is the
situation for airline workers? Mr Wachter's data are revealing. Even after
the latest round of wage cuts now being proposed by United, its mechanics
would earn 58 per cent above the economy-wide average for mechanics. Pilots'
continued equanimity looks even more understandable: United's proposed new
monthly salary of $10,464 would leave them in the highest-paid occupation in
the country, above judges at $10,218 and physicians at $10,090 (see charts).

Reflecting that position, pilots virtually never leave their job: employee
turnover remains negligible, at 0.07 per cent of staff from January to
September 2004. Turnover of flight attendants in the same period is just 1.6
per cent.

One senior airline executive says: "You hear a lot of grumbling from airline
workers but you need to compare them with jobs outside. Even with the
turmoil since September 11, attrition rates have not come anywhere near to
those of the general economy.

"People lost perspective about what a real job is today."

Battles looming over pension proposals

Pat Friend, president of the Association of Flight Attendants, recalls that
in 1966, when she first became a flight attendant, ³we didn¹t have a company
sponsored pension plan. There was a plan we could join with our
contributions, but the assumption was we wouldn¹t be there long enough to
assume any benefits.²

Forty years later, that situation is repeating itself. The difference is
that in the past it was expected that flight attendants would leave to have
babies. Today they may leave because the attractive benefits introduced in
the 1970s and later expanded are being taken away.

The biggest shake-up concerns the future of defined benefit pension plans.
Duane Woerth, president of the Airline Pilots¹ Association, says: ³Prior to
now, there was never a [situation] of airlines . . . leaving their pensions
and retiree health benefits behind.²

US Airways was the first airline to tackle the issue. In its first
bankruptcy two years ago it terminated the plan of its pilots, transferring
the liabilities to the Pension Benefit Guarantee Corporation, the US federal
body that insures these plans. Now in bankruptcy again, US Airways wants to
end the plans of its flight attendants and mechanics. ³What is happening to
pensions is criminal,² says Tim Baker, a captain at US Airways. ³It is the
largest transfer of debt from the private to the public sector since Savings
and Loan. The PBGC is taking over billions in debt.²

Even so, United - which is also in bankruptcy - and US Airways have said
they cannot leave bankruptcy in 2005 without abandoning their pension plans.
The problem is largely caused by legislation that forces companies whose
plans fall into deficit to accelerate cash contributions to close the gap.

In United¹s case the contributions would be enormous. It said it could have
to make payments of $4.3bn to fund its pensions from 2005 to 2008. United
barely expects to break even next year: pension demands would impose an
impossible burden.

The two bankrupt carriers are not alone in seeing pensions as the most
critical benefits issue. Delta faces $500m-$550m in pension funding costs in
2005. It has warned that payments from 2006 to 2008 ³could have an adverse
material effect on our liquidity².

Delta¹s hopes of evading bankruptcy are pinned on changing the legislation.
Northwest, which also faces a $500m payment in 2005, agrees. The two
airlines have yet t o come up with a final proposal but want to freeze
current defined benefit plans, move to cheaper defined contribution plans
and extend the time available to close the unfunded gap from between three
and five years to 25 years.

Critical battles loom in 2005. First, the PBGC, which already has an $11.2bn
deficit, could initiate legal action to delay assuming United¹s liabilities
- which it puts a t $6.4bn (United¹s own estimate is $1.7bn). Action could
come as early as January.

Second, there will be opposition in Congress to giving legacy airlines more
time to close unfunded pension gaps. Low-cost carriers without defined
benefit plans, such as AirTran, are expected to lobby against it.

Third, unions are split on the subject. A deal agreed by the pilots at
United, under which they agreed to the termination of their pension plans,
has sparked unease at other unions - not least because they made it
conditional on other employees also losing their pensions.

Other unions remain opposed to pension terminations. Robert Roach, vice
president at the machinists¹ union, has said: ³This is where a line has to
be drawn in the sand. If United gets away with it, every other major
industry will follow suit.²


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