I Guess it Takes Bankruptcy...

In our previous blog (see Here), we described the resuscitation of the comatose manufacturing employment due to renewed flexibility in many union shops, such as GM. I guess it takes bankruptcy to get attitudes to change. Look at American Airlines, for an example.

Over the last several years, its big airline competitors have been getting bigger. United and Continental combined, as did Delta and Northwest. U.S. Airways merged and Southwest has just purchased Air Tran. Through it all, American stood largely on the sidelines.

Most of the other competitors had a real advantage. They went through bankruptcy. Of course, Southwest did not, but the other legacy carriers did. What those airlines and their workforces learned in bankruptcy created a lower cost and more flexible set of work rules for these airlines. Now American Airlines is beginning to pay the price for its competition with lower cost airlines.

American is clearly a high-cost airline. Its 2010 cost to fly a seat mile is 12.76 cents. This is the highest among the six largest carriers. Predictably, its pretax margins for the first half of the year were negative, while its peers produced positive operating earnings.

The problem American faces is primarily due to high labor costs. This may surprise you since several of the unions agreed to give-backs in 2003. Further, the American Airlines pilots claimed to be working at 1993 hourly rates. In short, all the unions working at American seem to be up in arms in frustration over their lack of economic progress.

The problem is less the rate of pay for the workforce than it is the work rules. American is at the bottom on industry measures of productivity because of restrictive work rules. Does that sound like the American automobile industry’s problem before the recent spate of bankruptcies?

Still, the unions are up in arms. Despite long term negotiations, the company has reached little in the way of agreements. Some unions are now threatening a strike. Let’s see. Take a high cost airline that is losing market share, increase its costs and scare away its future passengers with a threat of a strike. That sounds like a prescription to insure the future of an airline and the jobs that go with it, doesn’t it?

A Low-End Competitor with Low Industry Costs

Southwest Airlines is an unusual competitor. Since its inception, the company has been a low-end, discount competitor. What makes it an odd duck is that it provides service levels equivalent to the industry’s large legacy carriers while it also has very low costs compared to the industry’s erstwhile leaders, such as Delta, United and American Airlines. Southwest enjoys this low cost structure because it is less encumbered by onerous union work rules. Southwest has unionized employees, but their work rules are less restrictive than are those of the legacy airlines. Southwest uses this low cost structure to reduce prices and gain share against their larger legacy competitors. This has been going on for long enough that Southwest really is approaching industry leader status, if it’s not there already. Surely flying Southwest has become nearly as convenient and comfortable as flying one of the legacy airlines. The service of the legacy airlines has come to the level of Southwest, rather than the other way around.

Now Southwest has the economic where-with-all to do things that the poorer legacy airlines can not afford to do. For example, the company has made a major financial commitment to a new air traffic control system called “Required Navigation Performance” (RNP) routes. RNP is next generation technology that allows a flight to be less costly for the airline and more comfortable for passengers. (See the Symptom & Implication, “The industry is adding new, more efficient capacity in the effort to reduce costs” on StrategyStreet.com.) Airplanes can shorten their flights because they are able to use narrower and shorter descent patterns, reducing time and fuel. Passengers will find the descent more continuous, quieter and more comfortable.

This new technology will set Southwest back by $175 million. It put each of its pilots through ground school training on the new cockpit equipment and rewrote all of its flight procedures. Southwest made this investment on its own ahead of its competitors. The legacy carriers have delayed their own investments, hoping that the government will subsidize them. They can not afford this investment as easily as can Southwest. So, here we have a low-end competitor who has become an industry leader and continues to invest to reduce its operating costs and improve its performance for customers. (See “Video #46: The Place of Cost Management in Hostility” on StrategyStreet.com.) These investments slowly bleed away the advantages of the legacy carriers, adding to their economic strife.

There have been other low-end competitors who have been able to rise to industry leader status by taking advantage of the onerous work rules of their unionized competitors. The Japanese automobile manufacturers, especially Toyota, Honda and Nissan, certainly took that path. It appears that Hyundai is now following their lead in today’s automobile market.