Today the DOT released the Mission Statement and Objectives of
Secretary Lahood's Aviation Advisory Committee.
Vaughn Cordle, CFA / May 13, 2010
More information can be found at: http://www.dot.gov/faac/index.html
Looks like a great group, and the objectives of the Commission appear to be perfectly politically
correct! Obama should be happy.
Labor has a seat at the table, which is good. As they say in Washington, if you are not at the table, you
are on the menu. A fair question to ask is how much influence unions have in Washington and whether
their views will prevail in the final report of the commission.
Balancing competitiveness and viability will be the toughest nut to crack for the group.
Our recent industry structure work provides an analytical framework for figuring out the right
concentration or number of airlines that would allow the industry to break even on capital costs over a
full business cycle. This is how viability should be defined and a full business cycle provides the time
horizon that matters most.
A "world class" workforce means different things to the consumer, shareholder, and unions. I find this
somewhat amusing since the voice of the labor will be loud given the current political slant in
Washington. World class implies the best-trained and highest compensated employees accompanied by
the best work rules. This "objective" is not consistent with an industry that is so fragmented (too many
airlines). Without further consolidation, the industry cannot satisfy the labor, let alone the most
important stakeholder - the shareholder.
Viability also means that the business provides the required rate of return for the investors in the
business. Without that required return, the shareholders withdraw their enthusiasm and dump the stock,
which in turn drives up the cost of debt and the odds of bankruptcy.
In the final analysis, the industry cannot produce a world-class workforce - whatever that means - given
the nature of its destructive fare competition, which is a function of a market concentration that is too
low. The solution, of course, is less competition and fewer airlines. This will not be viewed favorably by
consumer advocates who understand that fares will increase with higher concentration. However, a
strong case can be made that the consumer has captured almost all of the value produced by the
industry over the last decade - $70 billion in losses. Labor and fuel account for 50% of the costs.
I had an interesting debate about mergers with one of the Commission members, Berkeley's Professor
Severin Borenstein, this past week (see link below). Borenstein is a strong opponent of mergers and
believes the airlines want to merge so they can raise fares, not improve efficiency. His views would
quickly change if he were responsible, and accountable, to the key stakeholders of an airline.
Merger Debate: UC Berkeley'sBorenstein & Cordle / May 4, 2010 Point-to-Point KCRW
http://www.kcrw.com/media-player/mediaPlayer2.html?type=audio&id=tp100504will_the_latest_airl
This is not rocket science, but it does require a good understanding of what it takes for the industry to
meet the strategic tests of consistency and fit, as it relates to the objectives of the Commission.
The simple equation:
World class workforce + balance between competitiveness and viability + carbon taxes + funding for
ATC and aircraft technology = higher government taxes/fees, security costs, airport charges, ADS-B
technology costs, and labor costs for the airlines.
These higher costs must be viewed within the context of a $1.4 to $2 trillion budget deficit and Obama's
need to reduce government spending in later years.
Solution:
Allow consolidations and mergers which will allow the industry to pass the increased costs on to
consumers of the air transportation system.
Airports and manufacturers will not like consolidation because it results in less traffic and demand.
National unions will favor big mergers because it enhances negotiating power. Low-cost airlines will not
want to be constrained in terms of their ability to grow, which of course gets to the heart of why the
industry prices its product below capital costs. Airline executives and analysts understand what that
required return must be and that destructive fare competition - a byproduct of excess capacity - makes
the airlines unfit for long term investment.
Commission objectives:
It's easy to see where the Commission's final conclusions are headed before the first meeting is even
held. The Commission is a political means to provide cover for Lahood and Obama, who really don't
have a clue about how to fix the industry. In the final analysis it's about shifting costs, and those costs
will ultimately be absorbed by the shareholders and the consumer.
The good news is that the logic of why airlines must merge is overwhelmingly solid. More mergers
provide relief for the industry and the most important stakeholder, the shareholder, at least for a few
years.
Secretary Lahood's Aviation Advisory Committee.
Vaughn Cordle, CFA / May 13, 2010
More information can be found at: http://www.dot.gov/faac/index.html
Looks like a great group, and the objectives of the Commission appear to be perfectly politically
correct! Obama should be happy.
Labor has a seat at the table, which is good. As they say in Washington, if you are not at the table, you
are on the menu. A fair question to ask is how much influence unions have in Washington and whether
their views will prevail in the final report of the commission.
Balancing competitiveness and viability will be the toughest nut to crack for the group.
Our recent industry structure work provides an analytical framework for figuring out the right
concentration or number of airlines that would allow the industry to break even on capital costs over a
full business cycle. This is how viability should be defined and a full business cycle provides the time
horizon that matters most.
A "world class" workforce means different things to the consumer, shareholder, and unions. I find this
somewhat amusing since the voice of the labor will be loud given the current political slant in
Washington. World class implies the best-trained and highest compensated employees accompanied by
the best work rules. This "objective" is not consistent with an industry that is so fragmented (too many
airlines). Without further consolidation, the industry cannot satisfy the labor, let alone the most
important stakeholder - the shareholder.
Viability also means that the business provides the required rate of return for the investors in the
business. Without that required return, the shareholders withdraw their enthusiasm and dump the stock,
which in turn drives up the cost of debt and the odds of bankruptcy.
In the final analysis, the industry cannot produce a world-class workforce - whatever that means - given
the nature of its destructive fare competition, which is a function of a market concentration that is too
low. The solution, of course, is less competition and fewer airlines. This will not be viewed favorably by
consumer advocates who understand that fares will increase with higher concentration. However, a
strong case can be made that the consumer has captured almost all of the value produced by the
industry over the last decade - $70 billion in losses. Labor and fuel account for 50% of the costs.
I had an interesting debate about mergers with one of the Commission members, Berkeley's Professor
Severin Borenstein, this past week (see link below). Borenstein is a strong opponent of mergers and
believes the airlines want to merge so they can raise fares, not improve efficiency. His views would
quickly change if he were responsible, and accountable, to the key stakeholders of an airline.
Merger Debate: UC Berkeley'sBorenstein & Cordle / May 4, 2010 Point-to-Point KCRW
http://www.kcrw.com/media-player/mediaPlayer2.html?type=audio&id=tp100504will_the_latest_airl
This is not rocket science, but it does require a good understanding of what it takes for the industry to
meet the strategic tests of consistency and fit, as it relates to the objectives of the Commission.
The simple equation:
World class workforce + balance between competitiveness and viability + carbon taxes + funding for
ATC and aircraft technology = higher government taxes/fees, security costs, airport charges, ADS-B
technology costs, and labor costs for the airlines.
These higher costs must be viewed within the context of a $1.4 to $2 trillion budget deficit and Obama's
need to reduce government spending in later years.
Solution:
Allow consolidations and mergers which will allow the industry to pass the increased costs on to
consumers of the air transportation system.
Airports and manufacturers will not like consolidation because it results in less traffic and demand.
National unions will favor big mergers because it enhances negotiating power. Low-cost airlines will not
want to be constrained in terms of their ability to grow, which of course gets to the heart of why the
industry prices its product below capital costs. Airline executives and analysts understand what that
required return must be and that destructive fare competition - a byproduct of excess capacity - makes
the airlines unfit for long term investment.
Commission objectives:
- • Safety: gotta say this and more money is typically the only way to improve safety.
• World-class aviation workforce: skill set or in terms of wages/benefits?
• Balancing competitiveness and viability: without mergers, the networks are not viable and
will continue a slow liquidation.
• Securing funding: charge the airlines or taxpayers, with airlines likely paying for technology
that helps the airlines.
• Addressing environmental challenges and solutions - carbon taxes are coming and
airline passengers will have to pay their fair share.
It's easy to see where the Commission's final conclusions are headed before the first meeting is even
held. The Commission is a political means to provide cover for Lahood and Obama, who really don't
have a clue about how to fix the industry. In the final analysis it's about shifting costs, and those costs
will ultimately be absorbed by the shareholders and the consumer.
The good news is that the logic of why airlines must merge is overwhelmingly solid. More mergers
provide relief for the industry and the most important stakeholder, the shareholder, at least for a few
years.
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