Saturday, August 17, 2013

Please Fasten Your Seatbelts

There is not much to say about most airplane journeys. Anything remarkable must be disastrous, so you define a good flight by negatives: you didn't get hijacked, you didn't crash, you didn't throw up, you weren't late, you weren't nauseated by the food. So you're grateful. 
— Paul Theroux, The Old Patagonian Express, 1979.
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. 
— Warren Buffett, annual letter to Berkshire Hathaway shareholders, February 2008.

Being in the airline business has never been least for managers who try to make some money at it. The industry is simultaneously capital intensive: dependent on very expensive airplanes, labor intensive: dependent on a multiplicity of unionized labor groups, and operations are subject to the vagaries of a politicized oil supply from an unstable part of the world, along with network disruptions due to weather and technology. Piling on top of these challenges to profitability are cascading layers of government from local airport authorities each acting as a duchy unto itself with captive airline tenants as vassals, to the federal government, a multi-headed hydra of taxation, regulation, and control.

 Herb Kelleher, former CEO of Southwest Airlines once noted that in no other business does the government actually control the production line as the FAA does the movement of aircraft. Pace their personification as the steely eyed technicians on whose every move passenger's lives depend, FAA air traffic controllers probably have more in common with your average <facetious> friendly and perky </facetious> DMV receptionist. They and their union have figured out that working harder or faster means just that: harder and faster work with no reward. Hence the ongoing job action by FAA employees masquerading as traffic delays and congestion. The whole enterprise should be privatized like they've done up in socialist Canada. (Who's socialist now?) 

The government has enlisted airlines as quasi public utilities for use as political footballs and ATMs for decades. When added up, airlines are taxed more heavily than most "sin" taxes levied on alcohol, tobacco and guns. And those taxes are designed to reduce use of those products. Apparently embarrassed at the panoply of taxes, the DOT won't even permit airlines to break out their fares separate of the taxes applied on their web sites (like every other business on the planet does). They must show fares that already have the taxes and fees included.

Even just this week, the bright lights over at Eric Holder's thoroughly politicized and craven Justice Department Antitrust Division have decided that after allowing two mega-mergers, now is the time to close the barn door on the UsAir American merger. Never mind that the deal has been approved by the shareholders and unions of both airlines, in an industry where network size is a main competitive advantage, we will be left with a duopoly of  United/Continental and Delta/Northwest, while a stunted American and UsAir lose business traffic to the two airlines with larger networks and loyalty programs, and leisure traffic to Southwest and other low cost carriers (LCCs).

For Southwest, our favorite airline, this action by Justice is great news because it was likely going to find itself as a team without a conference in the new landscape. Southwest has recently been forced from it's traditional pocket as a low fare point-to-point carrier, but is in no way conditioned or large enough to make a break on a field populated by behemoths bulked up through the juicing of merger mania. Southwest, along with all airlines collectively face three new and one old threat which will significantly alter the competitive landscape for the industry. Those threats are new rest rules for pilots, new experience requirements for pilots, the TSA, and a new breed of ultra low cost carriers. Let us explore shall we?

New Rest Rules

Following the crash of Colgan Air 3407, Congress not wanting to let a crisis go to waste, enacted the Airline Safety and Federal Aviation Administration Extension Act of 2010 which was signed by the President on August 1st, 2010. The bill was sponsored by James Oberstar, (D, Mn) a well known friend of airline unions. This bill served as the perfect vehicle to enact a long standing wish list of union priorities masquerading as safety initiatives. Safety has long been used as a cover under which unions run quality of life and pay enhancements. Truth be told, in days gone by, this was a necessary function to pass needed safety enhancements. However, after being supplanted by armies of government regulators in recent decades, union safety committees are today more concerned with featherbedding and, often in conjunction with the managements of established market players, throwing up barriers to entry to newer nimbler competitors.

Though the Colgan crash was ultimately blamed on an incompetent pilot, the legislation enacted focused on both rest rules for pilots and also minimum experience requirements for new hire pilots. Both are pernicious. Rest rules for pilots operating commercial aircraft have up to this point been based on the number of hours flown within a certain timeframe. One of the rules for instance constrained pilots to operating no more than 30 flight or "block" hours in seven days. This might entail twice that many hours on duty due to sit times, which weren't counted. The new regulations, FAR Part 117 rules which take effect next January, are an entire overhaul and include limits on "flight duty periods" or days at work among other changes. 

The devil, as usual, is in the details. The big change to the rules is a change to how the rules are applied during irregular operations (delays). Previously, if a crew was legal to start their day but then ran into delays which might have had them fly more than eight flight hours in a day, they were legal to finish their flight sequence. Keep in mind that all major airlines have no-fault fatigue policies so under the old rules a crew could always decline to finish their sequence if they felt too tired. The new rules however, prohibit crews from exceeding the hard duty limits regardless of where they are or how they feel. Crews are even prohibited from taking off if, for instance, the planned flight time would mean an arrival say even ten minutes past their hard duty limit.

It doesn't sound like a particularly harsh rule until you consider the consequences of what happens during an even minor weather event. On a typical day following a gate hold for a passing weather front, delays getting airborne can easily top an hour. Since any time after push back from the gate is counted as flight time or "block hours" in FAA terminology, a crew which was scheduled for a seven hour and thirty minute day would become illegal under the rules and would have to taxi back to the gate to be replaced after a 31 minute delay. This of course assumes that replacement or "reserve" pilots are available. If this event happened at an airport other than a crew domicile where reserves are assigned, the most likely outcome would be a flight cancellation.

Realizing this, airlines will start preemptively scheduling their pilots for shorter duty days at delay prone airports, or simply be quicker to cancel flights for even relatively small anticipated delays. Both of these actions will raise costs, fares, and increase cancellations all for a negligible effect on flight safety. 

New Experience Requirements

Included also in the FAA Extension Act mentioned above are new experience requirements for new hire airline pilots. Up to now, pilots looking for a career in aviation had to attain a commercial pilot rating and have at least 250 hours of total time before applying to a commuter airline. They would build this time either on their own nickel or more likely as an instructor or perhaps as a pipeline inspector or banner tow pilot flying a single engine aircraft.  The new rules require all prospective pilots looking for work at a commercial carrier to have an Airline Transport Pilot (ATP) certificate which was previously only required for a captain and requires a minimum of 1500 hours of total flight time. With this one move, Congress and the FAA have done more to kill the commuter airline business than any number of commuter airline crashes ever could.

Since Orville and Wilbur first took to the skies, it has been a time honored tradition that aviation is something that was learned on the job. It could be no other way. Airplanes are expensive to own and expensive to fly. Fuel is expensive and renting a simple Cessna with an instructor can easily cost $150 per hour with forty hours needed for a private pilot's license. Secretary of Transportation Anthony Foxx was quoted saying  "We owe it to the traveling public to have only the most qualified and best trained pilots." Sure you do Tony. Just one question: where do you suppose this supply of 1500 hour pilots is going to come from? Flying banners around for a few hundred hours a year or perhaps crop dusting will only take about eight years or so before you are qualified to apply for a job that pays $16,000 to start.

Well, what about degree programs that offer flight training? They are out there and in fact the FAA will give graduates of such programs a break on the required hours all the way down to 1250. A check on the Embry-Riddle website, a respected aviation school, shows comprehensive fees at about $43k per year plus $15k extra for flight costs. The good news is that with hard work, you might be able to graduate in three years with an education costing $174k for that same $16k starting salary. 

If you get your flight experience in the military, the FAA will waive the new hire hours requirement all the way down to 750 hours. The trick is that the Air Force is now requiring a ten year commitment to the service following completion of pilot training. This means that no pilots with fewer than about 12 years of experience will be leaving the military for the airlines which makes the point moot. Additionally, at 12 years in a military career, the pension which only vests after 20 years looks quite good. As a result of the long commitment, pilot slots are going unfilled at the Air Force Academy, and of those who do become pilots, fewer are likely to leave the service for a relatively low paying airline job.

Now we'll be honest in pointing out that while doing practically nothing for safety, (remember, the pilots in the Colgan accident had 3379 and 2244 flight hours respectively) this new rule is an excellent barrier to entry and should serve nicely to bolster wage demands of those of us who are already in the profession. We had the opportunity to speak to the CEO of a commuter airline recently and asked what the plan for staffing his airline was re the new rules. After lots of tap dancing, it became clear that the plan was to park airplanes. There simply wouldn't be pilots to fly them. This means a triage of cutting the least profitable routes while raising fares on routes that will bear the cost and customers who are not able to retreat to their automobiles. With major airlines needing to hire thousands of pilots to replace retiring boomers, look for a lot of parked airplanes. 


Which brings us to one of our favorite federal agencies. The TSA, (thousands standing around) while nominally a security organization, has done an excellent job boosting gasoline and auto sales as passengers in the decade since 9/11 have decided that driving up to six or eight hours is preferable to a figurative body cavity search by government goons. There's not much more to be said about the TSA that hasn't already been said or posted to YouTube except that they are truly an exemplary federal agency embodying everything the public finds endearing about caring bureaucrats. It's all there.

Getting back to our favorite airline, a trend has become clear that Southwest is abandoning its core competency of low cost, high frequency point-to-point operations. In the past year or so Southwest has abandoned city pairs such as Philadelphia-Pittsburgh, Spokane-Seattle, Indianapolis-Chicago, Orlando-Ft. Lauderdale, and Baltimore-Newark to name but a few. The reasoning is obvious; they can't make money flying these routes. Certainly lots of people still want to go to these places but have found that after factoring in the time and humiliation of the security "process" their cars look more attractive. Herb Kelleher once noted that Southwest was good at drawing customers not from its competitors, but rather from their automobiles. Well it looks like Kelleher's business plan has met its match in a federal bureaucracy. Who'da guessed?

Ultra Low Cost Carriers

A new breed of ultra low cost carriers have recently debuted which seem to threaten to do to the established LCCs (Southwest, JetBlue) what those carriers did years ago to the established mainline carriers. Airlines such as Spirit, Allegiant and Frontier are based on a truly skeletal service model. Charging for everything imaginable such as aisle seats and stowing a bag in the overhead bin, these airlines are seeking to cherry pick truly price sensitive flyers. With new fleets, and young low cost employees, these airlines have margins which are nearly double that of  the traditional LCCs and mainline carriers. The question is how durable will this model be and how will it scale? With high dissatisfaction rates, the American consumer may have reached their limit on tolerating bare bones flying. Then again, low fares have proven to be the secret sauce of the aviation industry for some time now regardless of service.

In conclusion, the forecast as usual, is doom and gloom. But then again in this business it's the same as it ever was.


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Capt Rob