Friday, May 30, 2014

When Vikings Fly

A row over plans that a discount European airline, Norwegian Air, has to start flying to the US has recently broken out here in the colonies. Norwegian Air, the third largest discount airline in Europe has recently announced an expansion across the pond to several new US cities.

Incorporating as Norwegian Air International in Ireland, the company has drawn the ire of US airlines and trade unions on both sides of the Atlantic for what they perceive as unfair business and labor practices.

While Norwegian already flies from several US destinations to Europe, by incorporating the new unit in Ireland, Norwegian will be able to take advantage of a liberal open skies agreement between the EU and the US. In addition, Norwegian will also be able to circumvent some more restrictive Norwegian labor laws which has US pilot unions upset. From an ALPA whitepaper on the issue:

While the EU has created a common aviation area, it remains unclear which regulatory, tax, and labor laws apply to aircrews who may work aboard the aircraft of an airline headquartered in one country, be employed by an entity in a second country, be based in a third nation, and fly routes primarily out of a fourth.

I have to say that given the crushing thicket of rules, regulations, restrictions, and taxes that any airline must negotiate to make a profit, this arrangement (if true) seems rather clever. Personally, I think that the US union's time and effort would be better spent on reducing barriers to commerce here and abroad rather than working to impose those barriers on a smart competitor.

Now I'm no expert on bi-lateral agreements between the US and the EU, but it appears that Norwegian Air could avoid all this trouble by simply changing the name of their Irish unit to Irish Air and then getting on down the road. They would, though, still have to compete for passengers, recruit and train crews, and still operate their aircraft in accordance with both US and EU safety standards.

And speaking of crews, there still is apparently a worldwide pilot shortage which we've noted before. The commercial aviation markets in both India and China are exploding and there is a continuing huge demand for experienced transport category pilots.

Unions continue to be the bane of airlines worldwide, and one mechanism that many overseas airlines utilize to avoid the establishment of pilot unions is to not actually hire any pilots. Consulting firms are created which hire pilots on a contract basis, usually for periods of three to five years to staff the airline. If after the contract period is up and the airline likes you, you'll be offered another. If not, sayanora.

While Norwegian does maintain a website listing pilot requirements for new hire pilots, their jobs opening website has no pilot positions offered. Most curious until a quick search reveals the site of aviation consultants Rishworth Aviation who are "eagerly seeking" Boeing qualified pilots for placement at Norwegian flying brand new Boeing 787s.

In this way airlines can avoid the "ratchet effect" of ever increasing but never decreasing wage rates of unionized carriers. Asian airlines have used this practice for years using consultants such as Air Charter Service and Iasco to provide American pilots to airlines like JAL and All Nippon.

But getting the pilots is the trick, isn't it? How many type rated and current Boeing pilots do you suppose are just sitting around the house waiting for a call to go to work flying for Norwegian? My guess is that there aren't many (who aren't already working somewhere). How does one go about becoming a qualified Boeing pilot anyway?

I happen to know. Many years ago, to apply for my current job, I actually had to purchase my own type rating (which is an FAA designation to fly a certain type aircraft) for a 737. Boeing 737s can actually be rented for about $50...a minute. Cheap, right? So the whole deal was only about $10 grand. The 737 is Boeing's smallest airliner and a type on say a 777 would be unobtainable to most private citizens except wealthy dilettantes like John Travolta. Plus, this gets you the basic rating but no experience.

The point is, most pilots walking around with those types of ratings had them paid for by the airline they worked for. This means that Norwegian is hoping to raid the cadre of other airlines, and that means they have to offer a better deal.

There are many US pilots working overseas in hell holes such as the UAE and India who do so because they've been either laid off from a bankrupt US carrier, or perhaps got a late career start and don't wish to join the bottom of a union seniority list. They go overseas to fly in a lousy place for the pay. It will be these pilots that Norwegian will be trying to attract. And they'll have to compete on pay.

Will they be successful? It depends on how you define success. Part of Norwegian's business model is based on reduced labor costs. Implicit in this assumption is that "cheap" labor including pilots are available in sufficient numbers. The other part of the equation is the other big elephant in the room which is fuel and other costs which are unavoidable in long haul flying. From the WSJ:

It isn't uniformly accepted that low-fare competition is inevitable on intercontinental routes, though. "You cannot pack people like a sardine can," Qatar Airways Chief Executive Akbar Al Baker told reporters in October. "I don't think it will work." 
Among the challenges to the discount model on long routes: Many cost-saving techniques used by short-haul operators can't be replicated. Discount carriers like Southwest Airlines Co. LUV +0.08%  and Ryanair Holdings RYA.LN -1.89%  PLC, the U.S. and European leaders, try to get planes unloaded and back in the air quickly. That is harder to do on intercontinental flights, which face more departure restrictions. 
Southwest, America's putative low cost leader is having it's own problems, as the short haul market is collapsing and the long haul market is mature and populated by newly merged mega-carriers with freshly reduced labor rates due to post 9/11 bankruptcies.

If Norwegian manages to build a better mouse trap, then bully for them. They might find though that when flying the same airplanes in the same skies as their competitors, any competitive advantage is fleeting.

Sunday, May 25, 2014

The End of the Southwest Effect?

A recent article in the nation's favorite fish wrapper, USA Today, suggested that the vaunted "Southwest Effect" may no longer be in effect. For the uninitiated, the term Southwest Effect was coined by the bureaucrats in the Department of Transportation back in 1993 to describe the effect that the entrance of Southwest Airlines into a new market would have on passenger count. In short, it would explode.

It can be forgiven for those industrious analysts beavering away in the bowels of some leaden government agency to not be familiar with the underlying phenomenon causing the Southwest Effect. That would be the concept of supply and demand, otherwise known as basic economics. Lowering the price of any product usually increases the demand for that product. Back in those days Southwest had a cost advantage for many reasons. Today, not so much:

In 1993 the U.S. Department of Transportation studied how the entry of a low-cost carrier into a market can lower overall fares and spur demand for air travel, dubbing this the "Southwest effect." But for years now, aviation analysts have questioned if the airline that enplaned 115 million passengers in 2013 is still the low-fare leader.

It would make an interesting study to determine who is more ignorant of basic economics, journalists or government bureaucrats, but it would no doubt be a close race. The article then goes on to speculate as to the causes of Southwest's increasing costs:

The reasons include the end of Southwest's fuel hedging strategy, an increasingly complex merger with AirTran and the rapid consolidation of the domestic airline industry. This seems to be yet another reason why the spate of recent mergers has harmed consumers.

What I love about journalists pretending to know what they are talking about is that they tend to contradict themselves, sometimes even in the same article.  So here, the end of Southwest's fuel hedging strategy is one of the two listed causes for increased costs. And of course just a paragraph later author McGee exclaims that it can't be fuel prices:

Now before critics start yelling "fuel prices!" and "inflation!" let's compare these fares in an apples-to-apples fashion. The average domestic fare for the exact same periods rose from $362 in 2008 to $390 in 2013, so the percentage of increase on both these routes on Southwest is more than four times higher: 
Fare increase:
Domestic average: +8%
Dallas-Houston/Southwest: +38%
Dallas-San Antonio/Southwest: +35%

It looks like our intrepid reporter could use a primer on commodities price hedging. It's not difficult. Southwest made a wise bet back in the mid 2000s that fuel prices would rise rapidly and spent money on contracts to lock in a lower price. It saved the airline billions. But a necessary condition to make or save money in any hedging operation is a move in the underlying commodity price itself. If prices are stable, hedging is worse than useless as purchasing contracts is costly.

In fact author McGee probably could have learned that from an article in his own newspaper from 2008. But never mind. Reading the article one gets the impression that fuel hedging is something they just arbitrarily decided to stop doing. No, hedging helped because fuel prices skyrocketed. Oh.

I also love the way his "apples to apples" comparison uses two markets from Love Field where there is little competition against the many thousands of markets contained in the line item of "Domestic average".

But had this reporter really wished to get to the bottom of the issue a little homework is all that is necessary. Costs are in fact rising at Southwest as the business matures. Employees become older and more expensive while growth opportunities domestically become less available. There are other factors such as the collapse of domestic short-haul flying due to a combination of reasons that I've detailed before.

But the easiest way to figure this all out is to simply listen to the statements of the airline's CEO himself:

So the answer to that question is, really, how important is it for us in the future to be low-cost?  I'm arguing to you all that it is ultra-important, and so did Herb Kelleher on our video.  It is something that we can only continue to achieve if we really work together because the Company is kind of like your home.  It is very difficult to keep costs down in a world where there's inflation and especially with energy costs. 
So here is a really significant challenge for us because this shows you, I think very vividly, how our costs break down.  It's roughly one-third, one-third, one-third.  So what does this mean?  If you look at the gray area—I'm sorry, the blue area—our fuel costs today are fully one-third of our cost.  Believe it or not, one-third of our costs go to pay just for jet fuel.  When I started back in the 1980s, it was ten percent. (Emphasis added)  So if you think about it, every carrier pays the same amount for gas, so you've just wiped out 35 percent of our potential cost advantage versus Delta.  Delta and Southwest pay about the same amount for gas.  So that leaves us with 65 percent of our cost structure to work with to beat Delta and American and U.S. Airways—well, not U.S. Airways anymore, but Spirit.  So the challenge then becomes, how do you do that? 
If you look at the other category, which is the black, the 34 percent, we beat everybody.  We are more efficient for a variety of reasons—that I bet everybody here could describe—than any other airline when it comes to that other category.  But what's changed now in 13 years with all the bankruptcies is where we used to be lower than our competitors with that 31 percent slice, we are not.  How can we be the low-cost producer and the low-fare airline if our competitors, even legacy competitors, have lower unit labor costs than we do?  It's just—it's a question.  It's nobody's fault here, but it has happened, and so that is the question that we've really got to answer.

There, that was easy.

Friday, May 16, 2014

Laying Over Well

From the Times Union Arena, Albany, NY

The airline layover is more of an art form than a science. The definitive guide to laying over well was written by (now retired) Delta captain Kevin Garrison in his book The CEO of the Cockpit which I highly recommend as a humorous inside look at the piloting profession:

A great layover is made up of having an adventurous attitude, a good group of people and enough common sense to stay out of jail and appear for pick-up sober in the morning.

Most airline layovers consist of a short van ride to the hotel, signing in, taking a moment to unpack, unwind and decompress followed by a brief turn in the usually lame hotel gym followed by a chicken caesar salad and a beer for dinner with your flying partner. A candy bar makes a good dessert before the setting of two or more alarms and falling asleep reading the Kindle. That's generally about as good as it gets. Most of the time.

On occasion, though, the layover gods may smile and drop a good time into your lap. This happened last Tuesday in Albany, NY. 

After the usual sign in at the Albany Hilton, I ventured down to the bar to wait for my first officer to arrive. A commute day sleep deficit cancelled any gym plans. The bar was packed and a fellow next to me seeming to be in an expansive mood asked if I was in town for the concert. What concert? Oh, you don't know? It's the Boss. Yes, that Boss. Bruce Springsteen was playing at the Times Union arena that night starting at 7:30. The current time was 5:30. 

The gears started turning. I've never counted myself as a huge fan of Springsteen but I certainly didn't dislike his music. Growing up near Philly, Springsteen was on the radio dating back to the his debut Asbury Park album and has been more or less part of the American soundtrack for nearly forty years.

I never cared much for a lot of his political stuff, but his rockers were second to none and who knows how much longer he'll keep it up? Since I'd probably never consider going out of my way for a Springsteen concert, this was it. Now or never. So it was now. I figured I could scalp a ticket for less than a C note outside the arena.

Just after finishing some wings and my second IPA, a bartender who apparently overheard my conversation approached with several tickets for sale. After minimal haggling, I had in my possession a ticket to see Bruce Springsteen and the East Street Band, face value $118 for a reasonable $50. My first officer declined to join me even with the offer of a comped second ticket so I was off by myself.

The ticket turned out to be legit as the laser scanner gave an approving beep entering the arena. My seat was on the second level about halfway back. Not a bad seat at all. And I had an empty seat next to me. Perhaps the bartender had broken up with her boyfriend or something similar. Didn't matter at that point.

After about a half hour delay the house lights went down and the show was under way. Bruce looks pretty good for his mid-sixties and has no shortage of energy even if his voice has grown steadily raspier over the years. As I mentioned, not being a true fan, many of his more esoteric selections were foreign to me but he did several covers and many of his biggest hits.

I had to admire though the professionalism of his band which consisted of perhaps a dozen veteran performers to include two keyboard players, a fiddle player, three backup singers, a full horn section and Nils Lofgren and Tom Morello joining the Boss on guitar.

Springsteen is nothing if not a good showman and entertainer. He was good at working the crowd and brought several members of the audience up on the stage for a once in a lifetime dance with a rock god. I especially appreciated how the transition from the main set to the encore set only took a few seconds sparing both the band and the audience the obligatory five minutes of shouting and stomping to demand an encore.

The encore set included many of his largest hits resulting in the entire arena coming to their feet for the remainder of the evening. The encore setlist included Born in the USA, Tenth Avenue Freeze-out, Born to Run of course, and Thunder Road to close out. A very enjoyable three hours.

After making my way back to the Hilton, I spent a few moments setting my three alarms so as not to miss lobby time. My phone which conveniently shows the amount of time to pass before the alarm sounds reported a stout 6:18 hours and minutes available for blissful snoozing before go time. 

Considering I'd only gotten about four hours the night before due to a late commute flight into base, this would be like sleeping in. So of course I popped awake several hours early due to a too cold setting on the air conditioner only not to be able to get back to sleep. Well, sleep is overrated and I have a blog entry to write.

PS I do have a story to tell about the time my parents had dinner with Bruce Springsteen and his mother. As it turns out, my father graduated from Freehold Borough High School which he attended while my grandfather was employed at the NJ State Hospital in Marlboro, NJ.

Bruce Springsteen's mother also graduated from the same school (as did Bruce) and was attending a reunion along with her son. My parents had the good fortune to be seated next to the Boss and his mother and enjoyed an evening together. He was reported by my mother as delightful.