INTERVIEW: Smisek and Kellner, on guiding Continental's move to the Star Alliance

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Continental's Jeff Smisek and Larry Kellner are crafting one of the slickest leadership transitions in airline history while guiding the carrier's strategic move to the Star Alliance, writes Lori Ranson in Houston.

Few industries can match the ironies of the airline business. In his 1998 book From Worst to First, then Continental Airlines chief executive Gordon Bethune described the carrier's interest in recruiting prominent local attorney, Jeff Smisek, as general counsel. "Jeff likes to point out that his secretary had long-standing orders never to book him on a Continental flight because our airline was so lousy," wrote Bethune.Now,nearly 15 years after joining the carrier, Continentalpresident Smisek is poised to become chief executive on 1 January, succeedingLarry Kellner in the role.

Taking a brief reprieve from finalising Continental's carefully planned transition from SkyTeam to the Star Alliance, Smisek offers a glimpse into his recruitment process and how Bethune ultimately won him over."I got a call from a friend asking me if I would be interested in being general counsel at Continental Airlines." With a hearty laugh, Smisek continues: "I said no. I was a partner at a big law firm. Why would I want to do that?"

larry kellner & jeff smisek richard j. carson
 © Richard J. Carson

Although Smisek still had no interest in joining Continental, he was eventually offered an opportunity to meet Bethune and he agreed, thinking he could shoreup business for his own firm."Of course the dollar signs went off all over my head in terms of sales. I knew this was a company in enormous trouble. I had flown Continental. I knew how bad they were, and I figured these people need a lot of legal services," Smisek recounts.

In another ironic twist, Smisek says it was Bethune who ultimately got him to buy into the vision he was building for Continental. Smisek came away convinced of the desire to succeed among Continental employees, but he adds: "Candidly, I think they had not had the right management to give them the tools they needed to turn the carrier around."

Similar themes permeate the recruitment of Kellner as chief financial officerby Bethune. Kellner was living in southern California when he was contacted by Continental. He says his perception of the carrier was one of "older aircraft, contentious employee relations and financial calamity". Kellner told his wife not to worry about a move to Houston since it would have to be the perfect fit for him to join the company. But after Kellner met Bethune, he too was surprised by the significant opportunity for Continental.

Kellner determined that it had prime geographical advantages with its Houston hub, the opportunities in New York Newark airport and a key position in middle-America with its Cleveland presence.His biggest worry was not whether the airline could be changed from a management perspective, as he could see"there was a lot of opportunity",he recalls. His biggest worry was that"it is a big ship and how long it will take to turn that whole ship?"

larry kellner

TOUGH CHOICES

Kellner's decision to leave Continental was difficult, and ultimately made for entirely personal reasons. One thing he has always wanted to do is create something from scratch, "and see how successful I would be if I had to build it from the bottom up".

He came to the realisation that if he did not make a move within six months to a year, the odds were it would never happen. Kellner was aided in his thinking by his best friend from college, "who had pointed out to me you keep talking about this, but I think you'll be at Continental forever". Kellner responded by saying: "I like Continental, I love Continental, candidly." His friend then said Kellner just needed to acknowledge that, and realise it was unlikely he would fulfil that desire to build something from scratch.

But Kellner was not ready to make that acknowledgement, and explains as he turned 50 he realised if he wanted to launch his own company, "I need to do it before I get too much further down the road because otherwise I won't have enough time," he says. Kellner is heading Houston-based Emerald Creek Group once he leaves Continental at year-end.

Kellner says his decision to leave Continental creates upward mobility for other employees. He says there will be "a ton of continuity", but as Smisek starts to fill the gaps, new opportunities will be created, which he says is good for the company. "Everybody gets something when the top job opens up."

When Kellner announced his departure, several of the carrier's rising stars stopped by to say they were sorry he was going. "We would talk about that for two to three minutes, then you could see the energy as they were thinking what opportunities will this create."

It turns out not very long. Bethune, Kellnerand Smisek,along with the rest of the management team and airline employees, crafted a swift revival, swinging the company froma $204 million loss in 1994 to a $556 million profit by 1996. During that time Continental also won numerous customer satisfaction awards and transformed its operations, securing top tier rankings for punctuality and baggage handling according to US DoT figures.

Through a business partnership formed almost 15 years ago, when they both joined the airline, Kellner, Smisek and the carrier's executive team have guided Continental through a myriad of crises: 9/11, SARS, the second Gulf war and the global economic turmoil now enveloping the airline business.

But in July Kellner announced he was leaving, taking many by surprise. It is not every day a 50-year-old chief executive of a Fortune 500 company decides to vacate their position.

Continental's succession plan has been carefully crafted and flawlessly executed. Much of that is down to the strong relationship between Kellner and Smisek."When he [Larry] told me he was leaving I went home and told my wife I felt like I had been divorced by my work spouse," jokes Smisek. Yet the reality is their partnership is a cornerstone of Smisek's move to chief executive. "I donot view the company as having been run by me the last five years," Kellner says. "I view it as having been run by Jeff and I." To illustrate this point he says that during that time he and Smisek have attended virtually every employee meeting together.

While they admit to having occasional differences of opinion, Smisek says he and Kellner think a lot alike. "I donot think there is going to be much change. I think the overall strategy for the future of the company is pretty clear. It is always subject to change because the market changes and we have to be responsive to the market."Kellner chimes in and builds on thatcomment. He says many employees have asked what will change when he goes. His response is: "I cannot tell you because I really donot know, but it is likely the same things that would have changed if I had stayed. If you asked me two years ago did I ever see us charging a first bag fee, I would have said no."

Continental's decision to start charging for baggage is a prime example of its market responsiveness. Kellner would have preferred to keepbaggage within the fare, but that would have led to lost bookings and Continental slipping down the displays of Expedia, Travelocity and the GDS systems. Its market share was not benefiting from baggage being included and,with the charges representing roughly $200 million in revenue, Kellner explains that it ultimatelybecomes a competitive issue: a carrier can be disadvantaged by not charging those fees.Noting the gradual move towards additional charges, he says: "I would have said that is adding complexity rather than simplicity, but if you watch customer behaviour it tells you it is the right decision for the business."

Both Kellner and Smisek are steadfast in their belief that joining the Star Alliance is also a key decision for Continental to ensure its competitive long-term position.Once Delta and Northwest unveiled plans to merge in April 2008, Smisek says Continental put a lot of thought into what that meant for the carrier. "But nowhere in that did we think it was going to be good for us. It retrospect, it turned out to be very good."The merger allowed Continental to make a key move, buying back Northwest's "golden share", whichessentially prevented Continental from executing mergers. The Delta tie-up with Northwest also fostered Continental's strategic exit from SkyTeam.

jeff smisek

KNOWN QUANTITY

"I am not someone from the outside who is going to come in and revolutionise," says Smisek. "I am a well-known commodity. People know who I am, how I speak, how I think, and what I will do. There will be a lot of consistency."

He quips that since it was announced that he would succeed Kellner as chief executive, "my jokes have become funnier". Joking aside, Smisek and Kellner may occasionally disagree, but they sit behind closed doors until they hammer it out. "That is really valuable. I like people who tell me what they think." Smisek is confident that his executive team will continue this tradition. "I have developed that relationship with so many smart and competent people, none of whom is a wallflower, trust me. So if I am screwing up, I'm going to know about it, there's no question."

Both Kellner and Smisek manage by walking around, listening to staff, and Smisek says this means staff feel comfortable asking questions. "You learn what is on people's minds," he says. "If you hear the same question over and over you know there is an issue."

While Smisek describes SkyTeam as a fine alliance, the reality is "we were effectively a junior partner to Delta and Northwest". Candidly, he says, their merger gave Continental "a lot of latitude to forge our own destiny without being bound to carriers that we didnot particularly like being partners with". Smisek also takes a moment to credit United Airlines chief executive Glenn Tilton for his championing of Continental's entry into Star.

"We never imagined after deciding not to merge with United that Glenn Tilton would invite us into Star. I have to give him an enormous amount of credit and vision for doing that." The reality is alliances work best when they are "end-to-end", Kellner says, and in SkyTeam, Continental had significant overlap with Delta in New York and Latin America.

The move into Star and the forging of a strong domestic relationship with United gives Continental similar benefits to those it had with Northwest, says Kellner. "We didnot have to worry a lot about how to handle the competition where we had a lot of overlap [with Northwest] between us. We just did not have that overlap."Smisek has a similarphilosophy. "If I lie awake at night worrying about competitors, United is not one, because there is little overlap in our route networks." He says this is ideal for domestic operations as it provides the greatest scope and scale for passengers.

As negotiations continue for the establishment of an immunised transatlantic joint venture between Air Canada, Continental, Lufthansa and United, Smisek says the alliance hopes to create joint ventures across the Pacific and in Latin America. The focus is now on the transatlantic project, but Smisek says Asia is likely to be nextunder the multi-year plan. "Assuming Asia goes open skies, assuming Japan goes open skies, then having something in Japan and wherever else the joint venture could apply would be the next logical choice with Latin America to follow," he adds.

Leaving aside any anti-trust immunity and the joint venture gains, Continental's participation in Star should deliver a $100 million net benefit versus what it gained from SkyTeam. "And SkyTeam financially was a reasonable return for us," Smisek explains.

As Continental completes its Star transition, Kellner says last year's decision not to pursue a merger turned out to be a sound move. At the time the outcome was far from definitive. Kellner reflects that when Delta and Northwest were discussing a merger, "there is no way I thought I would be sitting here 18 months later saying, wow, we did not merge and that is good for us". InsteadContinental opted to join Star and is now preparing to reap the benefits.

Kellner says he is "very comfortable" with the airline's position versus Delta. "Now we will watch that merger and if things change we will change to react to the marketplace."But he also believes it is tough to find a merger that hasworked in the airline business or led people to say"wow that merger changed things".

Offering his assessment of a potential merger between Continental and United Smisek says many facets were involved, "including financial issues, and if you fast-forward from April 2008 to what happened in September, the financial markets did not exactly improve, so we were particularly right in making that call".

Smisek also cautions it is still a case of early returns on the Delta-Northwest merger. "We will see how they do. That was going to be a merger of addition that seems to be now pretty much a merger of subtraction from what I can tell, but part of that of course is the recession."

Yet if the Delta-Northwest merger is successful Smisek believes "everyone in the business, including us, needs to be thoughtful and responsive. I think the jury is out on that [the merger]. But we will watch it very closely."

While Smisek expects to realise a number of revenue synergies and cost savings from Star membership, he concedes that a merger can deliver greater benefits in those areas. However, through an alliance, carriers avoid significant integration costs, and more importantly, "you do not have to integrate your people and you do not have to integrate your cultures".

Characterising Continental's culture as its "secret sauce", Smisek emphasises that "is something I am very intent on preserving".Along with that, Smisek is focused on returning the carrier to profitability. He says there are early signs of a rebound in the capital markets, evidenced by Continental's aircraft refinancing this summer. And although the deal carries a higher rate than previous financing, Smisek still characterises it as "moderately attractive". He is also encouraged by the number of people approaching Continental with financing ideas, "which was not the case nine months ago".

Smisek believes Continental enjoys an edge in the capital markets over some of its legacy competitors owing to its younger fleet and the strength of its hubs in Houston and Newark. "We tend to be kind of at the front line of carriers in terms of being able to access capital at reasonable costs and that is an enviable position, and one that I want to maintain."

Summarising the broad goals he has as the leadership transition nears completion, Smisek explains he plans to sustain Continental's "working together" culture and "to return and sustain our profitability". He concludes: "That is what I want to do. If I retire having done that, I am going to be a happy camper."

"When Larry said he was leaving I told my wife I felt like I'd been divorced from my work spouse"