Northwest Airlines had less to celebrate at the end of last year than most of its US competitors. Jane Levere examines the potential impact of last year's battles on this year's performance.

For Northwest Airlines, 1998 will go down as the year it would rather forget. The effects of the obstacles that were thrown in its path - including labour unrest, a still-ailing Asian economy and a Department of Justice (DoJ) lawsuit over its promising alliance pact with Continental Airlines - continue to dog it in 1999. Early this year, senior management changes have been put in place and campaigns launched that the carrier hopes will steer it back on course. The question remains, will they be enough?

At the core of Northwest's ills are the lingering effects of the two-week strike by its pilots late last summer. Philip Baggaley, a managing director of Standard & Poor's, estimates the strike will ultimately cost the carrier over $1 billion, including lost revenues and additional costs incurred as a result of the walk-out. "The impact of the strike was quite severe, and they still haven't fully recovered. They're still not carrying as many passengers at as good fares as they expected," he says.

Northwest's pilots strike was the longest in the USA since the United Airlines walkout in 1986, says Brian Harris, airline analyst for Salomon Smith Barney. He believes it will take a long time for Northwest to recover fully. "Travel patterns take a long time to change, especially with connecting traffic. It's not easy to recover," he says.

Northwest admits that, beyond the actual economic cost of the strike - which the airline puts at $630 million (pretax) for the third quarter of 1998 and $300 million (pretax) for the fourth quarter - the labour action has strained relations with its constituencies, passengers and employees.

The airline has embarked on campaigns to improve these relationships. One focus of this effort is to resolve remaining labour disputes with other unions. In January, the carrier signed a tentative pact with its 18,000 employees represented by the International Association of Machinists. Meanwhile, talks with the flight attendants continue, but remain fraught. While some progress has been made, pension, pay and scope clause issues have yet to be ironed out. In contrast little progress has been possible in discussions with the mechanics, who last year voted to leave the IAM and join the Aircraft Mechanics Fraternal Association, a vote that the IAM is challenging. The current stalemate will probably continue until the National Mediation Board decides which union should represent Northwest's mechanics.

Customer service is another significant part of Northwest's recovery programme. As part of the management changes, Northwest has named Al Vecci, who joined the airline from Alaska Airlines in 1997 as executive vice president of customer service, to the additional post of president, Michigan operations. His oversight appears to be sorely needed, as Northwest's hub in Detroit continues to be the focus of passenger disaffection. Northwest alienated travellers there so much during a New Year snowstorm that a group of passengers have sued the carrier, charging it with "imprisonment."

Northwest has also named Richard Anderson, who previously served as executive vice president of flight and technical operations, executive vice president and chief operating officer. This assignment gives Anderson the prime focus on day-to-day operations including on-time performance, an area Anderson is committed to improving. In fact, the Department of Transportation (DoT) ranked Northwest's on-time performance respectively second, third and third in the last three months of last year, and customer complaints dropped from 1.81 complaints per 100,000 passengers in November to 0.69 in December. Northwest is under pressure this year to continue that trend as it simultaneously addresses all other issues. As part of the customer service programme, it is looking at waiving a $75 ticket reissuing fee for its top frequent flyers, and finding better ways to accommodate travellers when flights are cancelled.

Overseeing these efforts is a new team of senior managers. They include Timothy Griffin, former senior vice president, market planning and systems, and now executive vice president, worldwide marketing and distribution; and Philip Haan, former senior vice president, international, and now executive vice president, international, domestic and international sales and information services. Both men were promoted in January when Michael Levine, long-time executive vice president of marketing and international, retired. Levine gave his reason for leaving as not being able to reach the top management position at the carrier. President and chief executive officer John Dasburg chose to stay in office late last year, despite earlier reports to the contrary.

At least one important Northwest customer believes the carrier is beginning to improve its service. Charles Braswell, director of general services for the Detroit-based DaimlerChrysler Corporation, which allocates more than half of its $55 million annual air travel budget to Northwest, says: "I'd been concerned about the on-time departure of their planes, but it looks as if they're starting to address this. I don't get a lot of complaints about it."

Labour relations and customer service are not the only issues from last year that will continue to haunt Northwest in 1999. The economic malaise in Asia has hurt Northwest more than any other US carrier. To make matters worse, the airline lost its fierce campaign to prevent a phased-in US-Japanese open skies agreement. This means that, even when the Asian economy recovers, the marketplace is unlikely to offer the same opportunities as in the past. To try and counter these effects, the carrier has been reducing capacity and restructuring its Asian route system, particularly in the Japanese market. Pacific capacity is down 15% year on year, while both services between Minneapolis and Osaka and a daily nonstop service between Minneapolis and Hong Kong have been suspended. New intra-Asian services, such as flights between Kaohsiung, Taiwan, and Osaka, Japan, has been introduced. The region currently generates 30% of Northwest's revenues and represents 28.2% of its total capacity.

Standard & Poor's Baggaley agrees that Northwest is more exposed than any other US airline to the events in Asia. "Northwest has been particularly hard hit by the recession in Japan because it traditionally carries many Japanese vacation travellers, who are flying less," he says. Meanwhile, pricing competition for this business in particular is "fiercer" and 1998's new bilateral agreement abolished protection of Northwest and Japan Air Lines' former status as joint incumbents.

But Baggaley believes that while Northwest's Asian traffic is "very weak," the steep decline in this market has levelled off. "There's no sign of recovery, but it won't continue to fall," he predicts. "The airlines there are assuming traffic will be weak for the rest of this year, with a modest recovery in 2000."

Yet another potential obstacle to Northwest's revival is a suit filed by the DoJ last year that attempts to block the carrier from buying a controlling stake in Continental. Under the terms of the Northwest-Continental alliance, Northwest was to acquire stock in Continental from financier David Bonderman equivalent to 14% of the Houston carrier's equity and 51% of its voting rights. Northwest's pledge to place this stock in a voting trust for six years has not been enough to quell DoJ fears over competition. Despite the suit, Northwest and Continental have implemented the marketing aspect of their alliance, instituting codeshare arrangements on many domestic and international routes and linking their frequent flyer programmes. When these aspects of the alliance are fully implemented - some international codesharing is awaiting DoT and foreign government approval - the two carriers estimate it will generate an extra $500 million in revenue. As the larger of the two partners, 55% of those revenues would go to Northwest. The carrier believes it will take three years for these benefits to kick in.

Northwest remains confident that the DoJ will not succeed in blocking its efforts to combine with Continental, but observers are not so sure. Jim Lloyd, former general counsel for US Airways and counsel in Washington DC to Bryan Cave, a St. Louis- based law firm, believes the DoJ has taken its action because the government believes fares are too high in certain markets. "The political sense is that they don't want to see the big airlines get bigger," he says. Suggesting that the DoJ filed its suit "as much to hold off an avalanche of new mergers as to attack this particular transaction," Lloyd says the lawsuit will force the two carriers to move "more slowly and carefully" in integrating their alliance.

Baggaley adds that if Northwest is ultimately forced to give back its voting control over Continental, it would not be the end of the world. "They could ease up on control, and strike a compromise, getting 35% control," he says.

Alliances, however, are key to Northwest's recovery plan. Besides the deal with Continental - which gives it critical mass against the other US majors - Northwest continues to reap benefits from its codeshare agreement with Dutch flagship KLM and would like to see more of the same. The annual gain from this pact to each carrier exceeds $150 million, and Northwest hopes the benefits will grow as it assumes more transatlantic flying. Negotiations continue on Alitalia joining the alliance. The Italian carrier signed a long-term agreement late last year with KLM to share costs and revenues.

Northwest has also launched a codeshare agreement with Air China, a deal which Baggaley predicts could be "quite significant long-term." Marketing pacts with Alaska Airlines and Horizon Air, which late last year signed a similar agreement with American, have also been renewed. Alaska and Horizon should be able to sustain both relationships, since American and Northwest do not compete directly with one another on routes to the Pacific Northwest.

One last issue that Northwest must ultimately address is its fleet - now one of the oldest in the USA. Five years ago, the carrier opted to retrofit its 170 aircraft DC-9 fleet rather than retire them - a cost-effective decision, especially given low fuel prices. Although Baggaley believes it is not imperative that Northwest immediately replace these aircraft, ultimately the airline will have to weigh up its options. If it were to replace the DC-9s with either the Boeing 717 or Airbus 318, he believes Northwest would be able to command a good price as a "semi-launch customer." Both Air Tran and TWA have ordered the 717, while International Lease Finance. and TWA have both ordered the 318. "Or they could come in when the manufacturers are hurting for orders," Baggaley says. "They may have a better opportunity in a year or two." Northwest is not only considering replacing the DC-9s, but is also deciding what to do about its DC-10s and how it might simplify its mid-range 757, 727 and A320 fleet.

Always an opportunistic buyer, the airline might jump at a good deal. But shaking off the misfortunes of 1998 would be a good deal in itself.

Source: Airline Business