He did not want Continental to be the biggest - but he did want it to be the best. Now, as then, Gordon Bethune will focus on the basics to get there
This may not be exactly what Gordon Bethune had in mind when he walked into Continental Airlines almost a decade ago. Then, he announced his ambition to make Continental the best, although not necessarily the biggest. Even in a shrinking US industry, not becoming the country's biggest carrier has been a straightforward exercise, but the goal posts have shifted on what it means to be the best.
Nowadays, airline excellence is more defined in terms of what a carrier is not, than what it is. For Bethune, success is found in the fact that the airline is not bankrupt, it is not facing labour strife, it is not facing a customer revolt and by all estimates it stands a fair chance of becoming one of the first US carriers to make money when the economy recovers. Until then, Continental will just try to edge out the competition.
In the Presidents Club lounge of Houston's George Bush Intercontinental Airport, Bethune says: "Winning isn't defined as making money. Winning is defined as beating your competition. Margin and profitability are the real issues, not size, not a lot of testosterone. What Continental needs to do is stabilise its costs, including labour costs, for at least as long as our competitors do."
The problem Bethune faces is that Continental's advantage stems from his long established - but now vulnerable - status as a lower-cost producer. This position was established by the airline's two bankruptcy reorganisations and has been supported by relatively positive labour relations.
Continental's unit cost advantage is increasingly tenuous, especially as it is somewhat incompatible with the good labour relations that have helped the carrier excel in its post-bankruptcy life. Bethune has pledged not to ask for pay cuts in a bid to keep relations with staff amicable, meaning he must find other ways of getting costs out of the equation. However, other areas with cost-shearing candidates are not readily apparent, and the easy trimming of his early days at Continental, when he established a reputation for changing the organisation through sweeping management changes and copious profanity, is past.
For his part, Bethune plays down the cost advantages bankruptcy can bring. "This company changed because it wanted to, not because a bankruptcy judge wiped out our debts. You can always do that and then find some damned fool to give you money".
That leaves the nation's fifth-largest airline with the need to find other ways to limit cost growth. Since March, it has cut about 500 jobs, and will slash another 700 by year-end from its base of 43,000 employees. If unpopular, Bethune's approach to jobs cutting must at least be admitted to be egalitarian. When he announced the March layoffs, he also announced the involuntary early retirements of five of the most senior Continental executives, including the highly regarded C D McLean, executive vice-president and chief operating officer. McLean was a nine-year Continental veteran who had helped turn around its once lamentable on-time performance and "one of my best personal friends", says Bethune.
Explaining that "it was not an easy thing" to cut one-fourth of the executive ranks in a single day, Bethune says that he will rely on a small core of top executives to determine savings tactics and strategies. The airline has a triumvirate that make these decisions: Bethune, airline president Larry Kellner, and the chief financial officer, Jeff Misner.
Different management style
The team is unusual in that it gives the finance chief a greater role than do most airlines. Continental has long filled the offices of chief executive and president separately. A former banker, Kellner was the chief financial officer until becoming president in May 2001, following the sudden departure of Greg Brenneman, the former management consultant who had worked closely with Bethune. Misner is aircraft leasing and tax expert who joined the company in 1995.
As he walks through the airline's new terminal at the Houston airport, greeting employees, many by name, Bethune says: "We're all looking at the same thing, but we're looking at it differently. All of us have some background that the rest of us don't. When you get guys who have been around the block like Larry [Kellner] and Jeff [Misner], if it looks good to all of us, it probably is."
Giving an example of how the integrated decision-making process works, Bethune says: "Chief financial officers like to say cut all expenses by 10% because they can do that number. But broadband 10% approaches don't really understand the business. We're different."
In practice, Misner says that the planned cuts in expenditure will come from many small things rather than a major single source, but that technology will be key. "Just as we will be driving more and more business to our website," he says, "we'll also be looking at ways to cuts costs through airport kiosks and through the payments we make to suppliers like EDS and to the global distribution systems. The GDS is just a big computer box, so the more volume you put through it, the cheaper it should be. We're also going to airports, which we think have to live within their means just as we do."
Paper tickets will be eliminated by next July, and the carrier aims to double website bookings to cut distribution costs. About 22% of sales are now on-line, with 12% of that flowing through continental.com.
Continental's cost cutting has edged ahead of that of Northwest Airlines, its closest peer as well as partner. In the first three months of the year, the Houston-based carrier edged out Northwest's 6.8% reductions. In the second quarter, Continental trimmed its costs by 10.8% and its unit costs showed a 12.5% year-over-year drop, even as its unit revenues rose 3.9% for the same period.
On the more painful side of this process is the elimination of the 1,200 jobs by year's end. The carrier plans for the cuts to encompass 125 pilot positions, 500 reservations agents, 350 airport agents and 250 others, with voluntary redundancies the preferred route.
Legacy of bankruptcy
Continental still enjoys cost advantages from its two bankruptcy reorganisations, its first under former boss Frank Lorenzo in 1986 and its second ending in 1993, after Lorenzo's hasty departure. Blaylock and Partners analyst Ray Neidl says that the reorganisations "have kept out a lot of the unproductive work rules", but cautions that a new contract that Continental is negotiating with its pilots could change the equation.
After several years of being courted by the Air Line Pilots Association, the airline's 7,000 pilots voted earlier this year to dissolve their Independent Association of Continental Pilots union in June and join the dominant labour group. Union spokesman Michael Hynes says the contract has taken longer to negotiate than he had hoped, and adds: "We know that pilots at other airline have taken pay cuts, but we have been working at far lower rates than other airlines for most of a decade, and if they asked for concessions...if they ask us to give, we would have to respond by saying that we have been giving for a long time. We have certainly given on retirement security. If we are ahead of others, leading the industry, it's not a good time to ask for more cuts."
Hynes adds: "We all give Gordon a lot of credit for what did after he got here, but now it's almost 10 years later and we are asking, now what? He brought stability, but what's his new vision?"
But the airline is not going to try to cut wages in the way most other US carriers have. Bethune says: "We have not asked for labour cost concessions and we don't intend to." Misner says: "I've floated the idea of going to the workforce for savings, but Gordon always says no."
Bethune takes enormous pride in the fact that Fortune magazine has named Continental one of the 100 best places to work for five years in a row; many of the carrier's airliners carry a note of the winning streak next to their boarding doors. Among the perks: employees with at least six months of perfect work attendance can win a sports utility vehicle through a lottery drawing.
Fleet deferrals
In addition to its efforts at working on labour costs, the carrier is focusing on keeping fleet costs at their current levels. In July, it elected to defer the delivery of 36 Boeing 737s, originally scheduled from 2005 to 2007, representing most of a $2.5 billion order with Boeing. "It would be just plain stupid to be adding aircraft when we can't make money on the ones we have now. No-one is going to be that stupid. We don't need the aircraft. They were replacements, not for growth," Bethune says.
Talks are also taking place with Boeing on delivery terms of all 11 of the 757-300s it has on order, leading to widespread discussion that the 757 line - with just seven other orders - could be closed. The deferrals are the company's second major retrenchment this year. In February, Continental's ExpressJet became the first major regional to put off deliveries, postponing 27 Embraer ERJ-145XRs from this year and next until 2005-6.
Continental's capacity, Bethune notes, is down nearly 7% this second quarter, although the breakeven load factor was down 15 percentage points to 70.1%. Bethune says he is not counting on dramatic changes in the industry structure. "If someone disappears, that would speed the capacity reduction, but that cannot be the way we plan." Like others, he thinks it is possible that United will not emerge from bankruptcy reorganisation, and that could lead to "a fragmentation of the Star Alliance", with United's role in North America being fulfilled by other carriers.
Continental is well ahead of others in liquidity, notes Deutsche Bank's Susan Donofrio. The airline ended the second quarter with $1.6 billion in cash on hand, compared with $1.2 billion at the end of the first quarter. Since 11 September 2001, it has boosted its cash cushion from its usual level of around $1 billion.
The airline also has a ready-made source of liquidity in its portfolio: ExpressJet Holdings, the former Continental Express regional unit of which it owned a 53% stake and which was set to become the first major spin-off of a US regional.
Misner, the finance officer, says that the timing for the ExpressJet transaction has, if nothing else, been interesting. "We originally proposed the spin off for 10 September 2001, but obviously had to pull it back. After the decision was made that we didn't need to own ExpressJet, we were going to reduce our stake in it."
The most recent attempt to sell more of its stake in the Continental Express unit came "amid some very choppy market conditions, with bad news on consumer confidence and terrorist hijacking warnings, so it wasn't at a price we were comfortable with". Bethune simply says: "When will we sell it? When market conditions are right."
Sticking to basics
In addition to his wariness about selling company assets at the wrong time, Bethune will not try to clone a low-fare airline-within-an-airline, the approach that others, such as Delta and United, are employing in their efforts to fend off Southwest, JetBlue and other low-cost carriers. "We certainly learned from our disastrous experience with setting up an internal low-fare airline with an airline," he explains. The unit, Continental Lite, struggled and was shut down in 1995 within a year of its start up. With some of his famous straight-talking, Bethune calls the concept "stupid, really goddamned dumb".
He continues: "We learned a major lesson: people didn't want it. Look, we succeed by sticking to the three things that passengers want: clean, reliable and safe. We stick with things like offering a meal, not gimmicks like selling them food. We don't go around changing flight numbers or departure times because we want people to remember that there is a flight to Newark at the same time and that it's number so and so. People want the flight to get there on time, so our focus is on that set of basics."
But are the basics going to be enough in the current profit environment? "It's not all doom and gloom," Bethune insists. "The vital signs are beginning to show a return to normal. Until then, we aim to win through basics. Winning is a horse race running against the three-legged airlines. You know what the difference is in winning a horse race? About two kilos on a jockey's ass! That's it. That's all it takes. You've just got to be a little bit lighter than the other guy."
The airline will always be strictly a hub-and-spoke network carrier, he says. Airline president Kellner agrees, adding: "We are the ultimate believer in the hub philosophy. Every part of our system touches one of our hub airports." Its strength at Newark, which they refer to as the dominant airport in the New York metropolis, gives it a revenue premium.
Newark has such a large local traffic base that it only has to depend on transfer passengers for 35% of its unit traffic. This compares with a 42% local traffic component posted by Northwest's main hubs and 54% at the bases of rival American Airlines, Bethune says. He says Newark's position is strong enough that JetBlue, based on the other side of New York City at Kennedy, has not made inroads to its local traffic.
Senior vice-president for business development David Grizzle agrees Newark is the key, both for traffic across the Atlantic and to South America. After Miami it is the single largest source of Latin traffic, and the airline has made profits on Latin operations in periods like this year's first quarter when other regions have been money losers.
As for Houston, native Texan Bethune says: "They used to say Houston is too far south to be a hub. Not with Latin American and Mexico. We've already got the biggest network into Mexico and when we start co-operating with Aeromexico through SkyTeam it will grow even more." He adds: "People will always have to change planes. We're giving them a reason to do it here." The carrier's third hub, in Cleveland, is much smaller and basically serves as a regional jet operation.
Bethune says that Continental's integration into the SkyTeam alliance should be under way by summer of 2004, but that it will not change the airline's network significantly. For Continental, joining SkyTeam would be an expansion on already profitable relationships.
Bethune explains that the carrier "already depends on Northwest for much of our transpacific traffic". With the addition earlier this year of Delta to a domestic relationship between Continental and Northwest, the airline has a three-way alliance that "has produced surprisingly strong results, beyond what we had forecast", says Grizzle. Some IT work remains for Delta to be integrated fully into the domestic alliance, however.
Its complex set of codesharing relationships will probably not change very much; it has recently expanded its codeshare with Netherlands carrier KLM and is to expand its relationship with the UK's Virgin Atlantic to move beyond a ticket-buying pact into co-ordination with more frequent flyer benefits than before.
Primary partner
Continental and KLM are also expanding their codeshare to include non-hub cities, extending it until 2010 and adding 22 destinations, for a total of 64. Grizzle says that KLM will be the airline's "primary European partner" and should remain so, whatever alliance decisions KLM makes. Continental adds an alliance with TAP Air Portugal in September to 18 cities in Europe and in Africa. "We're looking for partners with unique route networks," Grizzle says.
Bethune insists Continental will not make basic changes, and that it survive by sticking to the basics he has stressed since joining, that is by giving people the "safe, clean, and reliable air service" that they want.
Bethune insists that he will be in charge at the airline through the recovery. "I'll retire in few years and I want to go out of here with the company having its wings level. When some headhunters called [last year] and asked me to take over United, I wasn't sure the company wanted to be fixed. I'm not for sale. I could never work somewhere else and compete against this airline. These are our guys. I owe everything to the guys who work here."
Plane speaker
Gordon Bethune, born in 1941, has spent much of his life around aircraft. After learning aircraft maintenance in the US Navy, he worked in engineering and maintenance with Braniff Airlines and then at Western Airlines from 1979-1984. In 1984, he went to Piedmont, serving as vice-president of operations until USAir absorbed it in 1987.
Bethune joined Boeing in 1988, serving as vice-president with the customer services division, and then vice-president for the Renton Division, where he was responsible for Boeing 737 and 757 aircraft.
He joined Continental in 1994 as president and chief operating officer, and within a year was named chief executive. In 1996 he added the title of chairman of the board.
Bethune attended Abilene Christian University in Texas and an executive programme at Harvard Business School. He is a licensed pilot, qualified on the Boeing 757 and 767. He says: "I'm not just a suit. I'm a mechanic and a pilot."
When Bethune joined Continental, he brought with him a reputation for bluntness that bordered on the outrageous, laced liberally with profanity. He once called pre-Leo Mullin Delta Air Lines "the land of dim bulbs". After the retirement of AMR's Robert Crandall, Bethune became a de facto industry spokesman. Since 11 September, his public pronouncements have become more nuanced. He says: "I don't want to speak for the damned industry. It's this airline I'm concerned about."
REPORT BY DAVID FIELD IN HOUSTON PHOTOGRAPHY BY RICHARD CARSON
Source: Airline Business
