The US carriers are proving slow to react to calls for over-reliance on labour cost cuts to give way to a reengineering of the entire way in which airlines do business. Jane L Levere reports. While cost-cutting is nothing new to the US airline industry, the term 'reengineering' represents a revolution in itself. And the true sense of that word is in the process of sinking in among the US majors, making it - perhaps rather belatedly compared to some other sectors - one of the hottest buzzwords in their business.

Faced with constantly declining yields and ever increasing competition from Southwest and copycat low cost, low fare new entrants, US major carriers have embarked upon a variety of campaigns to reduce operating expenses and increase productivity and, ultimately, profits.

Major malaise

But so far cutting labour costs - traditionally the highest operating expense and 35.3 per cent of total costs in the third quarter of last year - has been the prime focus of most companies. This has been spurred on by the steep rise in wage costs since two-tier wage scales began to expire in the late 1980s. But, as every airline manager knows, hostile unions can make labour cost cuts difficult and the amount of success in this area varies depending on the airline. While Northwest and United, for instance, have achieved notable successes - unionised employees at both airlines have exchanged significant wage and productivity concessions for shareholdings and board representation - USAir and American in particular continue to wrestle with their labour groups (see box).

As a result questions are increasingly being raised over whether US carriers' obsession with cutting labour costs - the alleged prime source of their ills - amounts to short sightedness. Some critics say this focus alone will not ensure a return to long-term profitability and argue that airlines should stop using labour as a scapegoat. Instead, they are urging airlines to reexamine every aspect of the way in which they currently do business, in a process described by one analyst as the application of 1990s technology to 1950s practices. This means finding cost efficiencies and savings throughout their operations, extending far beyond labour costs and productivity.

'We [hear] that labour costs are the major malaise of the US airline industry. Most aviation analysts have repeatedly stated that labour is the only controllable cost airlines face. This point of view is very fashionable and trendy, and almost universally accepted as fact. It is also flatly wrong,' says a 1994 study by Aviation Systems Research Corp and RMB Associates. 'The problem is that the structure airlines use is dysfunctional. [It] no longer works within the environment of the 1990s and beyond,' the report adds.

Other sources, while critical, are not so quick to condemn. 'I understand why US airlines focus so much on labour costs, but there are many other places they ought to look as well,' suggests Michael Gelhausen, a managing partner with Andersen Consulting. 'Cost reduction needs to be driven by [the airline's] system and strategy; there is too much emphasis on cutting labour for the sake of cutting labour. Airlines should be focused more on where the long-term strategy is, and less on the next quarter.'

Critics cite USAir as an example of a carrier with a limited long-term strategy that is making unfair demands of its unions. The carrier's management obtained major concessions from labour groups in 1992 but has now come back for more, they say. One embittered former USAir union leader says management rejected worthwhile concessions offered by labour last year, because it felt they did not go far enough.

Ironically, the increasingly evident need for radical reengineering to achieve lasting profitability has pushed a carrier with a reputation for conservatism to the rank of industry leader. Delta Airlines appears to be aggressively heeding demands for a viable, long-term operating plan that tackles all its costs, including labour. Unlike most carriers, Delta's workforce is not unionised, its pilots and a small group of flight dispatchers excepted, but Delta has traditionally tried to maintain good labour-management relations by limiting its demands on the workforce (see box).

Early last year the carrier announced its so-called Leadership 7.5 initiative, which aims to reduce annual operating costs by $2 billion, to 7.5 cents per available seat mile by June 1997. Some 11 teams have been set up internally to develop specific strategies to reach this goal.

In February, Delta took the bold step of capping domestic travel agency commissions, as part of the Leadership 7.5 programme. It set the maximum commission on roundtrip tickets worth more than $500 at $50, and maximum commission on one-way tickets with a value exceeding $250 was set at $25. Both the changes were matched by other US major airlines with the exception of America West and Southwest.

Serious attempt

Unofficially, Delta estimates these caps should generate annual savings of $100 million, while Andersen's Gelhausen projects they are worth $25 to $50 million in savings to a medium-sized carrier - not an insignificant sum in an industry which claims to be hell-bent on saving the last penny.

Delta's move represents the first example in a very long time of any carrier questioning travel agency commissions, hitherto considered an untouchable cost item. Yet travel agency commissions are US airlines' third largest expense item - 10.7 per cent in the third quarter of 1994 - after labour and fuel. From this perspective, Delta's move looks like a serious attempt to reengineer all the ways in which it does business, regardless of the reactions of the irate travel agency community.

Other changes made by Delta to its distribution methods have included a reduction in the commission paid on international ticket sales from 10 to 8 per cent, limited Smartcard airport ticketing in East Coast shuttle markets, and the reorganisation of its North American sales force to maximise revenues. Delta is currently considering whether to extend Smartcard ticketing to other markets.

Delta has also reassessed its communications costs. Last year it established a joint venture with AT&T Global Information Solutions to provide it with information technology infrastructure, including automated systems and operations support. The venture excludes reservations and related systems, which continue to be handled by Worldspan. Delta also negotiated favourable rates for a toll free telephone service with AT&T and intends to sell spare capacity to other, smaller businesses.

Lengthy list

Other measures on Delta's lengthy list include phasing out its 13 Airbus A310s to increase fleet commonality; outsourcing certain maintenance functions; selectively downgrading in-flight service; and realigning its domestic route system from 1 May by increasing long-haul flights and reducing some short-haul service. The carrier expects the resulting increase in operating efficiencies to boost operating income by $40 to $60 million. Delta has also repaid $372 million in long-term debt since July 1994, reducing its annual interest bill by $32 million.

Meanwhile American, which is presently seeking to slash its operating expenses by an annual $1 billion, has diligently sought to cut costs for a number of years. Beyond its specific demands on labour, efforts have focused largely on a paring of the route structure and fleet, including a reduction of 50 aircraft, the closure of the San Jose hub and the shrinking of Nashville and Raleigh-Durham with a transfer of service to Midway Airlines.

American is also turning to outsourcing to make its airport operations more efficient. It is cutting its nonunionised airport reservations and sales staff by 7 per cent, and outsourcing all work at 30 of its smallest airport stations and some work at the larger ones. American expects these steps to save it $35 million in 1995 and $130 million a year when the programme is fully implemented at the turn of the century. In addition the carrier is eliminating between 20 and 30 per cent of its headquarters staff of 5,000, which it estimates will save another $75 million. Other savings will come from food and beverage costs ($29 million); advertising costs ($16 million); maintenance costs ($15 million); group insurance costs ($12 million); and legal fees ($6 million).

USAir also has a stated goal of cutting its annual operating costs by $1 billion, of which $500 million will come from labour measures. Close to $400 million has been identified in non-labour savings, of which up to $300 million will kick in this year.

Among these initiatives are a centralised purchasing system instituted with partner British Airways which should save an annual $90 million by 1996; a realignment of customer service ($60 million); a new, upgraded crew scheduling system ($50 million); and outsourcing of cargo operations, telecommunications and other services ($20 million).

USAir is also revamping its maintenance and engineering operations to make them more efficient ($70 million in savings); upgrading its internal information services ($65 million); redesigning its reservations system ($27 million); and selling 11 B737-300s to General Electric Capital Corp for an estimated $170 million which will be used to pay down debt.

Northwest, which posted record fourth quarter and full-year operating profits last year, after teetering on the brink of bankruptcy in mid-1993, attributes its gains not only to its newly reduced labour costs but also to an upgraded yield management system - purchased from AMR - and a realigned route structure that focuses on its Minneapolis and Detroit hubs. Like USAir and BA, Northwest has a joint purchasing programme with partner KLM that it says could generate $26 million in annual savings. Last year the carrier also decided to hushkit and refurbish its 40 aircraft DC-9-30 fleet, now responsible for 50 per cent of Northwest's departures, at a cost of $240 million.

Like many of its competitors, United is realigning its route structure, cutting unprofitable transatlantic services by 2.7 per cent this year, focusing on more profitable routes - particularly at its Denver hub - and almost doubling the initial number of frequencies in its Shuttle by United operation. Later this year the carrier will also expand ticketless travel, which is currently restricted to its Shuttle markets, to the rest of its domestic system.

Already the industry's low-cost leader, Southwest is also improving its distribution methods. The carrier launched ticketless travel systemwide earlier this year and will modernise its internal reservations system by 1996 at a cost of between $10 and $20 million.

Southwest chief financial officer Gary Kelly estimates the new system will reduce operating expenses by up to $10 million a year. From May, travel agents will be able to book Southwest directly through Sabre, an improvement over the current system which requires them to book with Southwest over the telephone. Since up to 29 per cent of Southwest's bookings are made through Sabre, the new arrangement should eliminate a comparable level of calls to the airline's reservations centre.

More creative

Southwest is also reviewing its maintenance procedures and is about to begin an internal audit of its entire operation that Kelly anticipates could generate an additional 1 to 2 per cent in savings.

These initiatives aside, critics contend there are areas not directly related to labour where carriers could be more creative in cutting costs. Gelhausen pinpoints revenue accounting as one of them, adding that Arthur Andersen has developed a system that audits tickets sold to determine if fare rules have been violated. He claims the system, which has been purchased by five carriers including Northwest, can boost revenues by up to 1 per cent through debit memo recovery and cost reduction by the automation of routine tasks.

Meanwhile Aviation Systems Research Corp and RMB Associates advocate a reinvention of the US air traffic control system, via 'managed aircraft separation' or aircraft operating on the flight path best suited to each individual carrier, which they claim could save the industry $5 billion annually. This would, at minimum, provide 'the equivalent of negotiating a 15 per cent labour reduction with employees and unions. And it can be achieved without management and labour hissing at each other across the bargaining table,' the consultants say.

In the immediate future, Delta appears the most likely US major to achieve its cost cutting goals - in January the carrier said it had approved $1.55 billion of its projected $2 billion in reductions.

As Standard & Poor's Philip Baggaley points out, Delta is less hampered by the unions than others. 'In cost cutting labour relations can influence a lot of things besides salaries and benefits. Work rules, for example, can block changes in the use of aircraft or facilities. Delta can make any changes it wants, except those that involve its pilots. And it can implement these changes more quickly than a company like USAir, which currently is bogged down in negotiations.'

Sam Buttrick, airline analyst at PaineWebber, concurs: 'Having paid their employees premium wages for years to keep the unions off, management is now calling its chits in,' he says. 'Delta has the flexibility it needs to restructure operations.' Renee Shaker of Moody's Investors Service commends Delta's 'holistic' approach to cost-cutting. 'The people who will be responsible for implementing the changes are designing them, so there's also a certain amount of accountability there.'

Hopefully, the irony elsewhere of unions obstructing measures that could help protect jobs and reduce pressure on wages will not be completely lost on US labour groups and or airline management. A complete reengineering of costs in the US airline industry - with a less disproportionate emphasis on labour concessions - requires strong cooperation between the two groups.

Under the Southwest agreement, retroactive to September 1994, the pilots will receive options to acquire 14 million shares of the carriers' stock over 10 years. In exchange, they will maintain pay rates at existing levels for the first five years, and receive a guaranteed 3 per cent rate increase in three of the remaining five years. The pilots are also eligible for a 3 per cent bonus based on profitability in five of the 10 years.

America West and Continental have also instituted compensation programmes tied to performance. America West aims to cut its operating costs by $31 million in 1995 and $40 million annually thereafter, and will pay bonuses of up to 25 per cent to employees this year if annual income targets are attained. The carrier is also reducing its 11,500 member workforce by 1,100.

Continental, which is reducing its 40,000 person staff by up to 10 per cent, is tying wage increases to on-time performance.

Other carriers' efforts include Delta seeking $340 million in concessions from its pilots union as part of the Leadership 7.5 initiative. At the end of February, management had rejected the union's counter request for 22 per cent of the carrier's stock and one seat on the board. Delta also plans to reduce its 73,000 workforce by 16-20 per cent by 1997.

American is seeking $750 million in wage, benefit and productivity concessions from its pilots, transport workers and flight attendants. It is currently in talks with its pilots and a dispute with flight attendants is in arbitration.

USAir wants $500 million in wage, benefit and productivity concessions from its pilots, machinists and flight attendants. Progress on a concessions for equity proposal is being made with the first two groups.

Northwest obtained $886 million in wage and benefit concessions from its unions in 1993 in exchange for one third of the company's stock and three seats on its board. The concessions expire in late 1996.

United won $4.9 billion in wage, benefit and productivity concessions from its pilots, machinists and non-unionised employees in 1994, in exchange for 55 per cent of the company's stock and three seats on the board. The concessions are due to expire in 2000.

Source: Airline Business