C-1 Strong demand for air travel followed during the post World War II economic boom that swept the United States. In response, United expanded its workforce, acquired new routes, and purchased the company’s first jet aircraft. 3 On June 1, 1961, United merged with Capital Airlines, then the fifth- largest air transport company in the United States, and formed the world’s largest commercial airline. In 1968, United’s stockholders approved the for- mation of UAL, Inc., as a holding company, with United as a wholly owned subsidiary. The next 20 years were turbulent times for the company and tested not only United, but also the entire airline industry. The company had six differ- ent presidents between 1970 and 1989. Management changes resulted in new directions and new images for United. The company acquired other nonairline businesses including rental car businesses and hotel properties, which were later sold. UAL, Inc., also changed its name to Allegis Corporation in 1986, and then changed it back to UAL, Inc., in 1988. On February 11, 1986, United purchased Pan American Airways’ Pacific Division and began service to 13 Pacific cities, and in October 1990, it announced the purchase of Pan American’s routes between the United States and London. United sustained record losses in the early 1990s and worked to recoup them for several years. The company initiated a hiring freeze, grounded older air- craft, and sold its flight kitchens. However, the result- ing $400 million reduction in operating expenses was not enough to enable United to avoid launch- ing intensive labor costs negotiations with employee unions. The UAL board approved a proposal for 54,000 employees to exchange portions of their sala- ries and benefits for UAL stock, paving the way for the creation of the largest majority employee-owned company in the world on July 12, 1994. 4 United Airlines, Time to Fly “Together” United Airlines, formerly the wholly owned prin- cipal subsidiary of UAL Corporation, has experi- enced a significant amount of turbulence in its more than 80-year history. From its inception in 1926 it has weathered many storms including mergers, acquisitions, war, the Depression, strikes by labor unions, buyout and takeover attempts, terrorist attacks, and bankruptcy. The most recent major challenge to United and the global air transporta- tion industry has been the global economic reces- sion. Then in October 2010, United Airlines joined with Continental Airlines in a merger that created the world’s largest airline, with more than 80,000 employees. UAL Corporation changed its name to United Continental Holdings, Inc., with corpo- rate and operational headquarters in Chicago and its largest hub in Houston. Until a single operat- ing certificate is received from the Federal Aviation Administration (FAA), United and Continental will continue to operate separately as subsidiaries of United Continental Holdings. The certificate is anticipated to be received by the end of 2011. 1 As global economies struggle to emerge from the reces- sion, airlines will face numerous challenges. In this case, United Continental Holdings, its competitors, and the airline industry are examined to determine if United Airlines will have calmer skies ahead or if there are storms on the horizon. UAL History In 1925, an act of Congress made the carrying of mail by air a private operation under a system of competitive bidding. 2 United was formed a year later as Varney Airlines Airmail Service, an airmail ser- vice that carried mail between Pasco, Washington, and Elko, Nevada. This original venture evolved into a modern global airline. Analia Anderson, Derek Evers, Velislav Hristanov, Robert E. Hoskisson, Jake Johnson, Adam Kirst, Pauline Pham, Todd Robeson, Mathangi Shankar, Adam Schwartz, Richard Till, Craig Vom Lehn, Elena Wilkening, Gail Christian / Arizona State University
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Transcript
C-1
Strong demand for air travel followed during the post World War II economic boom that swept the United States. In response, United expanded its workforce, acquired new routes, and purchased the company’s first jet aircraft.3 On June 1, 1961, United merged with Capital Airlines, then the fifth-largest air transport company in the United States, and formed the world’s largest commercial airline. In 1968, United’s stockholders approved the for-mation of UAL, Inc., as a holding company, with United as a wholly owned subsidiary.
The next 20 years were turbulent times for the company and tested not only United, but also the entire airline industry. The company had six differ-ent presidents between 1970 and 1989. Management changes resulted in new directions and new images for United. The company acquired other nonairline businesses including rental car businesses and hotel properties, which were later sold. UAL, Inc., also changed its name to Allegis Corporation in 1986, and then changed it back to UAL, Inc., in 1988. On February 11, 1986, United purchased Pan American Airways’ Pacific Division and began service to 13 Pacific cities, and in October 1990, it announced the purchase of Pan American’s routes between the United States and London.
United sustained record losses in the early 1990s and worked to recoup them for several years. The company initiated a hiring freeze, grounded older air-craft, and sold its flight kitchens. However, the result-ing $400 million reduction in operating expenses was not enough to enable United to avoid launch-ing intensive labor costs negotiations with employee unions. The UAL board approved a proposal for 54,000 employees to exchange portions of their sala-ries and benefits for UAL stock, paving the way for the creation of the largest majority employee-owned company in the world on July 12, 1994.4
United Airlines, Time to Fly “Together”
United Airlines, formerly the wholly owned prin-cipal subsidiary of UAL Corporation, has experi-enced a significant amount of turbulence in its more than 80-year history. From its inception in 1926 it has weathered many storms including mergers, acquisitions, war, the Depression, strikes by labor unions, buyout and takeover attempts, terrorist attacks, and bankruptcy. The most recent major challenge to United and the global air transporta-tion industry has been the global economic reces-sion. Then in October 2010, United Airlines joined with Continental Airlines in a merger that created the world’s largest airline, with more than 80,000 employees. UAL Corporation changed its name to United Continental Holdings, Inc., with corpo-rate and operational headquarters in Chicago and its largest hub in Houston. Until a single operat-ing certificate is received from the Federal Aviation Administration (FAA), United and Continental will continue to operate separately as subsidiaries of United Continental Holdings. The certificate is anticipated to be received by the end of 2011.1 As global economies struggle to emerge from the reces-sion, airlines will face numerous challenges. In this case, United Continental Holdings, its competitors, and the airline industry are examined to determine if United Airlines will have calmer skies ahead or if there are storms on the horizon.
UAL History
In 1925, an act of Congress made the carrying of mail by air a private operation under a system of competitive bidding.2 United was formed a year later as Varney Airlines Airmail Service, an airmail ser-vice that carried mail between Pasco, Washington, and Elko, Nevada. This original venture evolved into a modern global airline.
Analia Anderson, Derek Evers, Velislav Hristanov, Robert E. Hoskisson, Jake Johnson,
Adam Kirst, Pauline Pham, Todd Robeson, Mathangi Shankar, Adam Schwartz, Richard Till,
Craig Vom Lehn, Elena Wilkening, Gail Christian / Arizona State University
The newly created Employee Stock Option Plan (ESOP) environment conflicted with the company’s prior culture because formerly control was cen-tered in the top-level executives. Subsequently, the chairman, president, CEO, and other key officials stepped down from their positions. One of the new management’s first steps was to begin to transform the corporate culture from a “command-and-control” philosophy to one based on higher employee involve-ment, with an emphasis on better communication. Workplace innovations were quickly adopted, including telecommuting, elimination of the fur-lough policy, and the introduction of casual dress codes in nonpublic areas of the company.5
Perhaps the most substantial change result-ing from the ESOP was the shift in the balance of power within UAL. Over the two-year period after its creation, the original 54,000 U.S. employees who launched the ESOP in mid-1994 were joined in own-ership by many of their coworkers in Europe, South America, and Asia.6 By 2002, a significant portion of the UAL workforce was represented by one of five different unions: the International Association of Machinists and Aerospace Workers (IAM), the Air Line Pilots Association (ALPA), the Association of Flight Attendants (AFA), the Transport Workers Union (TWU), and the Professional Airline Flight Control Association (PAFCA).7 With such a high level of union organization and enormous owner-ship stake in the company, UAL labor was able to create 3 employee representative positions on the 11-member board. Over the next several years the labor force became very powerful in such decisions as the approval of mergers and the selection and
removal of executive officers. Thus, the seats on the board gave employees significant control over major business decisions. By December 31, 2009, 6 labor unions represented approximately 82 per-cent of UAL’s workforce of approximately 47,000 active employees8 (see Exhibit 1 for a list of the six unions and their representation in United’s current workforce).
In response to the globalization of the airline industry in the early 1990s, United directed its strategy toward an international expansion through strategic alliances. In 1992, United entered into an alliance agreement with Air Canada, and in 1993 it announced a comprehensive marketing agreement with Lufthansa. With careful attention to antitrust regulations, United ensured that the company’s alliances received antitrust immunity from the U.S. Department of Transportation. On May 14, 1997, United Airlines, Lufthansa, Air Canada, SAS, and Thai Airways International launched the Star Alliance network, which also included Austrian Airlines, Lauda Air, Varig Brazilian Airlines, Singapore Airlines, and others, bringing the total to 14 airline companies. As a member of the Star Alliance, United received such benefits as the diver-sification of risks and the sharing of resources necessary for global competition. Increasing the number of destinations, creating a vast communica-tion network, and enhancing marketing and sales activities were the key factors that favorably influ-enced the company’s future growth and competitive-ness. Its advertising slogan, “Rising,” seemed well deserved (see Exhibit 2 for a listing of current airline alliances and their members).
Exhibit 1 Labor Union Representation at United Air Lines
Employee Group
Number of
Employees Uniona
Contract Open
for Amendment
Public Contact/Ramp & Stores/Food Service Employees/Security
Offi cers/Maintenance Instructors/Fleet Technical Instructors 14,811 IAM January 1, 2010
Flight Attendants 12,892 AFA January 8, 2010
Pilots 5,632 ALPA January 1, 2010
Mechanics and Related 4,678 Teamsters January 1, 2010
Engineers 218 IFPTE January 1, 2010
Dispatchers 164 PAFCA January 1, 2010
aInternational Association of Machinists and Aerospace Workers, Association of Flight Attendants—Communication Workers of America, Air Line Pilots Association, International
Brotherhood of Teamsters, International Federation of Professional and Technical Engineers and Professional Airline Flight Control Association.
Starting in 1995, United enjoyed three consecu-tive years of record-breaking profits. However, although United was named one of the ten best stocks for long-term investment in August 1999 by Fortune, the company soon encountered turbulent times again. The pilots and machinists staged work
slowdowns during the 2000 labor negotiations that resulted in canceled flights, angry customers, and a $700 million revenue shortfall. In an attempt to regain employee confidence, an agreement was made with the pilots’ union that made United pilots the highest paid in the industry.9 United then planned
an all-cash acquisition of US Airways, hoping that its strong presence in the eastern United States would complement United’s stronger nationwide and inter-national network. Because it sought the acquisition without first obtaining union approval, employee confidence again waned. The deal was canceled in 2001 when the Justice Department indicated that it would block the merger because it would reduce competition.
Administrative expenses also increased sub-stantially during this time, which, combined with 41 percent higher fuel expenses, resulted in fiscal year 2000 being one of United’s poorest in that decade.
In December 2002 United Airlines, the nation’s second-largest airline carrier, filed for Chapter 11 bankruptcy protection. The airline had posted losses of nearly $3 billion in the prior 18 months and had been losing money from its operations at a rate of $7 million per day. At that time United’s bankruptcy was the largest airline failure and the sixth-largest bankruptcy in U.S. history.10 United’s
downfall was caused by a combination of circum-stances and events, including the terrorist attacks on September 11, 2001, that affected the entire airline industry.
United was losing money even before September 11, 200111 and the terrorism attacks simply mag-nified United’s failed acquisition of US Airways and its declining profits. The sudden combination of demand reduction, high debt, and management/labor difficulties left United facing possible bank-ruptcy with few obvious solutions. United reduced capacity by eliminating flights, and laid off over 20 percent of its workforce.12 CEO Jim Goodwin wrote a letter to the board in October 2001 stating his concerns that the company was “literally hem-orrhaging money” and that the airline might not have a future.13 Only four days after the letter was received, Goodwin was replaced by UAL director John Creighton on an interim basis, primarily due to union pressures and lack of board confidence.14 Despite cost-cutting measures, UAL recorded a loss of $2.1 billion in 2001.15
Alliance oneworld® SkyTeam Star
Affi liate Members AmericanConnection
Air Nostrum
American Eagle
BA Cityfl yer
Comair
Dragonair
Globus
J-Air
JAL Express
Japan Transocean Air
Jetconnect
LAN Argentina
LAN Ecuador
LAN Express
LAN Peru
MexicanaClick
MexicanaLink
QuantasLink
Sun-Air of Scandinavia
Sources: oneworld, SkyTeam, and Star Alliance websites; http://www.oneworld.com/, http://www.skyteam.com/, and http://www.staralliance.com/en/.
One of United’s most pressing concerns was cash flow. Because of uncertain future revenues, manag-ing working capital became very unpredictable and difficult. Negative cash flows caused current liabili-ties to balloon, forcing UAL into a cash crisis near the end of 2002. In an attempt to avoid possible bankruptcy, management sought major concessions from all of the labor unions to secure $1.8 billion in loan guarantees from the federal government. Overall, the unions agreed to support $5.8 billion in concessions, usually in exchange for stock options.16 Regardless of the concessions, the Air Transportation Stabilization Board (ATSB) rejected United’s appli-cation for aid in early December. United Airlines declared bankruptcy on December 9, 2002.
Even while filing for the federal loan, United was having discussions with banks about bankruptcy financing. United knew that without the loan there would be no alternative to bankruptcy.17 Four banks agreed to finance Chapter 11 for United, and they set up loan covenants with very stringent require-ments. United was required to operate profitably within three months, stay in the black for the rest of 2003, and finish with $575 million in before-tax earnings.18 Many suggested that the unions would be the ones to suffer. The ESOP made them power-ful stakeholders in the company and they used this power to become the most expensive workforce in the industry.19 The company was not expected to liquidate, however, because its most valuable assets, the aircraft, were under financing by outside orga-nizations that would rather have the planes flying than idle awaiting sale.20 On another positive note, Lufthansa, United’s main Star Alliance partner (who had remained profitable), was willing to help.21
Glenn F. Tilton became the CEO of United in 2002, following several others that same year. Tilton had recent experience trying to help the financially distressed company Dynegy.22 Although his previous experience was within the oil industry, he remained confident that a recovery was possible, and referred to Chapter 11 as “Chapter One.”23 The challenges faced by Tilton and United were extreme, consider-ing the difficulties of management/labor relations, a declining industry structure, and the strict loan requirements.
United Airlines and its parent company, UAL, had applied for ATSB loan guarantees worth $1.8 billion in December 2002. The rejection by the ATSB precipitated UAL’s decision to enter Chapter 11 bankruptcy proceedings. Subsequently, on June 17 and June 28, 2003, the ATSB rejected two requests
for loan guarantees worth $1.6 and $1.1 billion, respectively. To continue Chapter 11 proceedings without liquidation, United needed immediate assis-tance from its creditors as well as additional cost reductions.24
In order to avoid default, United negotiated an agreement with Debtors-in-Possession (DIP) for an additional $500 million. (DIP financing allows com-panies to continue operations while going through Chapter 11 proceedings and is considered attrac-tive because it is done only under order from the Bankruptcy Court.25) Much of the $500 million comes from firms such as GE Capital, which had loaned airlines $7 billion since the 2001 terrorist attacks. GE was UAL Corp.’s largest creditor, hav-ing a $1.6 billion stake.
In July 2004, United Airlines took a different tack to avoid liquidation: it chose to avoid a $72 million payment owed to three of its unions’ pen-sion plans and indicated that it planned to skip more than $500 million in payments due in September and October. In May 2005 United received court permission to terminate its four employee pension plans that covered approximately 134,000 people. This was the largest pension default in the history of the federal Pension Benefit Guaranty Corporation (PBGC),26 a government-subsidized corporation that helps to fund pension funds of bankrupt compa-nies. The PBGC assumed responsibility for United’s plans, in exchange for a stake in the company. As a result, employees also lost their controlling stake in the company.27
On Friday, January 21, 2005, the bankruptcy court gave United approval to extend its exclusiv-ity period for another three months. Thus, United would have an additional three months to file its reorganization plan without interference from other parties. Its most recent extension was due to expire on January 31. In an interview with the Chicago Tribune, Tilton said that he expected United to emerge from bankruptcy in the fall of 2005 a differ-ent company. Although emergence from bankruptcy would be no guarantee of success, Tilton optimisti-cally believed that it would soon be “time to fly” for United.28
Bankruptcy and Beyond
Under bankruptcy protection, the company had restructured its labor contracts and defaulted on its employee pension plan. United took out a $3 billion loan from investment banks in order to
gain approval to exit bankruptcy, which it did on February 1, 2006.29 The timing was auspicious for the company as the U.S. economy was once again on the rise and airlines, including United, earned profits in 2006 and 2007.30 The good times came to an end in 2008, however, as the U.S. economy slipped into recession, and United posted its largest ever loss of $5.2 billion.31
In an unusual move for a bankrupt company, United also formed a new business line called Ted, which was a second attempt at creating a low-cost subsidiary.32 Ted failed to meet expectations and the company announced its closure in 2008.33
Company executives have tried to reposition the company since 2006. United bid to merge with Delta in 200734 and with both Continental35 and US Airways in 2008, but none of these negotia-tions were successful.36 United was forced to make significant cuts once again, and by June 2008 the company had announced plans to ground 70 planes, eliminate 950 pilot positions, and cut up to 1,600 salaried positions.
In early 2009, the U.S. economy was mired in its worst recession since the Great Depression. With airline industry business cycles closely mirror-ing larger economic trends, United Airlines felt the effects of the downturn. United, the fourth-largest U.S. passenger airline, lost more than $5 billion in 2008 and reported further declines in both revenue and traffic in the first quarter of 2009.37 Even before
the economy soured, United managed only minimal profits in 2006 and 2007, which were considered good years for the U.S. airline industry. Prior to that, the company spent three years in Chapter 11 bankruptcy protection as a result of losses early in the decade. In addition, United encountered chal-lenges related to expanding service internationally, introducing subsidiaries in an effort to compete with low-cost carriers (LCCs), and maintaining positive relations with its employees and the unions that rep-resent its employees. Thus, more than just waiting for economic recovery, United explored tactics to become profitable again and reclaim the image and success it once experienced. In an effort to reduce the negative impact of the global recession, in 2009 United implemented strategies aimed at capacity reductions, fleet optimization, revenue generation, and airline alliances.38 However, despite its efforts, UAL recorded a net loss of $651 million for 200939 (see Exhibit 3 for UAL’s financial information).
Prior to the merger, in 2008 United and Continental announced plans to enter a new alliance partnership. Although merger efforts failed in 2008, this partnership created new revenue opportunities, cost savings, and other operating efficiencies that benefited customers, employees and shareholders.40 Continental joined the Star Alliance in 2009, making it possible for the two airlines to link networks and services across the globe. The Star Alliance offers more than 21,200 daily flights to 181 countries
Exhibit 3 United Continental Holdings, Inc. (UAL) Financial Highlights
*In accordance with the Plan of Reorganization, the Company discharged its obligations to unsecured creditors in exchange for the distribution of 115 million common shares of
UAL and the issuance of certain other UAL securities. Accordingly, UAL and United recognized a non-cash reorganization gain of $24.6 billion and $24.4 billion, respectively.
worldwide.41 United’s operations were primarily focused in the western United States, with hubs in Denver and San Francisco. It also had a strong pres-ence in Asia, including China and Japan. Continental brought a strong eastern U.S. position with hubs in Houston and Newark, and an international presence in Latin America and Europe42 (see Exhibits 4 and 5 for United’s and Continental’s combined domestic and global networks). With lit-tle overlap in route networks, customers benefited from the codesharing opportunities of a coordi-nated process for reservations, ticketing, check-in, flight connections, and baggage transfer. United and Continental also participated in a reciprocity agreement for their frequent flyer programs (FFP). Customers who were members of Continental’s OnePass program and United’s Mileage Plus pro-gram could earn miles when flying on either airline and could redeem awards on both as well.43 Thus, United and Continental were developing synergies prior to the actual merger.
The Merger
On May 3, 2010, United and Continental announced the merger agreement, and on October 1, 2010, the agreement was finalized. During the five-month process, the Antitrust Division of the United States Department of Justice (DOJ) performed an investi-gation into the merger to ensure that no antitrust laws would be violated. The investigation was closed in August, and United received approval for the merger.44 In addition, the company had to obtain clearance from the European Commission, which conducted an investigation to ensure that the merger would not cause competitive issues in Europe or on trans-Atlantic routes. Approval from the European Commission was received in July.45 United and Continental held special shareholder meetings on September 17, and both groups voted to approve the merger. This time more than 98 percent of the votes by Continental shareholders approved UAL’s $3.17 billion all-stock purchase of Continental.46 During the UAL meeting, CEO Glenn Tilton said that with more cross-border airline partnerships the industry would be better able to match available seats for sale with passenger demand. “From economic col-lapse to pandemic to 9/11 to volcanic ash, it’s an industry that is buffeted by forces beyond its con-trol. Because of that, it’s going to require an indus-
try of this resilience and this magnitude to weather all that.”47
The all-stock transaction was called a “merger of equals” that created the largest airline in the world in terms of traffic.48 Under the merger agreement, Continental shareholders would receive 1.05 shares of United Continental Holding common stock for each share of Continental common stock previ-ously held. Continental shareholders would own approximately 45 percent of the equity in the hold-ing company, and United shareholders would own approximately 55 percent.49 United and Continental would operate separately under the holding com-pany United Continental Holdings, Inc., until a single operating certificate could be obtained from the FAA. This would allow them to operate under one common set of manuals and procedures for air-craft, crews and maintenance. It was estimated that it would take at least one year to receive the cer-tificate, and all union contracts would need to be renegotiated prior to its issuance.50
The combined airline would operate under the name “United” and the new aircraft livery would use Continental’s livery, colors, and design, along with the blue–gold–white globe displayed on the tail, combined with the United name in all capitals on the fuselage.51 The new look would begin to appear in spring 2011 (see Exhibit 6 for examples of the livery). As the largest airline in the world, United and Continental, along with United Express, Continental Express, and Continental Connection, serve 144 million passengers annually through 5,811 daily departures at 371 destination airports (223 domestic and 148 international) in 59 coun-tries throughout North and South America, Europe, Asia, and Africa.52 The combined company has hubs in Chicago, Cleveland, Denver, Houston, Los Angeles, Newark, San Francisco, Washington, D.C., Guam, and Tokyo.53 Together they operate a fleet of more than 700 mainline aircraft and approximately 540 regional aircraft.54 The new slogan, “Let’s Fly Together,” appears to be well deserved.
A joint management team was formed of Continental and United executives that would be based at the United Continental Holdings head-quarters in Chicago, formerly the headquarters for UAL Corp. Continental headquarters in Houston would be closed. A board of directors was selected, comprised of 16 members including six independent directors from each of the previous boards, two
labor representatives from United’s previous board, Glenn Tilton (former CEO of United who would serve as the nonexecutive chairman) and Jeff Smisek (formerly Continental’s CEO since January 2010; see Exhibit 7 for the board of directors’ member list). According to Glenn Tilton, “Drawing from both companies, we have an excellent board of directors and a strong management team, and we have the industry’s best people to deliver on the promise of great products and service for our customers, career opportunities for our people and consistent returns for our shareholders.”55
In 2009 United and Continental had total net revenue of $28 billion. The new company fore-casted $1.2 billion in total new revenue and cost savings that would be derived from synergies by 2013.56 With signs of improvement in the economy, analysts have indicated that the timing is right for airlines to take advantage of the anticipated increase in business and leisure travel. The price of last-minute business fares and airfares in general are expected to rise.57 In 2011 “pricing power will swing back to air and hotel suppliers for the first time in two years,” according to the American Express
Exhibit 7 United Continental Holdings, Inc. Board of Directors
Glenn F. TiltonNon-Executive Chairman of the Board
Retired Chairman, President and Chief Executive Offi cer
of UAL Corporation
Jeff ery A. SmisekPresident and Chief Executive Offi cer
United Continental Holdings, Inc.
Kirbyjon H. CaldwellSenior Pastor
The Windsor Village United Methodist Church
Stephen R. CanaleRetired President and General Chairman
District Lodge 141, IAM
Carolyn CorviRetired Vice President and General Manager
Airplane Programs, Boeing
W. James FarrellRetired Chairman and Chief Executive Offi cer
Illinois Tool Works Inc.
Jane C. GarveyNorth America Chairman
Meridiam
Walter IsaacsonChief Executive Offi cer
The Aspen Institute
Henry L. Meyer IIIChairman of the Board and Chief Executive Offi cer
KeyCorp
Wendy J. MorseUnited Airlines Pilots Master Executive Council Chairman
Air Line Pilots Association International
Oscar MunozExecutive Vice President and Chief Financial Offi cer
CSX Corporation
James J. O’ConnorRetired Chairman and Chief Executive Offi cer
Unicom Corporation and Commonwealth Edison
Company
Laurence E. SimmonsPresident
SCF Partners
David J. VitaleExecutive Chair
Urban Partnership Bank
John H. WalkerChief Executive Offi cer
Global Brass and Copper, Inc.
Charles A. YamaroneDirector
Houlihan Lokey
Source: United Continental Holdings, Inc. company website http://www.united.com/page/framedpage/0,6837,1379,00.html.
Global Business Travel Forecast released in October 2010.58 CEO Jeff Smisek, known for his swift turnaround of Continental Airlines, is optimistic that the company will succeed, stating, “If you are an airline geek, it doesn’t get any better than this: bringing these two carriers together. They are the perfect marriage, the perfect fit. I think we’re creat-ing a tremendous carrier here.”59
To gain a better understanding of United’s evo-lution and its relationship with Continental and other airlines, it is important to also gain an under-standing of the airline industry.
The Airline IndustryAs an airline, United operates in a unique environ-ment. Following the government deregulation of the airline industry in 1978, the industry began to evolve competitively into the model followed by most airlines today.
RegulationThe Airline Deregulation Act of 1978 phased out the federal government’s control over airfares and services, allowing the airlines instead to rely on competitive market forces to determine the price, quantity, and quality of domestic air service. The two most important consequences of deregulation were lower fares and higher productivity. Higher productivity was a result of increased flexibility in operations, introduction of the hub-and-spoke business model, and a more competitive industry environment.
Although deregulation allowed the airline com-panies to set their own prices and choose their own destinations, the industry was still regulated consid-erably in regard to taxation, air traffic control, and competitive behavior. The Airport Transportation Association (ATA) claimed that the federal gov-ernment taxed flying more heavily than cigarettes. Mergers, acquisitions, and alliances (global or domestic) were heavily scrutinized for monopolistic and anticompetitive behavior and were subject to approval by concerned regulatory organizations such as the FAA. Many industry analysts in the United States believed that regulations, such as those limiting the domestic competition of foreign airlines, stood in the way of much needed changes in the industry.
Cost and Price StructureThe airline industry as a whole has been spectacu-larly unprofitable over the last two decades, with
notable exceptions such as Southwest Airlines and JetBlue. The industry, even in the best of times, has been a low-margin, capital-intensive business, heav-ily burdened with high fixed costs and overcapacity. Labor and fuel were the two major components of the cost structure, while unions played a significant role in driving up the labor costs.
Price competition also became fierce. Although business travelers were typically willing to pay much higher fares for unrestricted tickets when times were good, they were not willing to do the same dur-ing a downturn in the economy. Business travel-ers began to choose leisure fares with restrictions or to travel coach, and many turned to the Internet for discounted ticket prices. Business travelers also chose to save money by traveling on LCCs offer-ing reduced prices for basic no-frills service such as Southwest Airlines.
Hub-and-Spoke versus Point-to-PointAdopted first by American Airlines, the hub-and-spoke business model has been used by major air-lines and alliances. Use of the hub-and-spoke model would enable an airline to serve a large number of destinations and provide frequent flights by chan-neling passengers through a hub airport on the way to their destinations using only a fraction of the aircraft that would be necessary if all flights were direct. One drawback of the hub-and-spoke model is the large upfront investment required to build the hub, which could result in increased fares to cover the investment and operation costs.
In contrast, the point-to-point system would provide customers with direct flights between two locations without making the additional stopover at a hub. Under this system, aircraft and crews typi-cally worked harder and LCCs such as Southwest and JetBlue relied on low fares to attract busi-ness. According to Aviation Economics, a London consultancy, “low cost carriers using the point-to-point system get 11 hours flying per day out of each aircraft, compared with only about nine hours for a network carrier using the hub-and-spoke system.”60 However, traditional carriers such as American Airlines and United continued to use the hub-and-spoke model because of its ability to service wider markets.
While United has suffered many trials since dereg-ulation, it has managed to survive. Many airlines have not been so fortunate, as competition in the airline industry continues to be intense.
Within the last 30 years the airline industry has undergone significant contraction, as healthier car-riers acquired failing competitors or their assets. Consolidation has been attractive as it means more routes, which can attract more passengers. It also results in considerable savings as executive ranks are reduced and reservation systems are combined.61 By January 2011 there were only three remaining major international American carriers. Following Delta’s purchase of Northwest in 2008 and the United Continental merger in fall 2010, only United Continental, American, and Delta remained. US Airways operated mainly as a domestic airline, which had competition from Southwest Airlines on 80 percent of its routes.62 The airline industry had survived the September 2001 terrorist attacks, the 2004 SARS epidemic, and the skyrocketing oil prices of 2008. In 2008, United witnessed a 59 percent increase in the cost of fuel, leading to a $3.1 bil-lion increase in overall costs related to hedging or direct fuel costs.63 These factors combined with the global economic recession resulted in reduced travel demand and increased costs. As the large network carriers struggled, LCCs such as Southwest and JetBlue developed more sophisticated networks and managed to attract more business travelers, which resulted in increased marketshare and more consis-tent profits.64
Competition became more intense among the traditional carriers as the amount of business travel decreased. To save money, companies implemented the use of videoconferencing, e-mail, and other Internet-based interactive technologies that make it easy to convey information without a face-to-face meeting. Even more significant, perhaps, were cuts in corporate expenditures and increased governance, which led to fewer approved trips and more price sensitivity among business travelers.
As an additional means of generating revenue, many airlines began to charge fees for services that had previously been included with the price of a ticket, such as fees for checked baggage, reserving a seat, priority boarding, and offering meals for pur-chase. United offers nine additional service packages designed to create value for customers and generate additional revenues marketed as “Travel Options by United.”65 These services include options to enhance both comfort and convenience for passengers, such as priority boarding and security line access, more
legroom, premium seating including complimentary alcoholic beverages, overnight baggage delivery, pri-vate delivery of foreign currencies to home or office locations, ability to purchase additional frequent flier miles, and travel insurance. In addition, custom-ers could purchase membership in the Red Carpet Club, which allowed them to access all Continental Presidents Club locations, all US Airways Club loca-tions and all Star Alliance member airline lounges. Such measures were effective for the airlines, and in 2010 the global airline industry was expected to earn as much as $22 billion from à la carte fees and other ancillary sources, according to Jay Sorensen, president of IdeaWorks, a company that tracks con-sumer trends.66 This practice is expected to continue in 2011.
The similarities between United and its major competitors are far greater than their differences. All operate a hub-and-spoke route network, seeking to efficiently transfer passengers across the country and internationally. They all run a mainline service with large jets and extend their reach through net-works of regional affiliates and global alliances. They all focus on the business traveler, offering ser-vice upgrades and frequent flyer loyalty programs to appeal to the business segment of the market. These companies differ, however, in their history, size, and hub locations (see Exhibits 8 and 9 for information on domestic market share and a com-parison of net profits between United and its major competitors.)
American Airlines (AMR Corporation)
Founded in 1934 as the Robertson Aircraft Corporation, American Airlines has grown from a small airmail service to one of the largest passen-ger airlines. American Airlines, American Eagle, and regional carriers operating as American Connection are subsidiaries of AMR Corporation, with 88,500 employees and a fleet of nearly 900 aircraft.67 AMR’s corporate headquarters are in Ft. Worth, and its “cor-nerstone” cities include Chicago, Dallas/Fort Worth, Miami, New York, and Los Angeles.68 The company transports 275,000 passengers on 3,400 flights to 240 domestic and international destinations in more than 40 countries every day.69 Like most traditional carriers, American operates a mainline business serving larger cities and a regional affiliate network (American Eagle) serving smaller airports. American Eagle accounts for 271 of American’s planes, flying
more than 1,500 daily flights to 160 destinations in the United States and the Caribbean.70 American’s network is further extended by its participation in the oneworld global airline alliance.
American is the only large traditional domestic carrier that has not filed for bankruptcy, narrowly avoiding this fate in 2003.71 In 2009, the company posted a net loss of $1.5 billion, compared with a net loss in 2008 of $2.1 billion72 (see Exhibit 10 for financial information on AMR Corporation).
Continental Airlines. Unlike American, Con-tinental Airlines has filed for bankruptcy protection twice—once in 1983 and again in 1990.73 Since the second bankruptcy, the company’s fortunes have improved significantly, leading Fortune to name Continental, “The World’s Most Admired Airline”
for five years running during 2004–2009.74 While several competitors posted multi-billion dollar losses in 2008, Continental’s loss was modest by compari-son, $585 million.75 In 2009 Continental posted a net loss of $282 billion.
In 2007, Continental entered into merger talks with United Airlines. The talks subsequently failed to produce a merger as Continental’s board backed away from the deal because of United’s poor finan-cial health and escalating fuel prices,76 but they did result in an alliance that involved Continental terminating its membership in the SkyTeam global alliance (anchored by Delta and Air France KLM) and becoming part of the Star Alliance dominated by United, Lufthansa, and US Airways on October 27, 2009.77
As of December 31, 2009, Continental and its regional affiliates, Continental Express, Continental Micronesia, and Continental Connection, flew more than 2,000 flights per day to 118 domestic and 124 international destinations using a network based on hubs located in Newark, Houston, Cleveland, and Guam.78 Continental had approximately 41,300 employees, representing 39,640 full-time equivalent employees, 45 percent of whom were represented by labor unions and covered by collective bargaining agreements79 (see Exhibit 11 for a listing of labor unions representing Continental employees).
In the third quarter of 2010, Continental reported a net income of $365 million. The fourth quarter 2010 financial results would be combined with those of United and reported under United Continental Holdings80 (see Exhibit 12 for financial information on Continental).
Delta Airlines. Founded in Georgia in 1924 by a crop duster named Huff Daland, Delta’s first decades of operation were dominated by agricul-
tural and public service flights, with the majority of its domestic flights dedicated to mail handling, and then for military purposes during World War II.81
From the 1940s through the late 20th century, Delta aggressively pursued a differentiation strategy, known for its innovation and contribution to the art and science of aviation. There were many “firsts” for Delta, such as being the first airline to offer night service, the first to employ interchange service among flight attendants, the first airline to transport living vegetables and plants, the first airline to use the Douglass DC-8 and DC-9 (which would become standard in the industry for decades), and the first to offer passengers an in-flight telephone system (Airfone). In 1962, Delta had the quickest flight time from coast to coast (Atlanta to Los Angeles); its record time of just less than three hours remains the fastest cross-country passenger flight to date. The hub-and-spoke system was Delta’s innovation that improved passenger plane transfers with coor-dinated flight arrival and departure times.82
However, this airline giant has experienced financial trouble in more recent years. In September 2005, Delta Airlines filed for Chapter 11 bank-ruptcy.83 Goodwill and deferred tax asset write-offs, significant declines in passenger miles, and high fuel costs led management to conclude that “… these results underscore the urgent need to make funda-mental changes in the way we do business.”84 A more fundamental shift in industry strategy, however, seemed to underlie the firm’s demise. The continued growth of LCCs, intense competitive rivalry within
the industry (most notably increased price sensitiv-ity), and increased customer use of the Internet for travel information challenged Delta’s differentiation strategy that was framed around exceptional cus-tomer service and innovative aviation.
To counter the increasing threats to its firm, Delta finalized its merger with Northwest Airlines in October 2008. Although the combined organization lost $8.9 billion in 2008,85 Delta sought to obtain three major benefits from the merger: (1) larger market share by including Northwest’s mid- and
northwest U.S. routes, along with its Asia routes; (2) improved financial capacity to sustain cyclical downturns in the economy and associated volatil-ity in fuel costs; and (3) synergy of resources cre-ated by the combination of the Delta SkyMiles and Northwest WorldPerks frequent flyer programs, facilitated by both airlines membership in the SkyTeam alliance (including over 20 other commer-cial carriers).86 As a result of the merger, Delta was able to offer the largest variety of domestic and inter-national commercial routes at that time. Delta was the largest commercial airline in the world87 until United merged with Continental. Although Delta recorded a net loss again in 2009 of $1.2 billion, this was a significant improvement of the $8.9 billion loss in 200888 (see Exhibit 13 for financial informa-tion on Delta). Currently Delta serves more than
350 destinations in approximately 70 countries and operates a mainline fleet of almost 700 aircraft.89
US Airways. Headquartered in Tempe, AZ, US Airways along with US Airways Shuttle and US Airways Express employs over 31,000 people and has more than 3,000 departures a day using a fleet of 349 mainline and 296 express aircraft serving more than 190 communities in the Unitef States, Canada, Mexico, Europe, the Middle East, the Caribbean, and Central and South America from its major hubs in Phoenix, Charlotte, and Philadelphia.90
As a result of its acquisition by America West Airlines in September 2005, US Airways avoided fil-ing a second bankruptcy in three years and inevi-table liquidation.91 The new US Airways (under the America West leadership team and CEO Doug Parker) was able to offer “more non-stop flights
and better connecting service than either the West-Coast-oriented America West or the old, East-Coast-centric US Airways had before,” and even “branded [itself] as ‘America’s largest low cost carrier.’”92 The postmerger airline earned $427 million in profit on reported $11.7 billion in revenue in 2007 and $304 million on $11.6 billion in revenue in 2006. The firm reported a net loss of $2.2 billion on increased revenue of $12.1 billion in 200893 and another net loss of $205 million on decreased revenue of $10.5 billion in 200994 (see Exhibit 14 for financial infor-mation on US Airways).
As with many of its competitors, US Airways relies on its regional affiliate, US Airways Express, to provide jet service to passengers traveling in and out of the smaller airports across the country, as well as flying during off-peak hours when it becomes inefficient to operate a larger jet.95 In addition, US Airways is a member of the Star Alliance, which provides customers with even more access to vari-ous destinations across the globe without additional costs for the airline.96
US Airways competes on price, flight availability, and level of service provided with both LCCs such as Southwest and AirTran, and full service traditional airlines such as American, Delta, and United.97 The weakened state of the U.S. economy, a higher oper-ating cost structure than that of true LCCs, and fluc-tuations in fuel prices make it extremely difficult for the airline to earn profits on an annual basis.
Southwest Airlines. Founded in 1971, Southwest Airlines introduced a new business model in the U.S. airline industry. It originally flew only intra-state routes in Texas, allowing it to operate outside the price and route regulations inter-state carriers faced.98 Thus, it was able to focus on providing low-cost no-frills travel to price-conscious consum-ers. When the industry was deregulated in 1978, Southwest began to expand beyond the borders of Texas. By 2007, Southwest had carried nearly 102 million passengers, more than any other airline in the world.99 By the end of September, 2010, the company had a fleet of 547 Boeing 737 aircraft that flew 3,100 flights to 72 U.S. cities daily.100
Unlike its traditional competitors, Southwest does not rely on a hub-and-spoke network, using instead a point-to-point service between medium and large metropolitan areas.101 Southwest mini-mizes costs by standardizing its fleet to reduce train-ing and maintenance expenses, by using secondary airports that charge lower access fees, and by mini-mizing downtime for both aircraft and employees.102 While traditional hub-and-spoke networks attempt to coordinate hub arrivals to facilitate shorter lay-overs for passengers, Southwest makes regular, frequent flights throughout the day. The result is a flatter demand for labor (less peaks and valleys) and higher aircraft utilization because of turnarounds that take half as long as the industry average.103
The customer experience on Southwest is described as “no-frills” because the company uses first-come, first-served seating and does not pro-vide complimentary meal service. Priority boarding
is available for an extra fee, but Southwest does not charge additional fees for checked baggage. Southwest was also a pioneer in online bookings, e-ticketing, and self-check kiosks, reducing the cost of the ticketing and check-in process.104
The company earned profits during every year from 1975 through 2009, including recessionary periods in the early 1990s and 2000s, and during the more recent global economic recession of 2008 and 2009, when traditional carriers suffered losses.105 In 2008, while every major traditional U.S. carrier posted a loss, Southwest turned a profit of $178 million,106 followed in 2009 by a net profit of $99 million107 (see Exhibit 15 for financial information on Southwest). The extent of the threat posed by Southwest and its model is evident in the number of LCCs that have been launched around the world and the extent to which traditional carriers have tried to change their business models in direct response
to the growth of low-cost airlines. Primarily, tradi-tional carriers have tried combating LCCs by creat-ing “low-cost” subsidiaries of their own. American Airlines is the only major competitor to avoid this temptation.
As the airline industry becomes increasingly glo-balized, traditional carriers and LLCs seek to expand their routes and destinations served through part-nerships, alliances, mergers, and acquisitions. As a result of the United Continental merger, Southwest was able to lease 18 slot pairs at Newark Liberty International Airport from Continental. Previously Southwest had limited service in the New York met-
ropolitan area and no service to Newark. The lease was created to resolve an issue raised by the U.S. Justice Department in its investigation of the pro-posed merger. Approval of the Department of Justice was one of the final regulatory hurdles prior to closing the merger in October 2010.108
To further expand into major East Coast cities and internationally, in September 2010 Southwest announced plans to purchase competitor AirTran for $1.42 billion.109 The acquisition would also give Southwest access to 37 new cities, including Atlanta, and routes to Mexico and the Caribbean, where rival JetBlue already has established routes.110
Analysts believed that further consolidation of the domestic airline industry would be necessary following the United Continental merger. Vaughn Cordle, chief analyst and managing partner at Airline Forecasts in Washington, D.C., said that the remaining network carriers would have a dif-ficult time surviving higher industry costs without consolidating.111 He projected that fuel costs would increase $6.5 billion in 2010 over 2009, and would increase $2 billion more in 2011. “With the merger of United and Continental, the odds of liquidation and/or bankruptcy for US Airways and American increase because it will be too difficult, if not impos-sible, for them to remain viable as stand-alone busi-nesses,” Cordle wrote in a white paper advocating industry consolidation.112 He also expressed his belief that the market could not support more than three network carriers. John Kasarda, an aviation expert and director of the Kenan Institute of Private Entrepreneurship at UNC Chapel Hill’s Kenan-Flagler Business School, said that a potential merger between US Airways and American would not be a “far-fetched” idea, but that it would most likely occur out of necessity. He believed that shareholders would push US Airways and American to make some type of response to the merger, whether it would be a merger or close cooperative agreements.113
Kasarda also said that both airlines had previously been “asleep at the switch” in regard to interna-tional service.114
International Transport
Generally speaking, an airline is permitted to carry passengers from a domestic airport to a foreign destination, drop them off, pick up passengers at that airport, and return to its country of origin.115 Airlines are usually not permitted to carry passengers to other airports in other countries or within any country other than their home nation. Obviously, this situation presents problems for a traveler who wishes to go, for example, from a small airport in the United States to a small airport in Russia. This traveler would need to purchase separate tickets on a U.S. and a Russian carrier, transfer his or her own baggage, and assume the risks of missed connections between the carriers.
One obvious way around this dilemma is a merger of carriers with domestic rights in both countries. Unfortunately, “U.S. law limits the amount of foreign ownership in its domestic airlines to a maximum of 49 percent, with a maximum of
25 percent control.”116 Because other nations have similar restrictions, international airline mergers are essentially impossible at this time.
To circumvent the limitations related to interna-tional routes and restrictions on ownership, airlines have formed global strategic alliances.
Global Alliances
Alliances allow passengers to book end-to-end itin-eraries to a much larger pool of international desti-nations through airlines code-sharing on their joint networks.117 In addition to extending a carrier’s net-work, alliances allow airlines to expand the value of their FFPs) by providing passengers the oppor-tunity to accumulate and redeem awards for other member airlines.118 These alliances have extended beyond code-sharing and agreements on FFP pro-grams to include food service agreements and main-tenance contracts for each other’s aircraft. There are three main airline alliances that compete against one another: oneworld, SkyTeam, and Star. Exhibit 2 shows the airlines participating in each alliance as of October 2010, along with key statistics for each alli-ance. The three major U.S. airlines compete through membership in different alliances. American Airlines is a founding member of oneworld, Delta is a found-ing member of SkyTeam, and United is a founding member of Star Alliance.
There are advantages and disadvantages of global airline alliances. Member airlines have been able to reduce costs and increase convenience for passengers through initiatives such as dedicated terminals.119 Placing alliance member airlines in a single terminal allows passengers to connect faster with shorter walks between gates. It also allows airlines to share lounges as well as personnel and resources used in check-in and ground handling activities.120
However, critics of alliances claim that code-sharing arrangements can lead to a reduction in com-petition, as “all the flights on a route carry the codes of [all] the ‘competitors’ and are jointly marketed by [all] the airlines.”121 Too many alliance members flying the same routes can also adversely affect the airlines involved, “as new airlines are added to the alliance, the importance of an existing airline may be reduced.”122
Additionally, airlines face expenses when they join an alliance. Service levels must be standardized, information technology systems must be integrated, and costs are incurred for running the alliance
itself.123 Still, there is general agreement that the ben-efits of alliances outweigh their drawbacks.
Of the six largest U.S. airlines, Southwest is the only one that is not a member of a global alliance. LCCs have traditionally avoided global alliances because of the service level requirements that mem-bership places on them, although they do have some domestic code-sharing agreements (Southwest had a code sharing agreement with ATA Airlines, e.g., until ATA ceased service in 2008).
In addition to extending its network glob-ally through the Star Alliance, United extends its network to smaller domestic airports through its regional affiliate, United Express.
United Express. The goal of this air carrier ser-vice is to transport passengers from smaller airports to United hubs for convenient connections to other United and Star Alliance flights.124 United maintains agreements with regional carriers such as Atlantic Southeast Airlines, Colgan Airlines, ExpressJet, Go Jet Airlines, Mesa Airlines, Shuttle America, SkyWest Airlines, and Trans States Airlines, all of which fly planes bearing the United Express insig-nia; as such, passengers are generally unaware of the relationship and consider these flights to be United Airlines flights.125 United Express conducts more than 2,000 flights daily to more than 150 destina-tions across the United States and Canada,126 and all of the same elements apply, such as acquiring points for the United frequent flier program.
Not only are alliances and networks important considerations for airline companies, but factors of production may be even more crucial.
Factors of Production
Aircraft Manufacturers. The most visible tangible asset of any airline is its fleet of aircraft. For large jet aircraft (more than 100 seats), Boeing and Airbus are currently the two major suppliers in the world. The two companies are relatively evenly matched in terms of capabilities, and “since both manufactur-ers price their aircraft almost identically, competi-tion occurs in the area of additional services, such as financing agreements or agreed buy-back of older aircraft.”127 Most airlines, including United, tend to maintain a relationship with both manufacturers to avoid becoming overly dependent on either supplier.
Fuel. With recent increases in the cost of oil, fuel has become the largest and most volatile expense for airlines.128 In 2008 oil prices escalated to a high of $145 per barrel in July, then dropped to $70 a
barrel in October, making it difficult for airlines to forecast expenses.129 To smooth the variance, air-lines routinely participate in fuel hedging, but this is not a foolproof practice. United lost $519 million in just the third quarter of 2008 when price decreases lowered the value of its hedges.130 American, Delta, Continental, and even Southwest also posted losses due to fuel hedges.131 By the end of fiscal year 2010, oil prices were rising again.
Airport Slots. The relationships between airlines and airports are quite complex. While airports gen-erally have significant latitude with regard to the fees they charge airlines to use their facilities, the resulting agreements give airlines significant power over gates, terminals, ticket counters, and slots for takeoffs and landings.132
Of particular interest is something called an “air-port slot.” Essentially, airport slots grant the holder “the right to land or take off from an airport at a given time.”133 Once these slots are granted, they exist in perpetuity as long as the owner uses the slot at least 80 percent of the time.134 This provides a significant incentive to slot owners to continue fly-ing in every slot they own to keep those slots from becoming available to other carriers.135
Labor. Labor relations can be challenging for any company, but for the airline industry, where a large percentage of airline workers are represented by labor unions, it is a very critical component of the business. Unfortunately for United, the firm’s his-tory of problems with the labor unions representing its workers continues to plague the company today.
After years of strikes and bitter negotiations, 1994 was something of a watershed moment for United’s labor relations. As part of contract negotia-tions, it became the largest company in the world to be majority owned by its employees. Pilots bought 25 percent of the company, machinists, 20 percent, and salaried and management workers, about 10 percent, and several seats on the board of directors were granted to union representatives.136 It seemed that United and its unions were finally working together; however, that perception ended quickly. While the company’s ESOP provided job security for the so-called new “owners,” there was little change in employee relations, airline efficiency, or customer satisfaction as workers still had little control over the critical decisions the company made. In retro-spect, it seems that there was no intention to cre-ate an “ownership culture” by either side. Instead, union leaders “wanted to use ownership to prevent United from breaking up into regional carriers … and
outsourcing work performed by union members,” while the company’s management saw ESOP “pri-marily as a way to get wage concessions.”137
United’s pilots, along with the ALPA, criticized CEO Glenn Tilton based on the fact that his com-pensation package was the highest in the industry by a considerable margin, even while his airline was reporting negative earnings, its employees were being laid off, and customers were being charged extra service fees.138 Further, United’s decision in June 2008 to eliminate 950 pilot jobs, lay off 1,600 salaried positions, and ground 70 aircraft was not received well by the ALPA community.139 In fact, the union’s pilots went on strike; in response, United sued the ALPA claiming it organized an illegal and disruptive “sick-out” that caused hundreds of flight cancellations costing the airline millions of dollars in potential revenue and “damaging its reputation with the flying public and disrupting travel plans of about 36,000 passengers.”140 In November 2008, the federal court ruled against United’s pilots, stating that their actions were illegal.141 United faced further challenges from the labor unions that related to the merger. Union contracts were required to be rene-gotiated within one year of the merger for the FAA to issue a single operating certificate.142 Although United and Continental pilots were members of the same union, the ALPA, there were different aircraft size limitations for regional carriers. A major issue for the union was the “outsourcing” of flights and pilot jobs to regional airline partners. This practice was common in the airline industry. The contracts in existence at the time of the merger limited the Continental pilots to using regional jets of 50 seats or less in commuter operations, while the more lenient United contract allowed commuter partners to fly planes up to 70 seats in size.143 Mr. Smisek said that Continental had been “hampered and competitively disadvantaged” by the contract, but did not say how the issue might be resolved.144 Pilots at both airlines viewed outsourcing as a method of “chipping away” at their jobs, and on November 22, 2010, United and Continental pilots picketed in Newark.145 The ALPA said that operating 70-seat service out of Continental hubs violated the Continental contract provision. United spokeswoman Megan McCarthy said, “We are re-deploying 70-seaters in some of our hub markets to better meet demand and improve profitability.”146
On January 7, 2011, approximately 100 pilots and other airline employees picketed at Cleveland Hopkins International Airport in an attempt to force
United and Continental to speed up negotiations with the union, and to show the airlines that the two groups would not be “pitted against one another.”147 Captain Jay Pierce, head of the Continental unit of the ALPA, said, “If you can combine two megacar-riers between May 1 and October 1, you should be able to negotiate labor contracts with your employ-ees. They need to put a stronger emphasis on their labor groups getting taken care of.”148 Mr. Smisek said that the goal is contracts that are fair to work-ers and fair to the company.149 A unified plan for assigning work to regional partners has not been determined but is essential for the new contract.
To further complicate matters, flight atten-dants were from different unions. United flight attendants were represented by the AFA, and the Continental flight attendants were represented by the International Association of Machinists and Aerospace Workers (IAM).150 On January 18, 2011, the AFA asked a federal labor board to prepare for a vote on which union would represent the 24,300 flight attendants (15,000 at United and 9,300 at Continental) at United Continental Holdings. This is the first request from unions representing workers at United and Continental.151 In 2010, the AFA said that the Machinists (IAM) had refused their requests to work together on contract talks to obtain better benefits. Sara Nelson, AFA international vice presi-dent, said, “Flight attendants have not been able to capitalize on the incredible opportunities that are available in this merger. What’s standing in the way is resolving this representation issue, so we don’t want to wait another day.”152
The IAM also represented approximately 16,000 workers at United, including ramp, stores, public con-tact, fleet technical instructor, maintenance instruc-tor, security guard, and food service employees. It had expressed concern about the merger in June 2010. General Vice President Robert Roach, Jr., tes-tified before three Congressional committees about the proposed merger, and said, “The IAM is con-cerned that the new entity may be too big to succeed. Failure of such a large entity could be disastrous to employees, the industry and the national economy. Our concern is for the entire industry, and we do not believe mergers alone provide the answers.”153
United Continental Holdings will face many chal-lenges as it works to integrate United and Continental workforces. One of the significant challenges is to integrate work forces from two different airlines that have different contractual arrangements with various unions. The negotiations can be difficult and takes
years to workout successfully. Stalled negotiations would also have a negative impact on its financial position.
Financial Results
During fiscal year 2008 and again in fiscal year 2009, five out of six major domestic carriers sus-tained losses on their income statements. Low-cost carrier Southwest Airlines was the only exception to this outcome in both years.
Competition from LCCs, emergence from bank-ruptcy, and intense competitive rivalry (because of high fixed costs and the need for high turnover) among carriers has forced United and other airlines to reduce capacity. In 2008, the firm permanently removed 100 aircraft from its fleet, reduced capital spending by $200 million, and cut 6,000 employees from its workforce.154 By the end of 2009, United had reduced capacity by seven percent from 2008, and had retired its entire fleet of 94 B737 aircraft and six B747 aircraft.155 To match the size of its work-force to the size of its reduced capacity, approxi-mately 3,000 more employees were removed from its workforce, to bring the total workforce reduction in 2008–2009 to approximately 9,000 positions. Approximately 45 percent of the reduction was accomplished through voluntary furloughs.156 Net sales of short-term investments accounted for the majority of United’s liquidity in 2008 ($2.2 million of $2.7 million).157 In 2009 United’s liquidity ini-tiatives generated unrestricted cash of more than $1.5 billion. This was accomplished mostly from issuance of UAL common stock, proceeds from new debt issuances and aircraft asset sale–leaseback transactions.158 Additional revenue was provided by United’s cargo service. In 2009, cargo (United Cargo) generated $536 million in freight and mail revenue, accounting for approximately three percent of the company’s operating revenue. This was a 37 percent decrease versus 2008.159 While United and most of its competitors derive some revenue from the freight market, “competition in the freight mar-ket has grown steadily, and it is becoming less and less likely that airlines treating freight purely as a by-product will be successful.”160 The bulk of the market (which was expected to grow more rapidly than passenger service) was expected to fall to dedi-cated air freight companies.161
By fall 2010 United had reduced systemwide capacity by approximately 15 percent, which helped
it cut operating costs such as salaries, repairs, and maintenance by eight percent (approximately $800 million) annually since December 2007.162 Analysts believed that the cost cuts would be permanent and projected that United Continental would be able to maintain approximately $600 million in annual sav-ings per year for the next several years.163
The global economy was also showing signs of recovery. Major U.S. airlines reported significant third-quarter 2010 profits, led by United with a third quarter net income of $387 million or $1.75 per share. Continental earned $354 million or $2.16 per share.164 In addition, Southwest reported a net profit of $205 million, or 27 cents per share.165 Delta, U.S. Airways and AMR Corp. also recorded profits, which further indicated that the recession was receding and high-profit business traffic was returning.166
United Continental Holdings’ CEO Jeff Smisek said that the airline industry was still seeing good demand, but economic trends were uncertain and fuel prices had increased in recent months. “We will not grow for growth’s sake. We want to derisk the business.”167 At the time of the merger in October 2010, United Continental Holdings had approxi-mately $9 billion in unrestricted cash and expected that the merger would provide $1.0–1.2 billion in net annual synergies by 2013, including between $800 and $900 million of incremental annual rev-enue.168 This would come from expanded customer options that would result from the greater scope and scale of the network, fleet optimization, and the expanded service that the larger combined net-work would make available. Based on the financial results of the 12 months ending June 30, United Continental Holdings anticipated having annual revenues of $31.4 billion.169
Although the future appeared promising, there were numerous challenges that would need to be over-come for the company to survive and be profitable.
Strategic Challenges
All mergers present challenges, but the United Continental merger created the world’s largest air-line from two former competitors with significantly different corporate cultures. Some loyal Continental customers are concerned that Continental’s high standard of customer service will begin to slip as Continental’s culture could move closer to that of United.170 Will United Continental Holdings be able
to maintain Continental’s customer service stan-dards? As complex reservation and distribution systems are combined, will the combined company be able to avoid costly computer problems and out-ages? Will United and Continental employees be able to work together as one team, and will labor con-tracts be successfully re-negotiated? How will the fleets be integrated? Continental has a young fleet composed mostly of Boeing planes. United has a mix of Boeing and Airbus planes, which could make maintenance and training more difficult.171 Will it be able to compete with low cost carriers? Jeff Smisek, Glenn Tilton, and the new executive team must find the most viable answers as the pathway for United Continental Holdings to operate in ways that will satisfy all stakeholders, certainly including share-holders, before United and Continental can truly “fly together.”
NOTES
1. 2011, About United Continental Holdings, http://www.unitedcontinental
holdings.com/index.php?section=about.
2. Era 2: 1926–1933, United Airlines, October 16, 2002, http://www.ual.com/page/
middlepage/0,1454,2287,00.html.
3. Era 5: 1946–1958, United Airlines, October 16, 2002, http://www.ual.com/page/
middlepage/0,1454,2290,00.html.
4. Era 8: 1990–1993, United Airlines, October 16, 2002, http://www.ual.com/page/
middlepage/0,1454,2293,00.html.
5. Era 9: 1994–1999, United Airlines, October 16, 2002, http://www.ual.com/page/
middlepage/0,1454,2294,00.html.
6. Ibid.
7. A. Abromitis, E-mail to Derek Evers, October 18, 2002.