The airline world is moving on from the turmoil at American Airlines and wondering which big carrier will next run the gauntlet of labor strife and bankruptcy threats as it restructures itself. Our hometown hero, Northwest Airlines, is a solid bet.
While there are of course developments practically every day, let’s take a look at the broad economic issues before the action at Northwest intensifies.
First of all, remember that the airline business is huge and will be huge even after the ongoing restructuring is through. Second, demand for air service has dropped off and no one is sure when it will be back to pre-2001 levels. Something has to give and will.
Third, the airplanes, hangars, ground equipment and other physical assets of airlines are valuable and aren’t going away. The question is who will own and control these assets in the future. Fourth, while some argue the airlines have created a value perception problem for themselves with their fare structure, there’s little evidence that another structure would generate more revenue. Most of the restructuring, therefore, has to be done with costs.
And that’s where I’ll focus — the pecking order of power in the cost-cutting game.
The outcome of the cost adjustments at Northwest — or any of the big carriers that haven’t yet restructured — depends on the relative power of unionized workers, shareholders, executives, middle managers and creditors.
Lenders and lessors are fairly well positioned because most own or have a strong security interest in physical property that can be taken away from the airline.
Shareholders should also be in a strong position. But, as Enron and other companies have recently demonstrated, governance of large corporations is highly imperfect. Stock owners are essentially captives of their board of directors.
Labor is the largest cost facing an airline. The only airline workers whose compensation clearly is driven by free-market forces are nonunionized lower and middle managers. If Northwest doesn’t pay those people what the market will bear, they’ll go to other companies. They’re in a relatively strong position.
Of course, most of an airline’s labor cost is with five groups for whom it is apparent that market-clearing forces do not always operate. These are the unionized pilots, flight attendants, machinists and mechanics and upper-level management.
It is clear the unions will bear most of the cost adjustment. It will be hardest on pilots, whose compensation is farthest from what would prevail in a nonunionized, free-market situation.
Other unionized employees will end up with smaller cuts than pilots. After all the dust has settled, pay for ground workers in particular will be near market levels. That is, union workers won’t earn any more than people doing the same thing for nonunionized carriers. There won’t be special incentive to “getting a job with the airline” the way there was in the past.
Union workers are understandably upset about the situation and criticize the pay and perks of top managers. These managers assert that they only get market wages for the expertise and ability they bring to the job.
Take such statements with a large grain of salt. There is a lot of economic research to show that top managers frequently can capture undue pay and perks for themselves when boards of directors are passive.
Northwest’s top managers are insulated to a degree by virtue of their relatively low salaries. Still, shareholders need to be on their guard against any looting by their hired managers. A firm approaching bankruptcy court is like an old sports arena just before demolition: the temptation to take a few souvenirs or even do some major looting can be very strong.
For those involved in the fracas, there is an important economic principle to keep in mind — opportunity cost. Advice columnist Dear Abby invoked this principle whenever she famously asked frustrated wives “Are you better off with him or without him?” What would the advice seeker gain and lose by ending the marriage?
Airline employees, pilots, mechanics, flight attendants, ground workers and nonunionized management all need to ask themselves an analogous set of questions.
We all know that employers can be generous or stingy, bosses can be fair or unfair, and our lives may be blessed by justice or scarred by injustice. But when push comes to shove, it all comes back to opportunity cost. Are we better off with this job or without it?
Note that this should apply to high-level management as well as to rank-and-file labor. A spokesman for one airline asserted, after getting criticism for the fact that executives were getting bonuses while union workers were asked to take reductions, that upper management in the firm was “grossly undercompensated” in comparison to counterparts at other carriers.
He may have been correct that pay levels at other carriers were higher, but the relevant question is whether executives at his firm were bailing out to take more lucrative positions elsewhere. I’m willing to bet that they are not! If they are not, there is no reason to raise their pay at a time when the firm is going bankrupt.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.