FLUG REVUE November 2003: US Airways climbs back

US AIRWAYS GETS SECOND LEASE OF LIFE

By Andreas Spaeth

With David Siegel, the almost 30,000 employees of US Airways feel they are in good hands. The youthful Harvard graduate is exactly 41 and has only headed the east coast airline since March 2002. In passenger numbers, US Airways ranks seventh in the United States and dominates most airports from Maine to Miami. In the east of the USA, the airline is the market leader, offering around 35 percent of all seats. Before joining US Airways, Siegel had been Chairman and CEO of Avis Rent A Car and before that a senior manager at Continental Airlines, where between 1995 and 1999 he built up Continental's successful regional jet subsidiary, Continental Express. Continental CEO Gordon Bethune praised him at that time as “one of the best guys in the airline business”. After the failed merger with United Airlines in the spring of 2000. US Airways had been in an extremely exposed position, with massive losses, no alliance partners and no concept. In just one year at the helm, Siegel has brought the airline back on course at record speed – quite an accomplishment, given the externally dismal conditions that the industry is facing at the present time.

A320 - US Airways

Only a year ago things were not looking nearly as good: the airline was plagued by notoriously high costs, and the fact that newcomers like the low-cost carrier JetBlue were making successful inroads on the east coast, with production costs half as high as US Airways', was adding to the company's woes. Already at the end of the 1990s, US Airways had tried to counter the increasingly strong Southwest Airlines on the east coast by setting up its own no-frills airline, Metrojet, but this had turned out to be a fiasco.

Halfway through last year the situation was back to the old way of things: US Airways' seat mile costs were 12.2 cents, while JetBlue, with 6.32 cents, and Southwest, with 7.5 cents, were having an easy job of competing with the portly giant. The latter was struggling with mounting losses. Just in the first six months of 2002 it lost $517 million, with sales down by 24 percent compared with the same period of the previous year. In 2001, the year of the terrorist attacks, the airline's losses came to almost two billion dollars. The situation was made even worse by the fact that after 11 September 2001 the lucrative business travel sector collapsed, especially on the short haul routes along the east coast.

In August 2002, US Airways took refuge in creditor protection under Chapter 11 in order to reorganise and avoid having to service debts of over $10 billion in the meantime. Radical reorganisation of the airline was the only way to qualify for a federal government loan guarantee of over $900 million, which in turn would back a billion dollars of private financing. But it had been a hard struggle up to that point, and no one was better suited than David Siegel to implement the necessary measures. The CEO has a reputation for trying his best to achieve the most labour-friendly solutions, and he is also a good communicator. Thus, “The sacrifices have to be shared,” was his favourite catchphrase. These tactics worked, and the workforce swallowed the drastic slim-down plan without protest. In the summer of 2002 – and this they are proud of in the company which is headquartered in Arlington, Virginia, close to Washington DC – not a single transatlantic flight was cancelled, US Airways was the best performing major airline for punctuality and baggage transport – not exactly typical of a company under Chapter 11.

“We gave Siegel what management had demanded years back in a similar form,” says Chris Beebe, staff representative on the supervisory board and an official of the Air Line Pilots Association (ALPA), “but his approach is quite different from his predecessor, Stephen Wolf, and above all he is much more talented at communicating.” The pilots had always suspected that Wolf and other predecessors only wanted to sell the company. By contrast, Siegel reassured them, “I have no plans to sell or merge the company.” Membership of an alliance, he argued, was the best way to safeguard the airline's independence. Already in the autumn of 2002 Siegel announced surprisingly early that it would definitely be joining the Star Alliance in the next 18 months. At first the Alliance was not prepared to comment on this. Then, suddenly the next thing was that the candidate must first be licked into shape.

After 11 September 2001 and then under Chapter 11 protection, 36 percent of the workforce or 16,000 employees were made redundant, the number of seats offered was reduced by 30 percent and the number of flights by 25 percent. The fleet which had comprised 417 aircraft at the end of 2000 was slimmed down to only 270 jets, not including US Airways' regional partners.

“By these measures we were able to cut our costs by about $2 billion per year. One billion of this came from labour savings, half a billion was gained from renegotiating leasing agreements for the fleet and another half billion was saved in other areas,” explained Douglas Leo, Vice President International, in an interview with FLUG REVUE. At the same time the burden of indebtedness was reduced from $10.65 billion to around $8 billion. The result was a significant reduction in seat mile costs to around 10.5 cents this year, and the target for 2004 is 9.9 cents. That is still one-third above the low-cost competitors. The company is therefore not expected to return to profit until 2004.

These measures meant that the company now qualified for a federal government loan guarantee to protect a $1 billion private injection of capital. Another signification investment came from the Retirement Systems of Alabama, which acquired 37 percent of US Airways for $240 million. On 31 March, the airline emerged from Chapter 11 after only seven-and-a-half months – a record for any industry.

However, at that time the Iraq war had just started, bringing with it new uncertainties, so the jubilation was somewhat subdued. Douglas Leo puts it in an amusing way: “It was both good and bad news at the same time. The good news was that we were coming out of Chapter 11, but the bad news was that we were still part of the airline industry.” Nevertheless, he adds, “It was the right time to exit Chapter 11, on the cost side there was simply nothing more we could do.” The figures for the first quarter of 2003 were not at all typical for an industry under siege: a profit of $1.63 billion on a turnover of only $1.53 million! However, these enormous figures are only because of the federal loan, and when that is excluded, one is left with a pre-tax loss of $282 million, albeit 35 percent better than in the previous year, but on a ten percent lower turnover.

Yet only a few weeks after the airline had emerged from Chapter 11 protection, a new headline took everyone by surprise: US Airways had placed an order for 170 regional jets worth $2.2 billion plus options for another 380 smaller jets with a potential transaction value of $4.3 billion. On the regional jet side, US Airways had fallen some way behind its competitors. “Before that our hands had been tied by the tight scope clauses with the pilots,” explains Leo. “Originally the number of regional jets had been limited to 70. Then during Chapter 11, the pilots agreed to raise the limit to 240, and now we are even allowed to have as many as 465 regional jets.” The massive slump in fleet size of the main players has meant that smaller jets, operated by regional partners under the name of US Airways Express, are now playing a decisive role in repositioning the airline. “Above all we have to cover the demand from the small and medium-sized destinations, and with this order for 50- and 70-seat planes we shall achieve that,” says David Siegel.

In addition to the difficulty of organising the financing for such a deal, it was also a challenge to actually get the delivery slots needed to allow the fastest possible handover of such a large number of aircraft, at a time when business was booming for the regionals. Neither the Brazilian manufacturer, Embraer, with which Siegel has had close ties since his days at Continental Express, nor its competitor Bombardier could deliver at the required tempo. So the order was arbitrarily divided four ways. 36 of the 60 CRJ200's ordered from Bombardier are to be supplied by the leasing company GECAS, and it was also agreed that US Airways would receive 25 series 705 CRJ700's from the Canadians, a custom order. These were to be based on a CRJ900 re-certified for 75 seats with a reduced take-off weight of 37.4t so as to keep the aircraft within the relevant scope clause. But the pilots' union, ALPA, viewed this as a violation of the agreement and the pilots refused to fly the larger regional jets. So in July US Airways changed its order to 25 standard CRJ700's, which are now to be operated by its partner Mesa Air from Charlotte, which also displeases the pilots. From Embraer the Americans are ordering another 85 aircraft of models 170 and 175, 30 of which will once again come from GECAS.

With this strategy, the airline will receive all its newly ordered aircraft within the next three years, with the first deliveries arriving as soon as November 2003. “We shall be able to expand our regional jet fleet from its present 70 to about 100 before the end of the year,” says Douglas Leo. “In so doing, we are pursuing two objectives, firstly to replace our turboprops at the lower end of the market and, secondly, to deploy smaller and more economic airplanes on routes hitherto flown by large jets.” By the end of 2004, all thirty Fairchild Dornier 328's operated by its regional subsidiary, PSA Airlines, should have disappeared and at the most only thirty of the present tally of 110 Dash-8 turboprops will remain.

“Apart from the regional jets, the other essential elements of our new strategy are alliance membership and international routes,” explains Leo. With regard to alliances, US Airways is proceeding at a pace matched only by the time it took to emerge from Chapter 11. “Within eight or nine months of receiving the invitation to join, we intend to actually be a member – no one else has ever managed to join Star so quickly.” A bilateral partnership with Lufthansa, which will cover the usual areas such as codesharing, use of lounges and frequent flyer programmes, is to come into effect already in October 2003. “Then in the first quarter of 2004 we plan to become a full member. Between now and then we still have a lot of procedures to bring into line.” For the Star Alliance, US Airways is an important addition which, on the east coast, is ideally situated to link up with the somewhat loosely knit United route network. After the failed merger with United, US Airways teamed up with it anyway on domestic routes, and this is now to be extended to international routes. “But our closest partners within Star,” says Leo, “will be Lufthansa and Air Canada. Then Spanair in Madrid and bmi British Midland in Manchester will also be important links for us.”

The last Lufthansa CEO, Jürgen Weber, had declared himself in favour of accepting US Airways into the alliance early on, having said at the time, “It is a company with renewed strength, whose declared aim is to offer its customers a world-class level of service – priorities that we share.”

After the traumatic experience of the early 1990s as the US partner of British Airways, which acquired a stake in the then US Air and later parted company from it when the relationship soured, US Airways has been on its own for some time. But in today's market it is virtually impossible to survive as a sole combatant, and now the Americans are expecting the Star Alliance to bring them substantial advantages. As Leo points out, “We are working on the assumption that full membership will boost our sales by between $25 and $50 million per year.”

One problem, however is the continuing lack of anti-trust immunity. “We are the only ones not have any immunity with anyone,” Leo laments. “We need a three-way immunity between ourselves, United and Lufthansa, and of course that will bring additional complications and delays with it, but we will get there in the end.” Despite imminent Star membership, they are assuming at US Airways that the airline will continue in future to operate its entire international route network, which it has steadily expanded in recent years, on its own.

The most important hub with plenty of future potential is Philadelphia, which has been the focus of US Airways' international expansion since 1996. “It is not the typical US Airways hub like Charlotte and Pittsburgh,” explains Charles Isdell, Director of Aviation in Philadelphia. “Around two-thirds of passengers are from the region and, in addition, about 60 percent of all the company's passengers there are business travellers, which makes the hub more profitable than others.” Sudden international expansion in Philadelphia has exhausted the available facilities, causing bottlenecks, so in May 2003 the spacious new Terminal A West was opened to international flights. This was built over four years for half a billion dollars and now offers 13 new gates and an extremely pleasant atmosphere.

Today US Airways' international route network comprises 16 routes to ten destinations in Europe. There are daily services from Philadelphia to Amsterdam, Dublin, Frankfurt, London Gatwick, Madrid, Manchester, Munich, Paris Charles de Gaulle, Rome and Shannon; some destinations such as London even enjoy a twice daily service. Most of the flights are operated with the nine Airbus A330-300's (308 seats in a two-class configuration), the rest with ten Boeing 767-200ER's (199 seats). Frankfurt and London Gatwick enjoy non-stop services from the inland hubs of Charlotte and Pittsburgh. “But our expansion strategy in the Caribbean is also very important,” says Leo. “Today we serve 23 destinations there, compared with only eleven in 2002.” This signifies a capacity expansion of 40 percent in the Caribbean and 20 percent across the Atlantic in the summer of 2003, compared with the previous year. Altogether, the international routes account for around 20 percent of the airline's turnover.

“Now that we have begun services to Shannon and Dublin this year, I expect us to expand our services to Germany in 2004, possibly in Munich,” Leo adds. And that is notwithstanding the fact that the market is recovering only slowly. “Before the Iraq war, the Europe routes were picking up slightly, only to dip back again, but despite low returns we are now seeing encouraging signs across the Atlantic, even if business travellers are slower to return than holidaymakers.” The First Class, which still has flat bed seats in the front row of the A330, was scrapped shortly after its introduction in May 2000 and today is sold as part of Business Class. “Demand for paid First Class tickets across the Atlantic is very low,” Leo observes. Lufthansa has noticed this too and also now offers only two classes to some destinations on the US east coast, such as Philadelphia. Thus, nothing stands in the way of closer co-operation between the new partners any more.

From page 28 of FLUG REVUE 11/2003

Last updated 10 October 2003

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