BUSINESSWEEK ONLINE : NOVEMBER 13, 2000 ISSUE
MANAGEMENT Will United's Woes Spread? Its offer for US Airways may not fly. But other carriers must pay for its labor settlement James E. Goodwin had had enough. In November, 1999, the UAL Corp. ( UAL) chairman and chief executive pulled his counterpart from US Airways Group Inc. ( U) aside at a business meeting to sketch out a widebody deal: He wanted to buy the rival airline. To Goodwin, the takeover was a no-brainer. Although already parent of the world's biggest air carrier, United Airlines, UAL could strengthen its lead only through a big-time acquisition. And US Airways, with its East Coast routes, would fill the only sizable gap in United's domestic operations. But despite rounds of talks, the two sides remained miles apart on a price. So in April, sensing no chance of a compromise, Goodwin walked away. As a negotiating ploy, his move worked beautifully. On May 18, US Airways execs lowered their asking price, and six days later, Goodwin stood triumphant in New York as he and US Airways Chairman Steven M. Wolf announced an $11.6 billion merger. After less than a year on the job, Goodwin had inked history's biggest airline takeover, one that would create a giant, with 145,000 employees, $25 billion in annual revenues, eight hub airports, and 6,500 daily flights. Too bad Goodwin didn't just keep on walking. The deal, which has yet to be completed, might look smart on paper, but it has set off a ferocious chain reaction that will rattle the industry long after the memory of United Airlines' disastrous performance last summer fades. By acquiring US Airways, Goodwin had hoped for a crowning victory that would be his legacy. Instead, he ticked off United pilots, who feared the merger would cheat them out of pay and perks. They punched back with a work slowdown that upset travel plans for millions of passengers. His back to the wall, Goodwin then handed pilots the fattest salaries in the industry, a deal that pulled UAL deep into the red and cratered its stock. As if that weren't enough, UAL, like other carriers, got smacked with a steep runup in fuel costs. Bottom line: On Oct. 19, UAL reported a $116 million loss for the third quarter. Now, UAL's other unions are clamoring for their share. That could mean more labor disruptions and, as settlements are reached and payrolls rise, could lead to even poorer earnings, falling stock, and higher fares. United, which six years ago set itself apart from the rest of Corporate America by boldly embracing employee ownership, today has the same explosive labor problems as any other big, unionized company. To top it off, the airline has so antagonized the public--including frequent fliers in Congress--that government regulators appear likely to kill or cripple the US Airways deal. From the start, the merger faced long odds because of the lock-grip it would place on many of the nation's biggest cities. But United's summer service fiasco subjected the entire airline industry to renewed scrutiny by Congress and federal regulators. And it raised another argument against the proposed merger: Imagine how much worse things would be if UAL were running US Airways as well. The Justice Dept. could issue its verdict as soon as mid-November. If the deal does go through, passengers seem likely to pay a heavy price. A combination of United and US Airways would probably force United's biggest rivals--American Airlines parent AMR Corp. ( AMR) and Delta Air Lines Inc. ( DAL)--to seek their own mergers. That could leave them bogged down for years trying to integrate balky workforces and one-of-a-kind computer systems. And instead of six airlines vying against one another, a round of catch-up mergers would likely leave a trio that would control 87% of the U.S. air-travel market. That would give them the clout to set prices almost at whim, industry consultants say. Drawing a parallel with a pending antitrust case, Terry Trippler of onetravel.com, an online agency, says: ''If the top six airlines went down to three, the impact on the ordinary consumer would be much bigger than if Microsoft came loaded into my computer when I bought it.'' But even if UAL never buys US Airways, Goodwin's quest is sure to send shock waves through the rest of the industry for months to come. Wages and ticket prices probably will rise as other airlines are compelled to match Goodwin's labor bargains. Indeed, some executives worry that May 24--the date Goodwin basked in the media spotlight--may prove to be a turning point for all airlines. ''If people look back five years from now, when the airline industry has collapsed, and they look for one reason why, one name will come up,'' snaps an executive at a rival carrier. ''Jim Goodwin.'' Goodwin, 56, naturally doesn't see it that way. A soft-spoken man with an easy grin, thick glasses, and the build of a retired football lineman, Goodwin says there's nothing he would do differently. The UAL veteran--he joined the company in 1967 as an accountant and rose to chief operating officer in 1998--says he has seen plenty of airlines go through rocky times after labor agreements came up for renewal. To get their way, he says, unions flex their muscles, and service suffers until new deals are reached. Then, quicker than outsiders would guess, passengers come back. He points to American Airlines, which was crippled by a pilot sickout in early 1999. Within months, the company was back to normal by almost every industry measure. Goodwin insists he was right in pursuing US Airways even as he was squaring off with United's 10,500-member Air Line Pilots Assn. (ALPA) and the International Association of Machinists (IAM), which represents 44,000 United mechanics, baggage handlers, and customer-service agents. ''You have to decide whether you want to be a shaper of the outcome or a follower,'' says Goodwin. ''We wanted to be a shaper.'' That meant grabbing US Airways before the chance was lost: ''Sometimes you can't control the timing. The ebb and flow of a transaction is whatever it is.'' DISPASSIONATE. Still, the months of crisis management seem to be weighing heavily on Goodwin. Last spring, when the deal was fresh, Goodwin enthusiastically made the circuit in Washington, extolling the promised benefits of the merger to congressional panels and federal authorities. But sitting recently in his office suite near Chicago's O'Hare International Airport, the United CEO was oddly dispassionate about whether the transaction would gain clearance from the host of regulators that must bless it: the Justice and Transportation Depts., the Federal Aviation Administration, the European Union, and as many as 50 state attorneys general. ''If it's meant to happen, it will happen,'' he says. ''And if it doesn't, life will go on at United Airlines.'' Goodwin has defenders in the industry, who note that US Airways, a chronic money-loser, was being shopped around a year ago. If Goodwin hadn't jumped in when he did, AMR might have stepped in with its own bid. At the time, US Airways stock was dirt-cheap, less than $20 a share. Today, it's around $37. These analysts and advisers also blame last summer's delays and cancellations squarely on United's pilots, who they say put pay concerns ahead of the well-being of customers and the carrier, even if it devalued their 25% stake in United. Moreover, they assert that United pilots, afraid of losing high-paying assignments to US Airways' more senior workforce, would have tried to sabotage a merger whether they were in negotiations or not. ''Labor has more power in the airline industry, and they use it,'' says Glenn D. Engel, an analyst at Goldman, Sachs & Co. But suppose all that is true. Critics still say it doesn't let Goodwin off the hook. In fact, if everyone in the industry knew pilots would object to a takeover, why didn't Goodwin make peace with them first, or at least make plans that would have kept the planes in the air? And once pilots grounded flights by turning down overtime work, why did it take him nearly all summer to regain control? The answer, say many of Goodwin's peers, comes down to inexperience and hubris. Although both Goodwin and his No. 2, President Rono J. Dutta, had been at UAL for many years before their promotions in July, 1999, neither had negotiated a labor pact before. And, of course, they had not put together a megamerger while simultaneously wrestling with a gridlocked air-transport system. ''In a sense, they picked up a gun and put it to their own heads,'' contends Michael E. Levine, an adjunct professor of law at Harvard University and a former airline man. Another ex-exec, who worked with Goodwin at United, judges him just as harshly: ''For him to enter into a merger without the pilots on board was just crazy.'' It might also be folly for Goodwin to assume he can copy American's speedy rebound. Already, mechanics in Los Angeles and Denver have staged wildcat work slowdowns, and union leaders have taken preliminary steps for a full-blown strike around Christmas if they don't get a contract in mediated talks by mid-November. The Association of Flight Attendants, meanwhile, is demanding that UAL reopen its 10-year contract so that its 25,000 members can get immediate wage hikes of as much as 30%. The union threatened to begin informational picketing by Nov. 4--just as people start planning winter vacations. Even pilots are testy, despite the big raises. Growls Frederick C. Dubinsky, chairman of ALPA's United chapter and a UAL director: ''I actually believe pilots should make even more.'' The combination of higher wages, spiked fuel bills, and fleeing passengers promises to depress UAL's results for the year. Net income will tumble to just $60 million, estimates Samuel C. Buttrick, an analyst at PaineWebber Inc. UAL shares have already skidded about 50% since Jan. 1, to $35, a five-year low, before bouncing back to $38. That shrunk UAL's market capitalization to $2 billion. That's not even half the stock value of AMR or Delta and, in fact, is less than the current market cap of US Airways. TRANQUIL. UAL's fall is freighted with irony. Until last spring, the company had been held up as a model of labor relations, thanks to its 1994 employee stock ownership plan (ESOP), which ceded 55% equity control and three seats on UAL's 12-member board to pilots and other workers. There were benefits for both sides. Management enjoyed labor peace for six years, an unusually long stretch in an industry that's so militantly unionized. Across the table, union leaders used their positions on the UAL board to block Goodwin's predecessor, Gerald Greenwald, when he wanted to negotiate an earlier takeover, in 1995. The target then? US Airways. But behind the scenes, labor was losing its solidarity. This year, when Goodwin presented UAL directors with a merger agreement, the IAM's representative on the board, retired union executive John F. Peterpaul, had a change of heart and voted to endorse the takeover. Since only a unanimous ''no'' vote from the board's union representatives can halt an acquisition, Goodwin's plan sailed forward over Dubinsky's solitary objection. Meantime, the ESOP had been losing worker support. In exchange for UAL stock awarded under the ESOP agreement, pilots agreed to a 24% cut in pay and pension contributions. Over the contract's term, however, many pilots felt they had been taken for a ride. An ESOP rule bars employees from cashing out until they retire or quit, which rendered the shares useless for financing a mortgage, say, or a college education. Also, pilots at Delta and American were passing them by in wages and benefits. United pilots had to sit and watch as UAL raked in record profits. Worse, the stock slid, diminishing their nest eggs. Disenchantment began to surface when United's pilots elected Dubinsky, in October, 1999. A firebrand who had earned the nickname ''Mad Dog'' for his role in the pilots' 1985 strike against United, Dubinsky warned Goodwin last fall that he would again make United's pilots the highest-paid in the U.S., once their old contract and the ESOP lapsed, on Apr. 12. But these tensions were hidden from the outside world until Goodwin and Wolf announced the merger six weeks later. Immediately, any pretense of harmony fell away. Why the sudden eruption? Goodwin admits he already had stirred up pilots by failing to give them a new contract the moment the old one ended, as management had long promised. But more than that, the US Airways deal threatened to undo not only wage gains United pilots were hoping for in a new labor pact, but also some previous raises. That's because, under seniority rules in ALPA contracts, senior employees get the highest-paid posts in merged airlines, and US Airways pilots generally have more years than pilots at United. STORMY. UAL had inadvertently put itself at the pilots' mercy. To keep its payroll down, the airline had been relying on overtime to maintain its daily schedule of 2,400 flights. But under the pilots' contract, extra work was entirely voluntary. Feeling double-crossed, United pilots stopped signing up for more hours. Already, an unusually stormy summer and overcrowded runways and air lanes had been triggering widespread delays and cancellations. The pilot shortage made matters exponentially worse. Management was forced to scrub hundreds of flights a week and delay even more. By August, as the summer travel season peaked, the airline had canceled 30,000 flights. Out of the 10 biggest airlines in the U.S., United dropped to dead last in on-time performance, with four of every five flights leaving late in August. The carrier's hub airports looked like emergency shelters after a natural disaster. Goodwin was buffeted from all sides. Big corporations were phoning him to say that because their employees could no longer get to business meetings on United, they were turning to other airlines. United's own employees were filing reports of abuse by frustrated passengers. Transportation Secretary Rodney E. Slater and congressional leaders summoned Goodwin back to Washington to explain how things got so out of hand. And the UAL board wanted reassurances that the turmoil would soon end. ''It ain't a good thing when an airline like ours is the subject of late-night television humor,'' concedes John K. Van De Kamp, a lawyer at Dewey Ballantine LLP in Los Angeles and a UAL director since 1994. ''The board was concerned.'' Then, a week before Labor Day, management and pilots reached a settlement. The Aug. 26 pact gave pilots pay hikes of 21.5% to 28.5% retroactive to April, plus annual 4% boosts through 2004 and a big pop in company contributions to pilot pensions, to 11% of pay from just 1% under the previous contract. Under the new accord, a Boeing 747 captain now earns $291,700 a year. In a side deal, ALPA also extracted a promise that United pilots would stay at their latest pay grades even if they got pushed into lower pay slots following a merger. Although it was pleased that the contract ended the summer conflict, Wall Street was aghast that Goodwin was paying so much. Indeed, Dutta estimates the deal swelled UAL's payroll expenses by $300 million in the third quarter alone. The four-year contract, however, did bring United pilots back to the cockpit, and today operations are returning to normal. On-time departure rates are up 40% from United's low point in late August, and the cancellations are down 60%. Still, United won't be back up to its usual 2,400 daily flights until January at the earliest. Goodwin appeared in a TV commercial last August to apologize personally to the public. An autumn fare sale has helped fill United planes, and the airline is wooing frequent fliers with special offers such as bonus points. Even the airline's competitors concede that, with its unrivaled flight network and schedule, United will win back passengers in just months if it can maintain decent service. ''You hear consumers say: 'I'll never fly them again,''' says Jeff Potter, CEO of discount carrier Vanguard Airlines Inc. ( VNGD) ''They will.'' Off-camera, however, UAL's rift with organized labor is widening. Envious of the pilot contract, the company's other unions are banging on Goodwin's door asking for double-digit raises. If Goodwin stands up to the flight attendants and the IAM's three huge bargaining units, he runs the risk of setting off another guerrilla war that could quickly catapult the airline into chaos again. ''We will just make life miserable for him,'' promises Linda F. Farrow, president of the United flight attendants' union. But as the airline's investors have discovered, the price of peace might be just as steep. UAL blamed much of its huge third-quarter loss on the generous raises it gave pilots, and Dutta warns that UAL will lose money in the fourth quarter, too, as raises for pilots and other employees increase its labor costs by a projected 16% from a year earlier. Goodwin's deal-cutting now is ricocheting through the rest of the industry. Repudiating their own leadership, American Airlines' 10,500 pilots spiked a one-year contract extension on Sept. 20, even though management had agreed to forgive a $45.5 million fine the airline is owed from their 1999 sickout if pilots O.K.'d the pact. The reason? The pilots were eager to move quickly to match United's pay hikes. Delta's 9,000 pilots also upped the ante in their negotiations and now are asking for immediate boosts of 21% or more to vault them back into the lead over United's pilots. In the meantime, the Aircraft Mechanics Fraternal Assn. stunned Northwest Airlines Corp. ( NWAC) in late September with demands for a 117% hike in average annual pay and benefits. UAL's pilot contract ''has caused a labor revolution,'' says O.V. Delle-Femine, AMFA's national director. So far, none of these demands has hit competitors' bottom lines. Indeed, United's mess has been a bonus for many competitors, as they picked up unhappy passengers. But the prospect of higher wages and fuel costs have shareholders worrying about the industry's future. Dutta says UAL's fuel bill jumped by $200 million in the third quarter, despite hedging in the futures market. He warns that jet fuel will cost 42% more in this quarter than it did a year ago. Other airlines face similar increases. FARES TAKING OFF. Passengers will be next to feel the pain. Northwest Airlines executives estimate they would have to hike fares by an average of $40 per ticket if they gave in to the wage demands of mechanics. Kevin P. Mitchell, chairman of the Business Travel Coalition, predicts that business fares will go up as much as 30% next year if the United/US Airways merger goes through and if AMR and Delta follow with takeovers of their own. Sound far-fetched? Not at all. In 2000, Mitchell says, business fares have jumped 20% as airlines passed along higher fuel costs. A combined United/US Airways would enjoy unparalleled dominance, accounting for more than 50% of traffic at seven major airports--including Chicago's O'Hare and Washington's Dulles International--and a dozen smaller airports. And it would control a third of traffic at five other big airports, including New York's LaGuardia and Los Angeles International. With that much of the market, airline consultants agree, United could handily stamp out pesky discounters and charge premium fares. Just look at Rochester, N.Y., where US Airways now has 60% of the market. Fliers there already pay the fourth-highest fares in the nation. Louise M. Slaughter, a Democrat who represents Upstate New York in Congress, calls constituents ''prisoners'' and asserts that high fares limit business growth: ''The economy cannot thrive if we cannot transport people and goods at a reasonable price.'' Other carriers would be pressured to consolidate as well. Today, United, American, and Delta are roughly the same size in domestic operations. But in tandem with US Airways, United would leap way ahead, carrying 35% more passengers than Delta and generating 65% more revenue than American. To maintain equilibrium, the CEOs of AMR and Delta have told Congress that they would be compelled to make acquisitions of their own. The likely matchups: AMR would resume negotiations with Northwest, while Delta would bid for Continental Airlines Inc. That could lead to bedlam as this troika contends with a raft of integration problems. ''Airline mergers are very hard to digest,'' says Paul Hudson, executive director of Ralph Nader's Aviation Consumer Action Project. Goodwin and Wolf knew antitrust regulators would stop their deal unless the companies reduced their combined dominance along the East Coast by unloading assets. So they worked out a companion deal to sell a big chunk of US Airways operations at Reagan National Airport in Washington to Robert L. Johnson, a US Airways board member and head of Black Entertainment Television (page 192). The parties wagered the side agreement would earn political points, too, because it would create the nation's only minority-owned airline. To temper opposition further, Goodwin pledged that United would freeze fares for two years, except to recoup increases in fuel prices. He also has argued that passengers in many smaller markets would gain from a merger because they could book flights from cities that US Airways has served and then ''seamlessly'' continue on a United flight. Of course, United would benefit by using US Airways as a feeder in the Northeast. SLIM CHANCE. Finally, UAL pulled out its lobbying checkbook and retained such well-connected advocates as major-league Democrat Thomas Hale Boggs Jr. and Kenneth M. Duberstein, a Reagan Administration chief of staff. Nonetheless, Congress seems to be siding with United's opponents. In the House, Representative James Oberstar of Minnesota, the ranking Democrat on the Transportation Committee, sponsored a bill empowering the Transportation Dept. to set airfares if the industry consolidates to a Big Three. And the Senate Commerce Committee passed a nonbinding resolution against the takeover. ''Passengers would lose in this deal,'' says Senator John McCain (R-Ariz.), the committee chairman. There's a slim chance the takeover could still go through, if Justice evaluates it without consideration for how the merger might trigger industrywide consolidation. But some airline consultants predict Justice will require the sale of many more US Airways holdings, and that could scuttle the deal. The few signals the government's antitrust lawyers have sent do not bode well for Goodwin. In particular, Justice went to trial on Nov. 1 to force Northwest to sell its controlling interest in Continental. If antitrust authorities have concluded that this smaller and less-complete partnership stymies competition, analysts wonder how they could possibly permit an outright takeover of the nation's No. 6 carrier by the biggest. And Justice isn't the only potential deal-breaker. The EU must consent too. Even if UAL wins national clearance, it still could be tripped up by state attorneys general. Already, Minnesota Attorney General Michael A. Hatch warns that he might sue to block the deal if Justice doesn't. Among other things, that would protect St. Paul-based Northwest from a takeover. Publicly, at least, Goodwin and executives at US Airways insist they still will obtain approval by Jan. 1, 2001, the expiration date of the merger agreement. ''We have no Plan B,'' insists US Airways President and CEO Rakesh Gangwal. But analysts say that if the transaction wasn't DOA as soon as it was announced, Goodwin doomed it by allowing United's operations to spin so wildly out of control over the summer. Even some of Goodwin's friends agree. One former executive recalls that last spring he gave the deal 50-50 odds. Now, he says, chances are much worse: ''There's a lingering knee-jerk reaction in Washington that if [United] can't manage themselves at this size, how can we let them become so much bigger?'' In the final stroke of irony, losing US Airways could be the best thing to happen to UAL. Otherwise, it would take on $7.3 billion in debt and lease obligations from US Airways and would have to borrow more to finance the $4.3 billion cash purchase of the airline's shares--at $60 apiece. Goodwin has also tied UAL's hands when it comes to cost-cutting, promising that no one would be laid off at United or US Airways during the first two years of the merger. There are other costs that could bloat UAL and bog down management. UAL would have to fold US Airways' 45,000 employees into its own 100,000-person workforce, a task made more burdensome by strict seniority and job classification rules spelled out in union contracts. In addition, UAL would have to mesh complicated flight schedules and cross-train mechanics to service the carriers' different fleets. Even the two carriers' reservations systems are incompatible. Given all that baggage, PaineWebber's Buttrick advises Goodwin to take advantage of the merger agreement's breakup clause, pay the $50 million penalty, and walk away. Whether Goodwin gets US Airways or not, United's image already has been tarnished, and the carrier has locked in higher wages that will crush earnings for quarters to come. Says Buttrick: ''This is a case where a good concept turns into a bad deal.'' Even in defeat, Goodwin could console himself that he would still be operating the world's biggest airline. And later, if US Airways puts itself on the block again as Wolf has suggested that it might, Goodwin probably could buy select routes and airport access. But if he does wind up empty-handed, it will mark the end of a costly and torturous trip just to get back to where he was a year ago. That's the kind of journey, unfortunately, that millions of United's customers can already relate to. By Michael Arndt in Chicago _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Will United's Woes Spread? CHART: While Service Woes Slam United's Customers... CHART: ...And Slow the Airline's Growth...Wall Street Punishes Its Missteps TABLE: How United's Labor Woes Are Spreading The DC Air Deal: More Likely to Stall Than Fly ONLINE EXTRA: United's James Goodwin: ``We Didn't Cave'' INTERACT E-Mail to Business Week Online

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