ONLINE EXTRA: United's James Goodwin: 'We Didn't Cave'
In a rare interview, the CEO defends the hefty pay hikes for pilots and explains why he bought US Airways

It took 22 years for James E. Goodwin to make it to the top of the world's biggest airline. It took just one year for the new chairman and CEO to see United Airlines become the world's most scorned carrier.

In May -- six weeks shy of his first anniversary in UAL Corp.'s No. 1 job -- Goodwin announced the $11.6 billion takeover of US Airways Group Inc., outmaneuvering rivals to pen the largest acquisition in airline history.

But in his rush to create a legacy, Goodwin forgot to make peace first with the Airline Pilots Assn. The pilots feared they would get bumped to lower-paying jobs by more senior US Airways employees in a combined airline. They were already grumbling that Goodwin let their old labor contract lapse in April without working out a new one, as management had promised. Many United pilots were still fuming over the big pay cuts they agreed to in 1994 in exchange for UAL equity under their employee stock ownership plan. (The ESOP expired for pilots in April and for other employees in July.)

Anyone who flew in the summer of 2000 knows what happened next. Refusing overtime work, pilots forced the cancellation of some 30,000 flights and the delay of thousands more. By summer's end, United's hub airports looked like refugee camps, and the airline was the butt of jokes on late-night TV.

Goodwin has since made amends with United's 10,500 pilots. But he still has a mess on his hands. The airline lost so many passengers and its new labor contract is so rich that UAL posted a $116.5 million loss in the third quarter. Now, United's other unions -- the 44,000-member International Association of Machinists and the 25,000-member Association of Flight Attendants -- are threatening job actions to get big raises, too. In fact, the IAM unit representing mechanics broke off talks with UAL on Nov. 2. Plus, Goodwin still has to get his US Airways deal past antitrust regulators.

Recently, Goodwin, 56, took time away from those tasks -- and the airline's public-relations campaign to win back fliers -- for a rare interview with Business Week Correspondent Michael Arndt. Goodwin talked about why he put UAL on this flight path. Here are edited excerpts of their conversation, which took place at UAL's headquarters near Chicago's O'Hare International Airport:

Q: Obviously, some of your problems are temporary. You'll get your customers back. But labor costs are going to be locked in for three or four years. How much of a drag will this be on earnings?
Let me put some perspective on this. The last pay increase our pilots received was in October, 1993.... So we had a one-time catch-up period to return to a more normal labor cost structure. Very surely, labor costs are going to be higher than they were before. But once we're beyond that, it's going to be an annual percentage base increase, which is more normal. Pilot pay is a productivity-based system. The...bigger plane you fly, the higher up the pay scale you go.

During the seven-year period that we had gone without pay increases, a lot had happened in the industry. Other airlines continued to negotiate wage improvements. That was one fundamental. Another was Delta with their 777 airplanes. Their pilots actually refused to fly that airplane unless they were offered a new, very high, pay line. The 777 pay raise was 29% above what our 777 pilots were making prior to this new contract. So when it came time for us to come to closure with our pilots on a pay raise, we had to get our 777 pilots up to equivalent with Delta. That's exactly what we did.

Q: So Delta put you in this pickle?
Delta put us in this pickle.

Q: But can United afford all this?
We think so. Obviously, labor costs will be higher. But labor costs are going to be higher across this industry. And we don't believe...that we're going to find ourselves significantly out of line with our competitors. History will support that. If you go back and track labor rates in our industry, carrier by carrier, they tend to all coalesce along a line that sort of mirrors cost-of-living increases.

Q: But if you've got these higher labor costs, how do you recoup that? You either take it out of profits, or you cut costs someplace else, or you raise fares, right?
All of those factors have to be looked at. Obviously, as industry costs continue to go up, the fare structure is going to have to reflect those costs because this industry is going to have to continue to generate a profit in order to provide services and grow our business.

Q: Looking back over the long haul, do you think the ESOP was worth it?
I think you have to look at it from two perspectives. The ESOP enabled this company to rebuild financial strength. Our industry and this company suffered during the 1980s and early '90s. The industry balance sheets across the board were pretty ugly. During the past six or seven years, the financial strength of this enterprise has improved, and that happened during the time we had the ESOP in place. So on that side of the house, I think the ESOP transaction produced some very positive results.

On the other side, I think there were a lot of mistakes that we made. We had a lot of people who were unwilling participants -- a lot of people didn't want to take the kind of pay cuts they took for the ESOP. So there was a lot of animosity against the ESOP from the very beginning. Another thing was we always [said] openly that we wanted to exit the ownership transaction with a new contract. In fact, as far back as 1996, 1997, 1998, we were talking about a seamless agreement. And that set an expectation that I don't think any of us really knew whether we could satisfy. I don't believe we could have, and we didn't.

Q: Given that you ended up paying a pretty high price to get the pilots' contract, at least according to Wall Street analysts, might it have been smarter just to have given them that money back in April? Then you could have avoided a summer of disruptions.
You have to put that in perspective as well. This is an expensive agreement. But for us to come to agreement back in April...would have meant that both parties could have got to that same spot back [then]. Obviously, the disruption had a cost. But we weren't at that point in April. The parties were too far apart.

Q: I take it that both sides compromised?
That's what negotiations are all about.

Q: But some analysts would say there was no compromise. They say you caved.
We didn't cave. We're not out of line with our competitors. It just all comes at one time. I was there, and I know what we were looking at.

Q: One other question on the residual impact: Do you think that political pressure is going to do in your merger with US Airways?
There has been a growing frustration in Washington about our industry in general. The constituents of our elected officials in Washington have been saying: "Here's an industry that is not able to deliver a level of service that it once did." They've been trying to find solutions. Reregulation isn't the answer. But we do have a responsibility, in partnership with the federal government, to start finding some solutions.

Now to get to your question with respect to the US Airways transaction -- I don't know whether we'll see any spillover effects. I am sure the Justice Dept. will scrutinize this transaction as they would any other. We're just going to have to wait and see.

Q: I'm curious about the timing of the US Airways deal. US Airways was being shopped around, but did US Airways in some way pressure you to do a deal now? Did they say if you don't take us, American Airlines will?
No, they didn't. We initiated this activity. We felt there were obvious benefits to this transaction. We also recognized there were, and probably continue to be, other interested parties that may want to acquire US Airways. And when you look at this industry, it's a mature business. Mature businesses don't have the ability to grow rapidly enough to sustain profitability and shareholder return over the long term.

If you look at any mature business, at some point there has to be consolidation in order to continue to grow your franchise. So once you focus on what are our strategic options -- and you truly believe there's going to be consolidation -- then you have to decide whether you want to be a shaper of the outcome or a follower. We felt that we want to be a shaper.

If it's meant to happen, it will happen. If it isn't meant to happen, it won't. If it doesn't, life will go on at United Airlines. But at the end of the day, I believe the Justice Dept. can find this is a pro-competitive combination.

Q: All this happened with you not even having a full year under your belt as the top guy. Is this what you expected?
No, and I don't say that in a casual way. We started off with a strategic vision of where we wanted to go. That hasn't changed one iota. What we all knew was going to be tough was the fact that with the ESOP expiring, we were going to have all these open contracts coming due, all simultaneously. One of the challenges is to ensure that we don't face that again. We're working hard with our labor groups so that we spread out our contracts on a going-forward basis.

I'm frustrated that we ended up where we did last summer, but I'm equally confident that the company will be back. We bruised a lot of people last summer. We're not happy about it. But at the end of the day, we're going to regain that trust. We're going to be back. We're going to be better.

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