Why Kevin O’Leary is wrong: the Airline Industry problem is not Unions

Some might not look at Canadian Airline Policy as something that the Liberal Party should tackle but it is a huge looming problem. At this point, Canadian transportation policy is largely based on private actors using public infrastructure. Airlines, for example, pay for the use of Not-for-Profit Airports. In turn, those Airports are charged rent by the Federal Government. Bus Lines use public roads. While, the only public players in the transportation field are intercity rail carriers like VIA and GO (Government of Ontario Transport Company) and inner city carriers bus systems like the Toronto Transit Commission, Calgary Transit or Metro Transit in Halifax.

Given that our Transportation Industry is full of private actors, it is possible that the bankruptcy of some players could have severe public policy consequences. For example, let us look at the fall of Canadian Airlines International Ltd. It was an airline that operated in Canada from 1987 until 2001. To be truthful, after the deregulation of the industry a number of airlines including Pacific Western Airlines, Canadian Pacific Air Lines, Eastern Provincial Airways, Nordair and Wardair got together to provide an alternative service to Air Canada.

However, a problem occurred: Canadian and Air Canada created too much capacity in the market and did not charge full market value for their service. After years of competition and racking up large amounts of debt, in 2000, Canadian went bankrupt. This was a major problem for the Government of the Day because Canadian was a large carrier.

At the time, it was the second largest carrier in Canada. To give one an idea of the scope of the Canadian just look at its fleet size. It had 163 jets at the time of its dissolution. This compares to Air Canada today which has 205 jets. Furthermore, at the time, Canadian flew to 160 destinations in 17 countries including an intensive network in Canada. It was necessary for the Federal Government to intercede and they did. On Aug. 13, 1999, the Federal Government suspended the Competition Act to let the airlines legally talk about restructuring. Furthermore, on Nov. 8, 1999, Transport Minister David Collenette said he expected Air Canada to take over Canadian Airlines. Or put differently, instead of allowing Canadian to fall into foreign hands – AMR had a proposal on the table – the Federal Government made it clear that it wanted a “made in Canada” solution to the situation at hand.

Consequently, as Liberals, we should discuss transportation policy from time to time because we will need to deal with hard situations. The question which we need to discuss today is how should a Liberal Government deal with airline market. For, problems may abound. Reuters reports that “The International Air Transport Association (IATA) cut its forecast for airline industry profits by a quarter to $3.5 billion for 2012 and warned the industry could plunge to an $8.3 billion loss if Europe’s debt problems trigger another banking crisis.” Furthermore, Canadians have seen the bankruptcy of American Airlines Bankruptcy; while the gossip about Air Canada’s Future is getting louder. So what is a Liberal Government to do?

If one listens to CBC’s Kevin O’Leary, one might think that cutting unions would be the answer. Chapter 11 proceedings helped Delta Air Lines and United Airlines to cut costs and restructure in the face of high fuel costs, slowing demand and high labour costs. So why should this solution not work for other airlines?

Well because it has not worked. US Airways went through the bankruptcy process twice. When Delta went bankrupt in 2005, it was the fourth of seven major carriers which went bankrupt. The recent bankruptcy of American Airlines will likely not be the end. For there will be more consolidation in the US airline Industry. Reuter indicates that “Since the Delta/Northwest and United/Continental mergers, American and US Airways have been considered logical partners for a potential combination, but analysts have said American’s high labor costs and unresolved contracts with its unions make any deal too difficult to negotiate.” Or put differently, the US companies will continue to merge, cut and go bankrupt. This has been the status of the US market since the early 1980’s, when deregulation started under the Reagan Administration.

However, one thing has been missed. Just look at this quote: “AMR’s decision to finally bite the bullet and file for Chapter 11 … was a transformational event,” said CRT Capital Group analyst Michael Derchin. “Virtually every airline is expected to benefit somewhat from AMR’s capacity retrenchment”.

Or put differently, what if overcapacity or too much capital are the real concerns? What if the problem is too much money coming from sovereign and wealthy interests is coming into the airline market? This is my contention.

Just look at the market. There are still a number of governments that own flag carriers. Estonian Air is owned by the government of Estonia. LOT Airlines, a Polish Carrier, has 2/3’s of its shares owned by the Polish Government. Bulgaria Air, Cubana, Ethiopian Airlines, Royal Brunei Airlines and Royal Jordanian also still have flag carriers. The interesting thing about those flag carriers is that they have government backing. This means that if a particular government wants to support its carrier it can. It can provide money for wages, gas or other services. Sometimes, it could be required to run a profit. While, other times profit is not important. Either way, a national flag carrier is not like a private carrier. For one needs to make profit; while the other has to fulfill national goals.

Yet, they all compete for the same passenger. In other words, the national carriers affect private sector players. In the case of LOT Airlines, the costs are noticeable. On their website, they note that they suffered operating and net financial losses in 2008, 2009 and 2010. However, LOT is a member of the Star Alliance. Consequently, LOT works closely with Air Canada and twenty five carriers. Further, LOT provides services in Canada, Australia, the US, Europe and Russia. This means that LOT has a significant influence on prices in a number of countries.

In additional to flag carriers, there are now “near flag carriers”. For example, let us take Emirates Airlines. They are an independent airline that has great financials. However, one thing sticks out. Emirates Airline has a lot of debt. While some is publically floated, most of the debt is held by the UAE or various Emiratis. Furthermore, Emirates Airline is only paying an effective interest rate of about 3%; a rate which would be reminiscent of a stable government. This is while there competitors would be paying interest rates which are between 6% and 12% Or put differently, “near flag carriers” get a lot help that allow them to provide a service for less than the market rate. If one notes that Emirates Airline has a number of strategic partnerships with airlines, like Sri Lankan Airlines; one can see that sovereign carriers are messing up standard market forces.

However, it does not end there. Governments privatization is causing even more chaos in the market. Air New Zealand, El Al, Monte Negro Airlines and Kenya Airways were all privatized within the last 10 years. While, in 2004, the Federal Government of Nigeria and Virgin Atlantic Airways signed a Memorandum of Mutual Understanding (MMU) that gave birth to the airline: Air Nigeria. So, there are a lot more carriers, or larger carriers, in the market. While this might seem to be good, one can only see issues. For, all of these countries have likely put a lot of money into these new private market carriers. Consequently, other private market carriers around the world will likely have to upgrade their planes – in response – or be considered to be second class carriers.  This would mean that capacity, as a whole, would increase.

Meanwhile, we have seen lots of wealth and private money come into the market. Porter Airlines is an example of this. Brent Jang wrote an article entitled “Porter: the little airline that could” for the Globe and Mail. (Published Friday, Nov. 20, 2009 7:44PM EST; Last updated Tuesday, Apr. 27, 2010 10:51AM)

“Porter’s shareholders include some of the smartest money on Bay Street: OMERS’ Borealis Infrastructure Management Inc. (which holds 21.4 per cent of the shares), EdgeStone Capital Partners (18.3 per cent), GE Asset Management Inc. (14.6 per cent) and Dancap Private Equity Inc. (3.1 per cent).

But the largest block of shares, 42.6 per cent, is held by Regco Capital Corp., the vehicle of a group of investors led by Mr. Deluce, veteran Bay Street money manager Ira Gluskin and Donald Carty, Porter’s chairman, with whom Air Canada clashed frequently when he was CEO of American Airlines Inc. and Canadian Pacific Airlines.”

The Caribbean provides us with another example. Most of the Caribbean is served quite well by foreign airlines including those who were based in Canada, the US and Britain. Consequently, it is not a surprise that Caribbean flag carriers repeatedly failed. For, there was an issue of overcapacity.

Instead of following governments lead, private money came into the game. They provided capital to airlines that should have gone bankrupt. Therefore, BWIA and Air Jamaica and their descendants, (i.e. Caribbean Airlines and the new Air Jamaica) were allowed to continue to compete in a money losing way for market share. We know that this is the case because, as of July 1st, both airlines are now owned by one corporation. However, because of international carriers, an overcapacity issue still exists. History tells us that this is the case and the market will reaffirm this.

So, the problem with the airline industry is not the union structure; the problem has been too much capital. If you question that just look at UPS. It is a unionized firm that makes more money than FEDEX – its non-unionized competitor.

Consequently, now that I have shown that the market has too much capital; my next blog will directly deal with potential policy implications for a Liberal Government.

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2 thoughts on “Why Kevin O’Leary is wrong: the Airline Industry problem is not Unions

    1. Actually, I do some research to ensure that all of my sources are accurate. In terms of the conclusion, I think that it speaks for itself. If one follows the evidence, one will find that Unions are neither bad or good, then one must search for another reason for the condition of the airline industry. I have argued and will continue to the argue that the issue is more related to its structure than its labour costs. Or put differently, a lot of private players with low labour costs have also gone out of business. So let us look at the structure of the industry and find a solution.

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