Labor Conflicts As A Manifestation Of Possible Future Oversupply Of Aircraft

Now that fuel prices are, at least temporarily, at much lower levels, labor conflicts are becoming more important to the airline industry.  Flight attendants of American rejected a contract by 16 out of over 16 thousand votes.  Qantas faces labor unrest and there is labor tension around the globe. The big news were serious strikes at Lufthansa and Air France/KLM.  The latter two cost hundreds of millions of Euros and forced Lufthansa to reduce its profit outlook a few times.  These conflicts are the result of different objectives of management and labor.  Management wants to increase profits by squeezing salaries while labor is averse to any reduction to their standard of work and living.  The major way legacy airlines can reduce costs is to try to lower existing salaries.  Not surprisingly, labor is vehemently opposed to such developments.  So, various new approaches are attempted.  One is to establish new low cost subsidiaries of existing legacy carriers.  This approach failed spectacularly in the US where all the “mini-me’s” were aborted.  The reason was that that the new start-ups, while supposedly appealing to a more cost conscious leisure traveling segment of the population were still faced with the same labor costs.  The pilots were the paid same as those on other routes.  Unions rationally understand that allowing those subsidiaries to pay less will eventually move more traffic to those entities, costing union members’ jobs.    Lowering costs through salary reductions is especially important for legacy carriers burdened by union agreements which tied salaries and retirement benefits to employees’ tenure.  For a legacy carrier that means high average salaries and a substantial burden of pensions.  The attempts at Lufthansa and Air France to reduce costs involved attempts to outsource jobs of existing union workers.

Why do we have the much publicized labor conflicts in Germany, France and other places now that the airline industry is on average relatively profitable?  As union members see it, now that airlines make money they can afford to pay their employees more.  Management is more concerned with costs because of added competition from low cost carriers (LCC’s) and new carriers, mainly domiciled in the Middle East.  Airlines in the US, for the last few years experiencing horrendous losses, finally are doing better and becoming the most profitable region in the world.  The reality in the US is that consolidation is actively supported by the government and all mergers were approved which resulted in a highly oligopolistic market with few remaining carriers restricting capacity growth and increasing fares.  There have been no real start-ups in the US for quite some time and the remaining carriers divide the market by controlling capacity.  The result is that the US industry has been highly, at least by historical standards, profitable.

The legacy carriers in Asia and Europe face a very different environment.  In Asia new LCCs are proceeding with huge orders threatening the legacies.  In Europe the situation is even more dire for legacies.  On shorter routes, where service differentiation and other benefits legacies can offer are much less relevant, LCCs are expanding very fast.  On longer routes the Middle East carriers expanded extremely fast and are on a trajectory to even faster growth.  This growth is at the direct expense of European legacy carriers like Lufthansa and Air France.  The huge orders placed by LCCs and Middle East carriers indicate that the status quo cannot continue.  European legacies will either have to stop expanding and cancel airplane orders or dramatically reduce costs to be able to compete.  This is one of the reasons for the large order bubble we are experiencing right now, which is a major factor explaining the strikes in Germany and France.

Two big changes are happening within the airlines as a result of changes in the competitive environment.  One is the movement towards unbundling, or transparency, in charging passengers for every individual aspect of flight.  The other is the attempt to reduce labor costs.  Since labor will not accept lower salaries, especially in times of enhanced airline profitability, management of legacy carriers tries to move part of their flying to entities with lower costs, attempting to avoid the mistakes committed in the US where lower salaries were not allowed.  Pressure for employing entities with lower labor costs creates strong resistance from unions which led to the recent European strikes.

What will the future bring?  The labor conflict is a part of much bigger problems.  If present realities continue, carriers like Lufthansa and Air France will either have to shrink or dramatically change their cost structure.  Labor conflicts always have a large irrational aspect to them.  If I were a guessing man I would bet that the outcome will be a diminished role of legacy carriers in European flights.  The recent collapse of oil prices, though, may help European legacy carriers by weakening their Gulf competitors.

Article featured in AirFinance Journal, ‘Pilarski Says’ column.