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US Airways highlights drawbacks of consolidation

TEMPE – Their marriage was billed as the bold deal that would pave the way for the next – and perhaps last — round of airline consolidation.

Thirty months after near-bankrupt America West acquired the larger but twice-bankrupt US Airways, saving it from almost certain liquidation, the merged company is at best only a qualified success. If anything, it has illuminated once again just why there have been so few successful mergers in the airline business.

The merged carrier, named US Airways but led by America West’s management, had the second-best operating profit margin among all U.S. carriers last year and the best margin over the last two-year period. But widespread flight delays, a botched integration of the two airlines’ reservations systems, a steep decline in service quality and plunging worker morale combined to alienate customers and employees alike. Those problems limited what could have been an even better financial performance and have contributed to a nearly 80 percent stock price drop since its post-merger high of $62.95 in November 2006.

Now, $100-a-barrel oil, the slowing domestic economy, a weak position in the profitable international market and labor costs that are certain to rise significantly all threaten to unwind the financial turnaround since the September 2005 merger.

To complicate matters further, the carrier’s employees — most notably, its pilots — are seriously at odds with not only management but each other. Pilots from the two constituent airlines that formed the new US Airways can’t seem to agree on anything except that they dislike and distrust management even more than they dislike and distrust each other.

The dissension among US Airways’ pilots is teaching a cautionary lesson about the risks of consolidation. It’s cited as the reason that a similar dispute between the pilots unions of Delta and Northwest has prevented managements of those airlines from announcing their own much-discussed merger deal.

Nevertheless, CEO Doug Parker, who as chairman of America West was the driving force in the merger, enthusiastically defends the deal. Even knowing all that he knows now about the problems the merged US Airways has gone through and expects to face in the months ahead, he’d do it again.

“Absolutely. In a heartbeat,” the raspy-voiced Parker says before launching into a good-natured rant touting the deal’s positives.

“We saved at least 30,000 jobs,” Parker says at the conclusion of his well-practiced rant. “We created an airline that now is nationally viable as a stand-alone and is providing service to lots of communities that otherwise wouldn’t have any service. I really do feel good about doing all those things.”

A rosy plan
When Parker and his management team at America West were promoting their merger proposal in 2005, they promised to generate an extra $600 million a year in operating profit. They planned to do that through cost savings and additional revenue that would come from offering more non-stop flights and better connecting service than either the West Coast-oriented America West or the old, East Coast-centric US Airways had before.

The merged carrier has exceeded that goal already, he says, in large part by reducing capacity about 15 percent through the elimination of duplicate flights, shutting down its underperforming hub in Pittsburgh (US Airways’ original hometown) and better matching aircraft size and daily flight frequencies with actual passenger demand. As a result, the airline earned $427 million last year on $11.7 billion in revenue. Though both of its predecessors were perpetually cash poor, the new US Airways now has $3 billion in cash.

But the merged US Airways has quietly benefited from labor costs that have remained artificially low while the unions representing mechanics, bag handlers, flight attendants and pilots from both airlines have battled over how to integrate their seniority lists. Until that’s resolved, new contracts with higher pay rates and improved benefits can’t be put into place.

“It’s not a matter of if their labor costs will go up,” says Michael Derchin, a veteran airline analyst at FTN Midwest Securities in New York, “but how much and when.”

But Derchin defends the merger, based mostly on its financial results, which he calls “impressive.”

“A lot of things went right,” he says. “They did reduce a lot of capacity and rationalized their system. They focused their assets where they could maximize their returns. They also generated a lot of free cash and fixed their balance sheet.”

Still, even defenders of the America West-US Airways merger see the problems that the merger didn’t solve, exacerbated or created.

Derchin says management at the new US Airways failed to recognize how hard it would be to merge the two carriers’ reservations systems and other technologies for tracking data on everything from market-by-market demand trends to spare parts for Airbuses. The resulting meltdown of airport and customer service operations peaked last March when only about 55 percent of US Airways’ flights arrived within 15 minutes of the scheduled time.

Nor did the former America West managers really understand, Derchin says, just what bad shape the old US Airways’ fleet was in; how congested, antiquated, understaffed and poorly run the old US Airways hub at Philadelphia was; or how much the merged carrier’s long-term success depended on resolving those problems.

Parker concedes that management “screwed up” the switchover to a single reservations system, which created a cascading number of customer service and labor problems. Management also underestimated how difficult it would be to solve some of the lingering problems brought into the corporate marriage by the old US Airways, which had suffered for years from underinvestment, sloppy operations and poor morale, he says. Those managerial missteps contributed mightily to US Airways’ tumbling service quality in 2007. That, in turn, turned off US Airways’ best customers, many of whom now complain loudly.

Last year, nearly a third of US Airways’ flights arrived late by the Transportation Department’s standards. Only two regional carriers scored worse among the 20 tracked by the government. In the first and second quarters of 2007, US Airways finished last, with more than 35 percent of its flights arriving late.

It also finished last in both 2006 and 2007 among the nation’s seven biggest carriers in the number of reports of mishandled bags per 1,000 passengers and last in both years in the number of complaints filed per 100,000 passengers boarded.

Troubles in Philly
Brian Shott, a plant project engineer from Hazelton, Pa., and a platinum-level member of US Airways’ Dividend Miles frequent-flier program, says the “service aboard the aircraft is embarrassing. The price paid for the ticket does not reflect the service rendered.”

Dale Emerson, a consultant from Lutz, Fla., whose 200,000 miles a year on US Airways qualifies him for Chairman’s Preferred status in the Dividend Miles program, says he has seen improvements in service in many cities the carrier serves, but the US Airways hub at “Philadelphia continues to be a major problem.” Five times in the past 12 months, his bags have gotten lost there.

Similarly, Norman Ross, a gold-level frequent flier from Frederick, Md., says service consistency is lacking, especially in Philadelphia. “For example, I have flown into both Bar Harbor, Maine, and Hagerstown, Md., and have been very impressed and pleased with the caring service I have received. But I must admit, I try to avoid going to Philadelphia since the level of service I experience at that airport is about the worst of any location, or carrier.”

Airline analyst and consultant Michael Boyd, head of the Boyd Group in Evergreen, Colo., is more biting in his criticism. “How many people have you heard say, ‘Gee, I really love flying US Airways’? You don’t hear that because the service mostly is just awful, and even when it’s not awful, it’s confused. It’s the airline version of Baghdad. Nobody knows who’s doing what.”

The 2006 death of America West’s longtime operations chief, Jeff McClelland, also set back the transition process, as did Parker’s decision not to hire a replacement.

Employees also grumbled that instead of focusing on melding the two carriers, Parker and President Scott Kirby, promoted from head of marketing after McClelland’s death, focused much of their attention in late 2006 and early 2007 on a bid to merge yet again, this time with Delta Air Lines, in Chapter 11 at the time.

Delta’s management, supported by its employees, at least some of its major creditors and some members of Congress, rebuffed US Airways’ $8 billion offer, arguing that Delta would be worth more on its own.

Parker says that’s in the past. US Airways now eagerly promotes the dramatic steps being taken to improve customer service, dress up planes, improve customer service and fix the problems at the Philadelphia hub.

This year’s budget includes $50 million for upgrading aircraft interiors. Public contact employees are getting new uniforms and more training. New equipment for handling bags and aircraft on the ground is being acquired. And a new internal campaign is being launched to help motivate employees to make theirs the “Airline of Choice” by delivering RCA — reliability, convenience and appearance — to passengers.

Last fall, Parker also brought in a new chief operating officer, Robert Isom, a former head of ground operations and airport customer service at Northwest Airlines. Isom hired two new executives from other airlines to manage the carrier’s East Coast division and its unruly Philadelphia hub. In fact, the carrier is adding so many new or relocated managers at Philadelphia that it has taken to calling it a “satellite headquarters.”

That new focus on operations seems to be having an impact. US Airways ranked first among the nation’s six big hub-and-spoke airlines in on-time performance in December and January and third overall among the nation’s 20 largest carriers by passenger traffic.

Isom projects another strong showing in the February numbers when they come out next month.

“I’m very proud of the improved performance our people have been responsible for,” Isom says. “But the real trick is going to be sustaining it.”

Employees of merged airline are still miles apart

Improving labor relations could be the biggest challenge in completing the merger of America West and the old US Airways.

So far only four smaller work groups from the so-called East (old US Airways) and West (America West) halves of the merged airline have agreed on how to integrate their seniority lists. The mechanics, bag handlers, flight attendants and pilots are still divided, bitterly so in the case of the pilots.

The pilots’ fight is over seniority, which determines which planes they fly, their days off, their career earnings and their retirement pay. It also determines how many years it takes a pilot to reach the top-paying job as captain of an international-range Airbus A330, and how many years a pilot will remain in that plum job before retirement.

America West’s younger, less-senior pilots demand the right to advance quickly to the A330. Their reasoning: all of the so-called East pilots would be out of work had there been no merger.

Pilots from the old US Airways want to retain seniority rights to those wide-body jets’ captain’s seats. An arbitrator’s ruling last May satisfied neither side.

Jack Stephan, head of the East pilots’ branch of the Air Line Pilots Association, says accepting the arbitrator’s award means “hundreds of our pilots would never see the left (captain’s) seat of a wide-body plane, and some smaller number would never even make captain” at all.

Still, members of Stephan’s East pilots group felt betrayed by ALPA and formed the US Airline Pilots Association, with the aim of replacing ALPA. USAPA organizers got more than 3,000 of the carrier’s 4,600 pilots to sign cards calling for a representation election. This week ALPA national officials ousted the three elected officers of the union’s local at US Airways’ Philadelphia hub, accusing them of siding with USAPA. Results of the online voting will be known April 17.

John McIlvenna, head of the West pilots ALPA unit, warns that if management bows to pressure from the larger East pilots group and cuts a deal bypassing the arbitrator’s ruling, “It will make their labor problems here much, much worse than they already are.”

And if USAPA wins the representation election, he says, “It’ll be all-out war.”

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