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McClean's Article on AC's LCC idea

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http://www2.macleans.ca/2011/04/25/the-cheap-seats/

Air Canada’s plan to shake things up by launching yet another discount airline

Can it learn from past mistakes?

by Chris Sorensen on Monday, April 25, 2011 10:00am - 1 Comment

Air Canada

The late 1990s were heady days for penny-pinching North American air travellers. Southwest Airlines, Frontier and WestJet were shaking up the industry with rock-bottom airfares and an army of fresh-faced employees in golf shirts prone to making jokes over the cabin public-address system. Suddenly finding themselves under attack, big, bloated network carriers attempted to respond by rolling out their own discount outfits, splashed with spirited names like Ted (United Airlines), Song (Delta Air Lines), MetroJet (U.S. Airways) and Tango and Zip (Air Canada). The idea was to not only mimic their new rivals’ low prices (although not necessarily their low cost structures), but also the look and feel of a fresh upstart—sometimes with amusing results.

“Somebody at United determined that one of the reasons Southwest was so successful was because they wore shorts,” says Marc-David Seidel, a professor at the University of British Columbia’s Sauder School of Business, recalling a visit to the California operations of Shuttle by United, another big carrier discount attempt. “So, you know the classic pseudo-military United uniforms that are made out of polyester? They basically just took those and cut off the legs.” It gets worse. “One day management decided employees were supposed to have more ‘fun,’ so all these poor people were running around San Francisco airport wearing those little beanies with a propeller on top.” Needless to say, the strategy didn’t work, and Shuttle was scuttled in 2001. Most of the other “airline-within-an-airline” efforts met a similar fate.

Now, a full decade later, Air Canada is once again toying with the idea. It’s trying to convince its unionized workers to support the creation of a new discount airline that would fly all-economy-class planes to various vacation destinations. But can Air Canada really make money on the cheap seats this time around? Though it’s far from clear whether the project will come to fruition after a key agreement with the airline’s pilots got bogged down last week, the reality is that Air Canada, which has seen its stock plunge nearly 90 per cent to around $2.40 since its post-restructuring IPO in late 2006, is steadily losing market share to younger, cheaper competitors such as WestJet, Transat and Toronto’s Porter Airlines. All this at a time when fuel prices, typically the second-biggest expense for an airline after labour, threaten to eat into already thin profit margins. It has no choice but to attempt a little shaking up of its own.

The proposed carrier would compete head-on with low-cost packaged holiday sellers such as Montreal’s Transat AT, WestJet Vacations, Sunwing and Thomas Cook’s Sunquest Vacations to destinations in Europe, the southern United States, the Caribbean and Mexico, although some less profitable domestic routes could also be included, according to people familiar with the plans. The business model calls for the use of four of Air Canada’s older Boeing 767s and six Airbus A319s, although the fleet could eventually grow to 50 planes. That would likely include more of Air Canada’s older 767s, which are scheduled to be replaced with newer Boeing 787s beginning in 2013. The yet-to-be-named carrier would ideally be launched within the next 12 months, according to recent statements by Air Canada CEO Calin Rovinescu.

“There’s a huge segment out there that Air Canada still has difficulty going after, and that’s the price-sensitive traveller,” says Steve Smith, who ran Air Canada’s last discount effort, Calgary-based Zip, until it was shuttered in 2004. “Take Florida, for example,” Smith says. “Everyone is looking for $99 fares and if they don’t get them, they don’t fly.” The long-term risk, argues Smith, is that some of the big players in the packaged holiday market, such as Montreal’s Transat, could one day become a viable long-haul alternative for travellers who aren’t wearing Bermuda shorts. And Air Canada, which managed a profit of $107 million in 2010, bouncing back from a loss of $24 million a year earlier, simply can’t afford to lose any more customers to its rivals. While Rovinescu is pitching the proposal as a growth opportunity, others suggest it is mostly a defensive manoeuvre. “You don’t make a lot of money flying people in flip-flops to Florida,” said one person with knowledge of the airline’s plans. “But maybe that helps you grow somewhere else.”

The key ingredient is driving labour costs low enough to make the effort profitable, or at least a break-even proposition. “There are razor-thin margins in this market,” says Rob Kokonis, the president of Toronto-based airline consultancy AirTrav Inc. “That’s why so many leisure carriers have come and failed.” WestJet is one of the few exceptions. It has managed to stay mostly profitable despite high fuel prices and increased competition because its costs are roughly 30 per cent lower than Air Canada’s on any given route. In part, that’s because WestJet’s workforce is non unionized, but also because the airline operates a single aircraft type, helping to save on pilot training and maintenance costs.

As a result, Air Canada is seeking a lower pay rate and more flexible work rules for pilots who work for the proposed discount carrier. But while negotiators for the two sides had hammered out a deal, officials at the pilots’ union called off a planned ratification vote last week because of members’ objections. Air Canada is also in talks with its other employee groups, including ground workers, ticket agents and flight attendants.

Getting everyone on board will not be easy. Bill Trbovich, a spokesperson for the International Association of Machinists and Aerospace Workers, made it clear that the union’s 11,000 Air Canada maintenance and other ground personnel are more interested in clawing back previous concessions. “We took a pretty healthy pay cut to keep this airline afloat,” he says, criticizing concessions Air Canada’s pilots made with regard to pension plans for new hires. “The pilots have thrown their young to the dogs,” he says. “That’s not going to happen with us.”

There’s also the significant challenge of building and marketing the new discount carrier. “All these airlines-within-an-airline, no matter the rationale, ended up duplicating too many of their costs, and it took management’s eyes off the ball, which is the parent corporation,” Kokonis warns. One of the few exceptions frequently cited by people familiar with Air Canada’s thinking is Australia’s Jetstar Airways, owned by the parent of Qantas Airways. Jetstar was launched in 2003 in response to the arrival of low-cost competitor Virgin Blue, and has since thrived alongside its bigger sibling.

The bottom line is that Air Canada has much to gain and little to lose. Even if its third attempt at a discount airline turns out to be another flop, it won’t have shelled out extra money on new planes or back-end infrastructure. And it will have given itself a chance to experiment with new discount strategies and products that can later be incorporated with the mainline carrier. That’s what happened with Tango, launched in 2001 with its own planes and purple colour scheme. It was folded back into Air Canada as a fare class just two years later.

Perhaps most importantly, creating a new discount carrier promises to usher in a new model of employee pay, benefits and work rules at Air Canada. While the new airline would be operated separately from the main carrier, likely with labour agreements that prohibit it from flying routes occupied by Air Canada’s better-paid pilots, Rovinescu is no doubt hoping that, if the gambit is successful, all of Air Canada’s unionized employees can be convinced that further cost-cutting is the road to the future. “It appears to me that they are trying to get lower-cost structures on the books,” says Seidel, emphasizing the need for Air Canada to more closely resemble its low-cost competitors. Minus the shorts and propeller hats, of course.

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.....because its costs are roughly 30 per cent lower than Air Canada’s on any given route.....

Once again an BS statement made by someone who does not know the airline business.

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I do not think the quality of middle and lower management is present in quantities big enough to run this venture successfully. Even if the AC LCC was to have the same labour rates as Westjet Or Transat, I doubt they could mobilize a workforce the way Westjet does. (productivity, it is all it's about!) Personally, if offered the same rates of pay at AC or Westjet (pension plan included), I would go to Westjet in a heart beat. The friends I have there are happy to work there, they work as a team and all seem to pull in the same direction. It's nice to be in a company where you feel like you make a significant difference. At AC, the bureaucracy is mesmerising and most initiative is discouraged by the present structure. When you are young and have the will and energy to change things, to improve them, you need to be in an environment where ideas can be proposed and implemented (if they are efficient and effective, why not?) not in a company where every day the same thing happen and the heavy bureaucracy assures the status quo.

The international LCC with a lower cost structure is probably not a bad idea but it seems like a better concept for some upstart carrier (not a division of AC). Let new ideas flow, let new people contribute and maybe with a decent business plan, a decent management team, a possibility of reward for success, some start up capital and some leased airplanes, it can be a success.

If you run the show with the same managers, within the same structure, you are sure to get so much internal squabbling and division fights that the venture will not last half as long as Porter has.

My humble opinion of this LCC,

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I do not think the quality of middle and lower management is present in quantities big enough to run this venture successfully. Even if the AC LCC was to have the same labour rates as Westjet Or Transat, I doubt they could mobilize a workforce the way Westjet does. (productivity, it is all it's about!) Personally, if offered the same rates of pay at AC or Westjet (pension plan included), I would go to Westjet in a heart beat. The friends I have there are happy to work there, they work as a team and all seem to pull in the same direction. It's nice to be in a company where you feel like you make a significant difference. At AC, the bureaucracy is mesmerising and most initiative is discouraged by the present structure. When you are young and have the will and energy to change things, to improve them, you need to be in an environment where ideas can be proposed and implemented (if they are efficient and effective, why not?) not in a company where every day the same thing happen and the heavy bureaucracy assures the status quo.

The international LCC with a lower cost structure is probably not a bad idea but it seems like a better concept for some upstart carrier (not a division of AC). Let new ideas flow, let new people contribute and maybe with a decent business plan, a decent management team, a possibility of reward for success, some start up capital and some leased airplanes, it can be a success.

If you run the show with the same managers, within the same structure, you are sure to get so much internal squabbling and division fights that the venture will not last half as long as Porter has.

My humble opinion of this LCC,

X2!!!

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Ah, because Fido says so, apparently.

Does Westjet pay similar Airport fees as AC?

Does Westjet pay similar rates for fuel as AC?

Does Westjet pay similat NavCanada fees as AC?

Does Westjet pay similar maintenance expenses as AC?

Does Westjet pay similar employee wages and benefits as AC?

AC might pay more then Westjet for maintenance, wages, training, and maybe aircraft food? As for the rest, I assume it's pretty much on par and it more then likely, is able to command a premium on some flight with a business class product and/or route exclusivity. Since wages command a 18% portion of general revenues, I doubt the 30% advantage is all in the wages. Where do you suppose that 30% comes from? Better aircraft utilisation? Cheaper cost of owning versus leasing? Higher productivity?

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Does Westjet pay similar Airport fees as AC?

Does Westjet pay similar rates for fuel as AC?

Does Westjet pay similat NavCanada fees as AC?

Does Westjet pay similar maintenance expenses as AC?

Does Westjet pay similar employee wages and benefits as AC?

AC might pay more then Westjet for maintenance, wages, training, and maybe aircraft food? As for the rest, I assume it's pretty much on par and it more then likely, is able to command a premium on some flight with a business class product and/or route exclusivity. Since wages command a 18% portion of general revenues, I doubt the 30% advantage is all in the wages. Where do you suppose that 30% comes from? Better aircraft utilisation? Cheaper cost of owning versus leasing? Higher productivity?

What about servicing Debt and Pension shortfall. That might add to the bottom line/CASM.

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...and the staggering training costs associated with the musical chairs game that starts with the pilots every time someone retires etc.

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Look at the cost buckets that an airline must fill:

30% to 50% is fuel

17% to 25% is labour

8% to 11% is maintenance

8% to 11% is aircraft ownership, leasing, rent

.0001% is insurance

~10% is landing, passenger terminal, or enroute fees

The 30% difference is made up entirely by Westjet not having anything but economy seats. The 'new' Air Canada LCC will be roughtly the same. International Executive First is a BIG cost item mainly because of the amount of space it takes in the airplane.

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Look at the cost buckets that an airline must fill:

30% to 50% is fuel

17% to 25% is labour

8% to 11% is maintenance

8% to 11% is aircraft ownership, leasing, rent

.0001% is insurance

~10% is landing, passenger terminal, or enroute fees

The 30% difference is made up entirely by Westjet not having anything but economy seats. The 'new' Air Canada LCC will be roughtly the same. International Executive First is a BIG cost item mainly because of the amount of space it takes in the airplane.

Music to my ears. 15 years and nothing has changed.

:cool:

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There is another difference between WJ and AC that is lacking in the list. Landing fees for widebody aircraft are higher than narrow body counterparts. This drives up the cost of operating a larger aircraft so AC will incurr a greater cost for landing fees.

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There is another difference between WJ and AC that is lacking in the list. Landing fees for widebody aircraft are higher than narrow body counterparts. This drives up the cost of operating a larger aircraft so AC will incurr a greater cost for landing fees.

Not on a per seat basis/ The cost per seat of landing fees actually decreases.

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I don't believe Westjet is an IATA member either. AC pays a fair bit to them annually as well.

Membership Application Fees and Dues for 2011

All the below mentioned amounts must be settled prior to membership approval.

Active Member: operating international services, including domestic.

Associate Member: operating domestic services only

One time fees

Application fee (non-refundable) paid on receipt of the application

form US$ 15,000

Entrance fee paid on completion of the application review :

Active Member US$ 15,000

Associate Member US$ 12,000

Annual dues

Fixed fees* US$ 16,755

Variable fees**

International Airline Training Fund (IATF)*** contribution US$ 1,500

Not really a significant amount given other expenses.

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Not really a significant amount given other expenses.

You forgot this part:

*The fixed fee is the minimum fee paid by all IATA members. It is assessed annually.

**The variable fee is calculated only for active members that perform over 5 million Revenue Tonne Kilometers (RTKMs) per annum and is paid in addition to the fixed fee. It is calculated based on the airlines traffic statistics (RTKMs) for the previous two years.

***Each member contributes to IATF for scholarships to members from countries with developing economies.

I don't recall the amount I was quoted a while back, but I believe it was millions annually.

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Music to my ears. 15 years and nothing has changed.

:cool:

No kidding. It's actually laughable that over the years everything you have preached about could have educated Mr Steve Smith how to properly run an LCC, yet here we are staring at a possible Zip 2.0...

The concept is simple, yet so few actually get it.

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The concept is simple indeed but you need to start with clean slate in order to be effective. When WestJet was formed back in the day it could have not been high cost even if it wanted to because it was beginning from zero.

No legacy airline can morph into an LCC unless it is allowed to start a division from scratch.

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I think the AC LCC is probably a smoke screen. I think the true target is the pensions. CR must realize the pilots would never agree to such a set up as they're reporting in the news and it'll be a blame-the-pilots scenario when the deal fails, so they'll get the pension reform they sorely need as a 'secondary' conciliation.

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Where does the idea of low wages come in. I know that's what being suggested for AC lite but why? Aren't southwest crews among the best paid in the Industry. Isn't the total compensation of a WJ pilot with profit sharing roughly the same as an AC pilot with a pension?

Wages aren't the secret to a successfull LCC and if they're gonna gonna start a LCC with that low wage assumption using old beaten up aircraft then I might just voluntary switch to a DC pension.

Edited by Specs

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Someone is definately missing the big picture here. An LCC cannot be setup and run successfully simply by paying the workers less and working them harder.

I have been at WestJet for 11+ years now and have been a captain for almost 10 of those years. When I look at my T4 and compare it to collegues flying the narrow body fleet with the maple leaf on the tail I am quite satisfied with what I earn. Without bragging or going into too much detail the number on my T4 was considerably larger, by in some cases over 50K than some of my collegues.

  • Some of the places WS gets more efficiencies are scheduling pilots between 77.5 and 82.5 hours of hard time per month, we do not have a credit system.
  • Aircraft utilization of over 12 hours per day.
  • Motivated employees, many still scoff at this citing koolaid etc but you can't argue with success. This model does work, unfortunately for AC (both management & employees) there is so much mistrust between the employees and management that Calin could come up with the perfect plan to resurect AC and it would probably get voted down through misunderstanding and lack of trust.
  • Single fleet type, although there are rumours that this my change over the next few years.
  • No J class and the associated costs
  • RNP approaches save us 80-100 pounds of fuel per arrival/departure. This ads up to huge savings over the course of a year and the side effect is less GHG emissions.
  • Crew grooming of aircraft saves us millions each year and allows us to have shorter turn times leading to greater aircraft utilization.

WestJet does not have lower costs simply on the backs of it's employees. The efficiencies are found throughtout the company and it's operations. Just hacking the saleries and working conditions and leaving everything else the same is a recipe for disaster.....again.

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