Milton's YVR Speech

[Guest GDR]

Speaking Notes For

Robert A. Milton

President and Chief Executive Officer

To

Vancouver Board of Trade

Vancouver

February 20, 2003

Good afternoon ladies and gentlemen. It's a pleasure to be here just 131 days before the International Olympic Committee names Vancouver as host of the 2010 Olympic Games.

Although I don't have a vote in Saturday's plebiscite, I do want to voice my support for the Vancouver Bid, Team 2010 and all the ongoing work of the Vancouver Board of Trade.

As a proud member of the bid team, it is Air Canada's objective to add value to the games by doing what we do best which is by "bringing the world to Vancouver" and leveraging all the work we have done to create a world-class hub for air services in this city.

Of course, 2010 is a long way off - especially for the airline industry. We are generally more concerned with what will happen in the next seven days, rather than the next seven years.

These days, the North American airline industry is a tough business. Seven days could mean yet another bankruptcy, more layoffs or another major financial loss. It's a sector in turmoil. Not just because of fallout from 9/11. Not just because of the economic downturn. Not just because of soaring government and government-mandated expenses. The airline industry is a tough business because the traditional airlines we grew up with - like United, American, USAirways, and so on - just don't work anymore.

In the airline sector, we call these the legacy airlines - the old, traditional, full-service network carriers which have been around for decades. For years, legacy carriers have tried to be all things to all people, but in today's world they are quickly becoming obsolete for a number of underlying reasons:

An inflexible cost structure.

A mammoth distribution infrastructure which relies heavily on costly computer reservation systems.

A vast airline network which is unnecessary for the price-conscious traveler.

It is estimated the major U.S. carriers lost $16 billion in 2002, and an Iraq war could make matters much worse.

American Airlines posted a (CDN$) $5.6 billion loss in 2002.

United lost (CDN$) $5.1 billion.

US Airways lost (CDN$) $2.6 billion.

US Airways and United are already under bankruptcy protection. Daily speculation abounds about when American will make its trip into bankruptcy court. Since 9/11, over 160,000 airline employees in North America have been laid off. That's the equivalent of over four Air Canadas and it's not a pretty sight. Negative financial outlooks abound around the globe. European carriers including KLM, British Airways and Lufthansa have recently issued warnings of reduced earnings following the pattern of the major U.S. airlines.

So where does Air Canada stand in all this carnage?

Well, by virtue of its history, Air Canada can also be described as a legacy carrier but for the past two years we have been working to ensure we do not become obsolete.

In 2002, a year of ongoing crisis for the airline industry, where billion-dollar losses at large North American airlines almost became the rule rather than the exception, Air Canada stood out and was the ONLY North American network carrier to post a sizeable year over year improvement in financial results. However, reading Canada's newspapers, you'd hardly know that this was the case.

But international observers have been generous in giving credit where credit is due. For example, just last week, one of the leading U.S. publications for our industry, Aviation Week and Space Technology announced their ten Laurels for 2002 awards in the Commercial Air Transport Sector. And Air Canada was a recipient. They recognized us for: "transforming the flag carrier into a nearly profitable operation in 2002 and successfully integrating Canadian Airlines.

Air Canada has unbundled a full-serviced, extensive, network airline and created separate units for the Aeroplan loyalty program; maintenance, repair and overhaul; and the on-line travel services portal. Each are now profit centers. They grasped the meaning of the changed environment and applied it to the carrier with a new business model."

Yes, Air Canada did report a net loss last year but, in reality, those results continued to surpass all North American international carriers, recording a whopping year-over-year improvement of almost $900 million versus 2001.

The radical improvement comes from some radical changes to Air Canada's full service airline model.

In fact, I think it's fair to say that Air Canada has undergone the most dramatic change in its history, and perhaps even in the history of the North American industry over the past 12 months, and perhaps even in the entire North American industry. We realized earlier than most that legacy carriers needed to re-invent themselves to survive the new industry environment.

I am proud of the fact that over the past two years Air Canada has consistently been ahead of other network carriers in re-positioning itself. It's worth mentioning that Vancouver has been particularly well served by this strategy as new brands like Tango and Zip have established a strong presence in this community.

With the introduction of initiatives such as Tango, Zip, Jetz and destina.ca, as well as the commercialization of Aeroplan, we have led network carriers in adapting to the new realities of the marketplace, and today, the world over, we are being copied.

With the introduction of the brand concept, came accompanying changes in virtually every facet of our operation including pricing, markets served, products, cost reduction and technology introduction.

We have been busy cutting costs:

Through the increased use of online bookings and restructuring of ticket sale commissions;

Through the reconfiguration of seats aboard our aircraft to add seats at little additional cost;

Through the removal of older jets and the expanding the efficient Airbus fleet;

Through process changes throughout the organization.

And, we have been breaking out the hidden value inherent in Air Canada's component businesses. Establishing new profit centers and highlighting shareholder value.

That's what we did with Aeroplan and our strategy was validated a few weeks ago with the announcement of an agreement to sell a 35 per cent stake in our Aeroplan subsidiary for $245 million. I love this deal. It's a concrete manifestation of something I've been saying for years: that the sum of Air Canada's constituent parts is grossly undervalued.

For Air Canada, the Aeroplan transaction values our frequent flyer program and its related commercial agreements at between $900 million and $1.2 billion. This is a first in the airline industry and we see it as a solid template for moving ahead with other subsidiaries. That includes the possible sale of a significant interest in Air Canada Technical Services and the creation of an Airport Ground Handling Services subsidiary. We are also moving ahead with the conversion of Air Canada Cargo to a stand-alone subsidiary.

Our approach is regularly validated by the number of initiatives we have seen at several international airlines.

Whether it's a Star Alliance partner like SAS setting up their own version of Tango; Delta Airlines taking part in their own musical number with their new low cost brand, Song another Tango clone; or American Airlines which recently became the latest legacy carrier to say that it too was looking to join the low fare game; the fact is the industry is following where Air Canada has led.

Yet while we have done all these things, it is still not enough in today's environment.

We are smack in the middle of our transition and the next phase is going to be the most challenging yet.

Last year confirmed for us that revenue trends and market dynamics have changed permanently and the new year is off to a rough start with the threat of war, escalating fuel prices and a challenging economic environment.

In Canada, we're seeing a nasty replay from the 1980s where carriers are chasing too few customers with so many new seats. That's a backward step for all carriers serious about serving Canadian travelers over the long term.

Consumers, including business travelers, are buying down and this trend is permanent. In addition, uncontrollable costs such as fuel, government-mandated fees and airport charges continue to rise at an alarming rate.

We've made a lot of progress in all areas. We've worked hard on reducing costs wherever and whenever we can, but it is not enough. That's not my opinion. It's the economic reality. We have to do more.

This time, we are not looking at planes and schedules and seats. We are looking at the new realities of the marketplace and the partnerships necessary to succeed. That includes partnerships with employees, the communities we serve and the federal government.

When we announced our results, we put everything on the table for our people and our unions. Old-style airline management would probably immediately resort to shrinking the airline and its workforce, just as the U.S. legacy carriers are unsuccessfully doing. I am convinced that is not the answer.

At Air Canada, we believe that the next step is not to shrink our airline but essentially to transform it into a low cost carrier in its own right. To do this we must address labour costs.

Air Canada's salaries and benefits represent over 30 percent of our operating costs - over $3 billion annually and we must do things differently to compete in the new environment.

If we had our main low-cost competitor's work rules, pay scales and so on we would drop $1.3 billion to our bottom line. If you stop and reflect on this, if we had our competitors labour cost structure we would have made a profit of $900 million dollars last year. So we've cut that $1.3 billion. And just remember, other recent low-cost carrier start-ups in Canada have even lower labour costs - that's what we're competing against. I'm confident our employees understand that reality. We have already started meetings with union representatives to discuss how we can find a permanent solution together. It's a formidable challenge but it is doable because, unlike the naysayers, I have faith in the people of Air Canada.

Just as we recognized the low fare travel phenomenon ahead of other traditional carriers and turned conventional wisdom on its head with brands like Tango and Zip, we intend to stay ahead of the curve and lead this change with the collaboration of our employees and their unions.

To succeed, we also have to embark upon a new style of partnerships with the airports and communities we serve. There has to be a realistic understanding of the industry's financial predicament from airport authorities and municipal authorities, and we have to work as partners in the development of sustainable air services.

Just as the airline industry has changed, the dynamics of the airline/community relationship will also change. Airlines will rely more and more on a collaborative approach to sustaining or implementing services and operations.

The Vancouver area - and British Columbia - has much at stake in the success of Air Canada. That stake adds to up $1 billion a year in the airline's direct contribution to the BC economy covering everything from fuel to salaries and benefits. Vancouver is home to 8,800 Air Canada employees and we are one of the largest private-sector employers in the community. Vancouver is also a key Air Canada hub linking North America to the world through Vancouver.

We may be determined to replicate the cost structure of our low cost competitors, but there is no way that they can replicate the contribution and spirit of this airline.

Now, there is a debate in this country as to whether or not this country needs a strong international flag carrier. Well, as part of this debate, consider the following:

As Canada's international network airline, we make good things happen in this community. Last month, we officially launched a new state-of-the-art Airbus A340 simulator, the latest addition to a major flight training facility in Richmond which now comprises four simulators. A fifth simulator, for Dash 8 aircraft, will be added this year.

This gives us critical mass here and provides an opportunity to market our Vancouver-based flight training services to other airlines. We estimate the new simulator will generate at least $2 million - a year - in spending in the local economy from the influx of visitors and staff who will train here.

That's just one snapshot of what a strong, international carrier - and only a strong, international carrier - can do for this community. Our vast network facilitates the growing trade and tourism links between Vancouver and some 20 international destinations.

Air Canada has worked hard to build Vancouver into a North American gateway hub - particularly for Asia-Pacific destinations like Hong Kong, Beijing, Shanghai, Tokyo, Osaka, Seoul and Sydney. And there's good news on Europe as well where we are boosting our Vancouver-Heathrow service from twice daily to three times a day over the summer months. Together with Star Alliance partners such as Lufthansa, United Airlines, ANA, THAI, Mexicana and British Midland we have strengthened our Vancouver hub to bring consumers throughout Western Canada more choice and better access to the world.

Just as Cathay Pacific is critical to Hong Kong; as Qantas is to Sydney; as British Airways is to London and as American is to Dallas; Air Canada is the critical player for Vancouver and only Air Canada is positioned to play that role.

Like you, we recognize that Vancouver is one of the world's top cities and has the potential to generate even more jobs and more economic activity. We want air transportation to be a catalyst for this growth, but the fragile economics of the airline business dictate a very careful and cost-effective approach. In finding that balance, we welcome the opportunity to work more closely with good partners like the Board of Trade and the business community in this city.

This is even more critical at a time when Vancouver is looking at the 2010 Winter Games as an opportunity to generate sustainable growth, travel and tourism. We look forward to working with all partners in this project to ensure that Air Canada's network is positioned to bring the world to Vancouver and to continue our work of building this city into a major transportation hub.

A strong airline industry is a facilitator for commerce, trade and travel, for two-way links between communities, provinces and countries. Airlines are the modern day glue that helps bind free trade agreements together and develop increased tourism.

At Air Canada, we are proud to play that role and we will continue to forge new links and new routes to the world. But, at the same time we need our partners to work with us to ensure an environment that allow airlines to grow the economy.

There are also many ways in which the federal government can work with the industry. The reduction to the domestic security fee announced this week is a good first step, but much more needs to be done. Let's look at ways to relieve the burden of fuel taxes when fuel prices go sky high. Let's work together to keep a lid on rising air navigation fees at a time when carriers can least afford it. Let's not be passive bystanders watching the US industry slide into bankruptcy.

Let's be proactive in Canada and create an environment for a sustainable airline industry in this country.

There's no doubt that adds up to a very tall order. It's an ambitious agenda for the future.

The challenges are formidable but surmountable.

Speculation in the media warning of Air Canada's imminent demise serve only to harden our resolve to prove them wrong - particularly when this speculation is fueled by competitors who have much to gain by the prospects of a diminished domestic presence for Air Canada.

Some suggest that we should simply concentrate on international routes and leave the domestic market to our low-fare competition. While that may suit the narrow agenda of some, it does not suit Air Canada's and it certainly does not suit Vancouver's. Such a prospect would be disastrous for Canada's major hub cities - particularly Vancouver.

A strong international hub carrier needs an extensive domestic feeder network to guarantee ease of connection for its international customers and a strong international city like Vancouver needs a strong international hub carrier to remain relevant in today's world. Without a strong international hub player, Vancouver would be reduced to a simple gateway without the linkages a strong hub infrastructure demands.

From our very first flight from Vancouver over 65 years ago, Air Canada has proudly served the breadth and width of this country - from St. John's to Victoria and 60 points in between.

We have contributed to the communities we serve and we have brought millions of Canadians together and with your support and the hard work of our employees, we will do so for many more years to come. I believe we will weather the storm. I look forward to the months ahead as a time of unprecedented opportunity and an exciting time for new ideas and innovation in our business. Whether it's a question of our support for this community or support for the 2010 Olympic Bid, you can count on us to say "yes" to a strong and vibrant future for Air Canada and for Vancouver.

Thank you.