Air Canada's Bad Choice

[Guest Avcat]

AIR CANADA'S CHOICE

The parallel histories of Qantas and Air Canada read like an experiment in bad decision-making. Guess which one made the bad decision

Peter Shawn Taylor

Financial Post

Friday, March 28, 2003

With the historical similarities between Australia and Canada obvious and well-known, it can be more illuminating to dwell on the differences. So what does Australia have that Canada doesn't? Animals with pouches, a Prime Minister with a backbone and an international airline that makes money.

Geography and evolution explain the lack of marsupials. The political reality is more of a mystery. But surely the most curious situation of all is the fact that Qantas, the Australian airline, made $380-million last fiscal year, $316-million in the six months ending Dec. 31, 2002, and stands among the few consistently profitable airlines in the world. Air Canada, on the other hand, lost $428-million last year, $1.25-billion the year before and is currently scrambling to cover a cash-flow crisis that necessitates the layoff of 10% of its work force and the possibility of a government bailout.

Admittedly the past few years have been unkind to the airline industry worldwide; but the parallel histories of Qantas and Air Canada read like a scientific experiment in bad decision-making. Air Canada would likely be profitable if it had made the same choice as Qantas.

Both Australia and Canada are big countries with small populations. Five years ago their respective air industries were characterized by one formerly government-owned international flag carrier and one domestic competitor that was perpetually on the verge of collapse. Canadian Airlines filled that role in Canada, Ansett in Australia. When both domestic competitors finally gave up the financial ghost, there was speculation that the larger airline would take over its competitor and rescue the industry.

And that's where the two paths diverge.

Air Canada bought Canadian in 2000 after a frenzy of offers and counter-offers. This move was aided and abetted by the federal government, which suspended the Competition Act to allow merger discussions to take place and refused to relax foreign ownership rules that would have allowed new entrants from overseas compete for Canadian's assets. Air Canada, in a moment of hubris it must now regret, grabbed a near-monopoly in domestic air travel. It hasn't made money since.

Australia's Ansett failed in September, 2001, just as the global air industry was being thrown into chaos. The Australian federal government asked Qantas to purchase Ansett to save jobs, but the request was largely a pro forma exercise on Canberra's part. It took Qantas just two days to say "no thanks." With Ansett grounded, Qantas was then able to take advantage of the massive collapse in international air travel by diverting its excess capacity to the domestic market. This kept it profitable through one of the worst years on record for world air travel. The resultant surplus in airline staff has also given Qantas the whip hand in dealing with unions.

The timing of Ansett's collapse was a tremendous gift to Qantas. But it was an opportunity that management was smart enough to seize. Air Canada, on the other hand, turned opportunity into financial disaster. By agreeing to buy Canadian instead of letting it fail, management played a key role in the re-regulation of its own industry. In addition to saddling itself with the combined millstones of excess labour, old aircraft and massive debt, Air Canada was also stuck with restrictive agreements on union contracts, routes and fares. Today Air Canada can be investigated by the competition bureau for having fares too high, too low or even the same as its competitors. The price of a near-monopoly in its home market was to become a regulatory target.

The Australian government was spared the problems of domestic dominance by Qantas and has opted for competition over re-regulation -- to the benefit of airlines and consumers. Prior to Ansett's collapse, Richard Branson's Virgin empire was allowed to open the discount carrier Virgin Blue in Australia. Over the past three years, its presence has actually pushed discount domestic fares down by 23%. A Virgin-style franchise arrangement was specifically ruled out by Ottawa. While WestJet and others do provide serviceable competition in Canada, these primarily seek niches not dominated by Air Canada. Virgin Blue competes head to head with Qantas on most major domestic routes.

"Qantas has escaped without the regulatory strings attached that Air Canada has had from its competition authorities," observes Keith Trace, a Melbourne airline consultant who recently returned from Ottawa after talks on cross-border transportation issues. "It would have been a drastic mistake for Qantas to buy Ansett." Qantas's ability to switch routes, planes, staff and fares on a moment's notice is what has allowed it to innovate throughout these difficult times.

Ottawa may never allow Air Canada to fail, as Transportation Minister David Collenette suggested recently. But the current structure of the industry means it will never become successful either.

So what would have happened if Air Canada had said no to Ottawa? More than likely it would be making money today, despite the tough times. All the current problems of cash flow, debt, layoffs and overregulation stem directly from the ill-fated decision to buy Canadian. Air Canada was actually profitable before the merger. And had the merger never taken place, Ottawa could have been forced to review its restrictive ownership rules with a more liberal view to competition.

Qantas is an extremely well-managed company that has cultivated a close relationship with its federal government and benefited greatly from the loss of its chief competitor. In similar circumstances, Air Canada's management has racked up massive losses and turned Ottawa into an adversary despite doing its bidding. Two roads diverged in a yellow sky ... and Air Canada wishes it had taken the other one.

[Guest kevbert]

Interesting interpretation.

A few things that the author should have included:

(1) the Canadian/AC merger took place at a time when the world was the airline's oyster - I believe both side saw the benefits of the merger. Also if AC had said "no thanks" to Canadian, I believe there were a few oneworld partners with cash. AC was also able to tap into that thinking with the funding from UAL and LH. Why else would someone put in no-layoff clauses if they thought they weren't going to make money?

(2) restrictive union rules existed before the merger and exist now. The comment of being "able to switch aircraft at a moment's notice" is a stretch.

(3) "it hasn't made money since" - I believe there was an economic downturn, a terrorist attack, and a war in there somewhere....

(4) "sadled with debt" - AC had a bit of it before the merger - also see comment #3

(5) the government got involved - that's just as much as a fact as the takeover took place. Sure, it put pressure on AC management but managers are employed and paid to make due with what assets they have.

The competition argument is valid yet stretched - Australia is a country with large cities and very few city pairs. Canada has many small communities which is must serve. Competition is much more difficult on thinly traveled routes.

Also the author should have done his research that AC was targeting at 10% operating margin (to be competitive with the US majors) and that had eluded AC management for years, even with the flocks of loyal business class passengers flying AC in the triangle. I would be hesitant to give AC management such praise.

[Idle Thrust]

At last! A newspaper that "got it right".

IT.

[Guest JW]

...and re: hubris, maybe the term is applicable, but not with regard to the dominance issue (monopoly as stated in the article)- at the merger or collapse of CDN, AC was bound to be the dominant carrier in ANY case.

That's reporting, op ed, editorial, or ...??

...imo!

JW

[Guest Starman]

Actually, he got it wrong:

Since the merger, the most profitable routes flown in Air Canada's system have been ex-Canadian routes. The fact that the company has hired pilots and flight attendants since the merger puts the lie to the miss-conception that Canadian brought unneeded employees to the equation. The "massive debt" brought to Air Canada at the time of the merger was Air Canada's debt, not the net $1.35 billion added by Canadian Airlines.

Robert Milton added another $1 billion in debt, buying up Air Canada stock at $15 plus in attempting to ward off Onex Corp in a deal which was ultimately ruled illegal anyway, because of the Air Canada privitization act of 1988. The same Onex Corp who he now runs to, cap in hand, to purchase valuable company assets at deflated prices.

Unlike the QANTAS / Ansett scenario, Canadian Airlines brought an international route structure to Air Canada which gives it all the route authority of all five U.S. majors combined. And if Air Canada had Canadian Airlines cost per seat mile today, we'd be operating in the black.

[bluemic]

And a few other disparities...

Ansett was primarily a domestic carrier with very few overseas routes. CDN had an overseas network that rivalled AC. By not picking up CDN, Milton stood a good chance of losing those destinations to C3, Air Transat, etc.

Qantas wasn't involved in a takeover battle that would have seen itself swallowed up by a consortium which included Ansett.

Qantas doesn't feel the pressure from south of the border. The next place south of Oz doesn't have much of an airline system.

"Air Canada was also stuck with restrictive agreements on union contracts, routes and fares." Exactly! I'll speculate that Australia (and Qantas) doesn't have near the government involvement (read: fees/rules) that our country does.

"While WestJet and others...primarily seek niches not dominated by Air Canada". He's kidding right? So Robert really doesn't have to worry about WJA after all…

"Air Canada was actually profitable before the merger." R-i-g-h-t. And an investor in AC shares back in the '80s would be a rich man today. Now where'd I put that deed...?

"Prime Minister with a back-bone?" Well, it might be a little early to call that one. I'd venture that Mr. Peter Shawn Taylor doesn't have a son/daughter in the military. Personally I'd have left that statement for the history books.

If I may philosophize for a moment? As the author says, Australia is a country that has many similarities to Canada. It also has many differences. Australians have an intense, American-like, pride in their country and themselves. They value (and respect) most things Australian. Unlike Canada where we spend our lives navel-gazing and dissing our leaders, our institutions and ourselves. They think of themselves as "the lucky country". We think of ourselves as living in the shadow of a giant. Trying to compare us (whether pouches, leaders OR airlines) is a lot like paw-paws and oranges.

Lastly, "Qantas is an extremely well-managed company". Okay, he might have gotten that one right.

All in all, just another effort from a writer who, having cobbled together a few facts with lots of assumptions, and after adding a whole bunch of hearsay, has stirred it up, and presented it as "reality". But even the first bite reveals it as just another fairy-tale.

mic

[RFL]

qASSESSMENT OF RECENT PERFORMANCE OF CANADIAN CARRIERS:
Dr. Tae Hoon Oum
Dr. Chunyan Yu
SUMMARY
This report provides an assessment of the performance of Air Canada and Canadian
Airlines during the 1990s in comparison with eight major US carriers. In particular, we
examine the airlines’ performance in terms of input prices and input cost shares, partial
factor productivities, total factor productivity (TFP) and residual TFP, unit costs and cost
competitiveness, yield, profitability and other financial performance. Our findings can
be summarized as follows:
• AC and CAI enjoy lower average labour price and materials input price than the US
carriers, whereas the US carriers generally enjoy lower fuel price. Overall, Air Canada
and Canadian Airlines enjoyed substantial input price advantage in the second half of
the 1990s, largely due to Canadian dollar devaluation.
• Air Canada was among the lowest performers in almost all of the productivity
measures we computed and analyzed. The only aspect Air Canada achieved an above
average performance was fuel productivity. On the other hand, Canadian Airlines
made significant improvement in its productivity, and achieved above average
performance among our sample carriers during the second half of the period with the
exception of 1999 when its performance suffered a sharp drop. CAI’s productivity
and efficiency levels were consistently higher than those of AC throughout the 1990-
99 period.
Between 1990 and 1998 (also true for 1999) AC and CAI’s cost competitiveness
improved essentially due to the fact that devaluation of Canadian dollars made labour
and other input prices cheaper as compared to the U.S. carriers. As a result, despite
its dismal performance in productivity and efficiency Air Canada become cost
competitive relative to some of the major U.S. carriers including American,
Continental, Delta, Northwest, and United. By 1998, CAI became the most cost
competitive airline in North America, and its unit cost advantage over AC was about
21% mainly due to the CAI’s relatively high productive efficiency.
• Air Canada was able to achieve a slightly higher than average yield during our sample
period, but it had a rather high unit cost. As a result, Air Canada’s revenue-cost ratio
was among the lowest ones during the 1990-99 period. Canadian Airlines, on the
other hand, was among the most cost competitive carriers in our sample, but its
average yield was the lowest of all the carriers. Consequently, CAI had the lowest
revenue-cost ratio during the second half of our sample period. CAI’s average yield
was substantially lower than that of AC throughout the period. In fact, the gap in
average yield between AC and CAI increased consistently from 12% in 1993, to 24%
in 1995, 30% in 1997 and 37% in 1998. Even after statistically removing the effects
of differential average stage length and output mixes between AC and CAI, the
residual yield level for CAI was less than AC’s by 12% in 1996, and 14% in 1998.
These differences in average yields is likely to have been the most critical determinant
for the CAI’s sustained losses, and for the AC’s survival.
• Air Canada made considerable improvement in its financial performance, and
achieved about average performance compared to the US carriers. CAI’s financial
performance was at the bottom of the group in almost all aspects. CAI’s financial
performance remained poor, and even declined during our sample period, despite the
fact that most of the other airlines improved their financial performance.
Our results show that productive efficiency and cost competitiveness alone does not
decide success or failure of an airline. This is clearly illustrated by the case of Canadian
Airlines. Despite the fact that CAI was among the most efficient and the most cost
competitive carrier among all North American carriers, but still it folded financially. On
the other hand, although Air Canada was among the most inefficient carrier from the
beginning of our study period, and in fact, became the most inefficient carrier in 1998,
AC was able to survive financially, and was able to acquire CAI at the end of 1999.
CAI’s high productivity and cost competitiveness (e.g., 21% unit cost advantage over AC
in 1998) are not sufficient to compensate for its exceptionally low average yield (e.g.,
37% lower than AC in 1998), leading to its financial disaster. Clearly, the management
strategy on product design, pricing and yield management, and other marketing side of
airlines (in addition to cost efficient operations and management) are crucial to an
airlines’ success.
The above observation is also consistent with the fact that (a) America West, the
most cost competitive carrier in the U.S. in 1990, had to face Chapter 11 bankruptcy
reorganization during the early 1990 economic recession; and ( US Airways, the carrier
with the highest average yield among all major North American carriers (and the second
highest after statistically removing the effects of average stage length and output mix),
survived thus far despite the fact that it has been the least efficient carrier and also the
least cost competitive carrier among all of the U.S. carriers during the entire 1990-99
period .

[RFL]

ASSESSMENT OF RECENT PERFORMANCE OF CANADIAN CARRIERS:
Dr. Tae Hoon Oum
Dr. Chunyan Yu
SUMMARY
This report provides an assessment of the performance of Air Canada and Canadian
Airlines during the 1990s in comparison with eight major US carriers. In particular, we
examine the airlines’ performance in terms of input prices and input cost shares, partial
factor productivities, total factor productivity (TFP) and residual TFP, unit costs and cost
competitiveness, yield, profitability and other financial performance. Our findings can
be summarized as follows:

• AC and CAI enjoy lower average labour price and materials input price than the US
carriers, whereas the US carriers generally enjoy lower fuel price. Overall, Air Canada
and Canadian Airlines enjoyed substantial input price advantage in the second half of
the 1990s, largely due to Canadian dollar devaluation.

• Air Canada was among the lowest performers in almost all of the productivity
measures we computed and analyzed. The only aspect Air Canada achieved an above
average performance was fuel productivity. On the other hand, Canadian Airlines
made significant improvement in its productivity, and achieved above average
performance among our sample carriers during the second half of the period with the
exception of 1999 when its performance suffered a sharp drop. CAI’s productivity
and efficiency levels were consistently higher than those of AC throughout the 1990-
99 period.

Between 1990 and 1998 (also true for 1999) AC and CAI’s cost competitiveness
improved essentially due to the fact that devaluation of Canadian dollars made labour
and other input prices cheaper as compared to the U.S. carriers. As a result, despite
its dismal performance in productivity and efficiency Air Canada become cost
competitive relative to some of the major U.S. carriers including American,
Continental, Delta, Northwest, and United. By 1998, CAI became the most cost
competitive airline in North America, and its unit cost advantage over AC was about
21% mainly due to the CAI’s relatively high productive efficiency.

• Air Canada was able to achieve a slightly higher than average yield during our sample
period, but it had a rather high unit cost. As a result, Air Canada’s revenue-cost ratio
was among the lowest ones during the 1990-99 period. Canadian Airlines, on the
other hand, was among the most cost competitive carriers in our sample, but its
average yield was the lowest of all the carriers. Consequently, CAI had the lowest
revenue-cost ratio during the second half of our sample period. CAI’s average yield
was substantially lower than that of AC throughout the period. In fact, the gap in
average yield between AC and CAI increased consistently from 12% in 1993, to 24%
in 1995, 30% in 1997 and 37% in 1998. Even after statistically removing the effects
of differential average stage length and output mixes between AC and CAI, the
residual yield level for CAI was less than AC’s by 12% in 1996, and 14% in 1998.
These differences in average yields is likely to have been the most critical determinant
for the CAI’s sustained losses, and for the AC’s survival.

• Air Canada made considerable improvement in its financial performance, and
achieved about average performance compared to the US carriers. CAI’s financial
performance was at the bottom of the group in almost all aspects. CAI’s financial
performance remained poor, and even declined during our sample period, despite the
fact that most of the other airlines improved their financial performance.
Our results show that productive efficiency and cost competitiveness alone does not
decide success or failure of an airline. This is clearly illustrated by the case of Canadian
Airlines. Despite the fact that CAI was among the most efficient and the most cost
competitive carrier among all North American carriers, but still it folded financially. On
the other hand, although Air Canada was among the most inefficient carrier from the
beginning of our study period, and in fact, became the most inefficient carrier in 1998,
AC was able to survive financially, and was able to acquire CAI at the end of 1999.
CAI’s high productivity and cost competitiveness (e.g., 21% unit cost advantage over AC
in 1998) are not sufficient to compensate for its exceptionally low average yield (e.g.,
37% lower than AC in 1998), leading to its financial disaster. Clearly, the management
strategy on product design, pricing and yield management, and other marketing side of
airlines (in addition to cost efficient operations and management) are crucial to an
airlines’ success.
The above observation is also consistent with the fact that (a) America West, the
most cost competitive carrier in the U.S. in 1990, had to face Chapter 11 bankruptcy
reorganization during the early 1990 economic recession; and ( US Airways, the carrier
with the highest average yield among all major North American carriers (and the second
highest after statistically removing the effects of average stage length and output mix),
survived thus far despite the fact that it has been the least efficient carrier and also the
least cost competitive carrier among all of the U.S. carriers during the entire 1990-99
period .

[RFL]

Debt Comparison (in millions):
(excluding aircraft leases)

Air Canada 1990 - $2,194.0
Air Canada 1998 - $2,997.0

Canadi>n 1990 - $1,552.4
Canadi>n 1998 - $1,239.6

[bluemic]

"No doubt there are still some former CP employees who insist that AC's current situation has nothing to do with the forced aquisition (sic) of CP."

If this is a poll you're running, mark me down as "TRUE".

mic

[dozerboy]

I am surprised that bluemic hasn't blamed Mitchnick...yet.

[DEFCON]

I'm not CP and I don't believe CP is the problem. They were /are from a different culture club created in isolation just as is AC.

Politicians and misguided management are the real problem as is the pilots union (ACPA).

JM Belanger refers to CP as a "disease" when in fact many outsiders share the opinion that the ACPA is in fact the true disease that is most in need of a cure.

[Kip Powick]

Oh, hey...did you hear that ACPA's Judicial Review was squashed....,unanimously, by the court

[zipped]

True for me too.

The sole decision to purchase Canadian Airlines was Miltons and the BOD's......so if it didn't turn out the way you would have wanted, Wedge..Talk to Milton

So now we all have to be part of the solution, Right Wedge!!!!!

[bluemic]

"I am surprised that bluemic hasn't blamed Mitchnick...yet."

Yeah. I tried to work him in there.

But even I couldn't quite segue from "catching the blue disease" to instant "Mort-ification".

mic

[dozerboy]

segue...segue...?

[Kip Powick]

So far the full decision is only on the ACPA web site.

[Mitch Cronin]

.....sigh....
You know Wedge, you can hold the opinion that acquiring CDN hurt AC without insulting anyone. It's that spreading disease notion that really stings. Especially when you know the differences in how each airline was run.

By all means, blame CP, PWA, WD (hell, it was WD that killed Canadian, ask some of the ex CP folks), but please let the "disease" crap die.

And just for the record, count me among those who know AC's current woes exist in spite of the merger, not because of it.


Mitch

[Mitch Cronin]

seg-way get it? I can't find the blasted word in my dictionary, but it means to smoothly flow or connect from one thing to another... you know?

[bluemic]

Right on Mitch!

segue (sèg´wâ´, sâ´gwâ´) verb, intransitive
segued, seguing, segues
1. Music. To make a transition directly from one section or theme to another.
2. To move smoothly and unhesitatingly from one state, condition, situation, or element to another: "Daylight segued into dusk" (Susan Dworski).
[From Italian, there follows, third-person sing. present tense of seguire, to follow, from Vulgar Latin *sequere, from Latin sequì.]

To paraphrase Maverick: in case "you feel the need for read"...

mic