Thoughts on Milton

[Guest GDR]

Let’s just have a quick look at what Milton has had to deal with since taking over at AC.

1/ Less than a month after taking over as CEO a combination of the liberal gov’t, ONEX, and AMR attempt a hostile take-over of the airline.

2/ He has to work at trying to put together 2 companies with an antagonistic history, both overstaffed and with many of the employee groups having no lay off agreements.

3/ Sep 11 and the fall off of traffic from that.

4/ A prolonged recession

5/ The collapse of Nortel which meant a loss of approximately 40% of our business class traffic.

6/ Oil goes from a low of about $10 a barrel to as high as $37.

7/ In spite of winning awards for our service, our safety as well as general management the airline and Milton are continuously vilified in the press and thus in people’s minds.

8/ New entrants into the market that hire enthusiastic young people at lower pay scales. These new entrants are able to make money with much mower yields. (In the end even when, and if everything else stablizes is the one reality that will have to be dealt with.)

9/ Gov’t sanctioned tribunals that take us to court when we lower the fares or if we increase them.

10/ A massive increase in gov’t taxes and fees without any parallel improvement in services.

11/ War in Iraq, and federal gov’t policy that antagonizes our American customers.

12/ Lately, just in case things should start going better, we have a plague that is carried around the world by the airlines with Toronto being one of the world’s hot spots.

As someone said to me he has had to deal with the “Perfect Storm”. It is very easy to vilify the guy at the top when things go bad, but we also might want to look at how much worse things might have been.

As employees it is quite probable that eventually we can have Milton’s head on a platter and maybe that will make a lot of people feel better in the short term. What happens then? Just whom are we going to get in his place? Milton has worked at preserving jobs as best he can. His plan on Feb 6 was to increase revenue by introducing new routes with a lower cost structure.

My guess is that if Milton has to be replaces we are going to wind up with a Frank Lorenzo type. Ask yourself this; if you were a member of the BOD isn’t that the type of individual that you would hire as CEO at this point? The BODF will not be going at looking for a warm fuzzy CEO. They will be hiring a hard-nosed slash and burn manager.

Every time one of our unions comes up to contract time we have a system of negotiation that is bound to create friction. The union’s mandate is to get a contract that provides maximum money for minimum work. Management’s mandate is exactly the opposite. We then barter back and forth, usually with the threat of strike or lockout hanging over our heads until we come to some compromise which leaves most people unhappy. From a union stand point it leaves the membership feeling disappointed and frustrated. It is a system that leaves us feeling that company management is the enemy.

In my opinion our best hope, by a long shot, of pulling out of these bankruptcy proceedings in the best possible shape, is to work with Milton. We are only a part of the process, but it does appear that many of the financial issues that revolve around our debt and long term financing are being effectively dealt with.

I don’t advocate just agreeing to any and all requests, but I am suggesting that we sit down with the attitude of moving the airline ahead, instead of adopting the attitude that this is just another contract negotiation.

Greg Robinson

[B75/76]

Interesting and valid points. Not all of them are unique to AC, things like fuel prices and taxes apply to all.

Certainly, like many businesses, AC has suffered from the effects of events beyond their control. It also seems true, however, that much of their difficulties are rooted in the business philosophy/model.

It seems to me, as one who does not work for AC, the business goal has revolved around market share more than profitability. RM certainly didn't create this strategy, but he also has not apparently done much to change it thus far.

If I were a shareholder I would be far happier for the company to have, say, 45% market share and make money versus 70-80% share and losing money.

Also, from a shareholder point of view, the restriction on the percentage of shares owned by any one entity is a problem. It has not enabled a single strong voice to hold the executives accountable for their actions.

Certainly there have been many variables that have led to the current crisis, but I think it is time now to concentrate on strengths. Spend a little less energy focusing on what the other guy is doing and do the things AC does well to the best of their ability.

Obviously if I had all the answers I would be a CEO. Since I'm not these are just my observations/opinions.

[B75/76]

Interesting and valid points. AC, however, is not alone in having to deal with many of those issues.

It seems to me that AC has had a business plan that revolves around market share more than profit. While RM is not the one that initially embarked on that strategy, he also has not appeared too keen to change it thus far.

If I were a shareholder, I would be happier if the company had less market share but was profitable.

I believe the restriction on the percentage of shares permitted held by any single entity has also been a problem (not AC or RM's fault). If there had been a single, strong voice amongst the shareholders, to help ensure accountability of the executive team’s decisions, perhaps the direction taken would not have been maintained as long.

Certainly, there are a multitude of factors that have led to the current crisis, and I obviously don’t have the answers to them (Or else I would be a CEO somewhere). These are just some thoughts and considerations I have.

[Guest Airmail]

The market share vs. profitability argument is a myth.

AC's domestic marketshare has declined to 55 to 60% due partly through AC domestic capacity reductions and growth at competing carriers. This at a time when AC was not able to exit from any domestic market until January of this year (just 3 months ago). This does not sound like a marketshare-obssessed airline or CEO to me.

[B75/76]

Out of necessity market share is much less of a concern because it has been unsustainable.

[Guest Airmail]

But if it were true that AC pursued marketshare over profitability, it would never have reduced its domestic capacity by a third from 2000 to today (again, at a time when they were required to maintain service to every domestic market per the government of Canada).

Whether it is out of necessity or otherwise, it is never the less true which renders the argument that AC has pursued a strategy of protecting marketshare over profitability false.

[B75/76]

AC may have changed now, but the point is the years of trying to maintain or increase share before profit has contributed to their current financila woes.

[dagger]

Prior to 2000, Air Canada was modestly profitable. Westjet was small. Canjet and Jetsgo didn't exist. Royal and Canada3 were less focussed on domestic scheduled operations. With all due respect, I suggest that up to 2000, Air Canada did pursue a market share driven strategy, and with rare exception, it was successful.

Starting in 2001, the airline has faced a succession of market driven difficulties which make maintenance of market share, with its current costs, impossible to maintain. Westjet is bigger. You can hypothesize - absent any glimpse at their books - that Rowe and Leblanc have finally gotten it right. There have been fundamental changes in what the market wants to buy and/or is willing to pay.

Air Canada now faces this reality: There is only a very small market for the value-added products that used to be the cornerstone of its revenues per seat mile. When it was able to generate a lot of high paying business traffic, the argument that it might do better by abandoning money-losing domestic routes was a valid hyopthesis. At least you could make such a contention.

Now, with the trend to discount fares on more and more routes, there are fewer and fewer routes with the kind of revenue-generating potential for which Air Canada can fall back on. If only 20 percent of the jet routes in this country had a discount carrier option, you could say that Air Canada should forget about that 20 percent and fall back on the balance. However, the combined fleets of Westjet, Canjet and Jetsgo now approximate the number of aircraft Canadian Airlines had in the domestic market in the mid-1980s, and their aircraft have more seats than Canadian had until at least 1996. Westjet in particular is committed to adding dozens of aircraft. So there are very few markets in Canada on which Air Canada can fall back profitably WITH ITS CURRENT COST STRUCTURE. With signficantly lower unit costs, a larger number of unprofitable or marginally profitable routes can become profitable again.

The issue isn't about market share and hasn't been since 2000. The issue is survivability in the face of radically changed market conditions which render the current revenue and cost models at AC unsustainable. This is what Milton means by the model being broken.

Zip is an attempt to install a prototype lower cost, lower fare structure that could be the model for Air Canada across Canada. It's not my favorite approach - I would prefer to lower AC costs across the board, institute discount-like pricing structures throughout AC's North American market - though not necessarily identical in all respects to Westjet - and fold Zip.

[Guest JW]

>>It seems to me, as one who does not work for AC, the business goal has revolved around market share more than profitability. RM certainly didn't create this strategy, but he also has not apparently done much to change it thus far.<<

AC concentrated a great deal on the business traveller as the "bread and butter" for a long while, and hung onto that beyond the best before date.

...imo!

JW

[Guest Wilber]

Prior to 2000 Air Canada was operationaly profitable but has been accumulating debt at a rate of almost a billion a year since it was privatized. That is not sustainable and does not make a profitable airline, merely one that had some money left after paying it's bills. Kind of like making your Visa payments and having enough left over for lattes but the balance keeps growing.

This was all done in the pursuit of market share (the old one with the deepest pockets wins principal) but it also set the company up so that it is unable to cope with the events that have now befallen it.

I don't know why so many people think Milton is such a genius when he was one of the principal architects of this policy. To be fair though, considering the carnage going on amongst the worlds mainline carriers, he and his management team are not the only ones to fall into this trap.

[dagger]

At no time was Air Canada debt free. In 1988, it's first full year of being privatized, it had debt totally $1.5 billion. The government did not give it a new fleet, so it then embarked on a program of fleet renewal which has taken out in succession the 727s, DC-8s, older 747s, L-1011s. It also took on both the assets and restructured debt of Canadian Airlines. Today, it's debt - as in financial paper - is just over $3.2 billion. It's long term leases are over $9 billion, though much of that will soon be marked to market rates. Most other airlines are going through the same process. All things considered, Air Canada has not been accumulating debt at a rate of $1 billion per year, because the assets on which the leases are based normally generate revenue, unlike bonds or debentures which are a net outflow if the proceeds are used to cover operations.

Last year Air Canada debt service was about $200 million, a significant amount, but not the make or break issue you make it out to be.

Is debt good? Not to this extent. Is it the story of why AC is where it is? Hardly. If you wiped out every dollar of AC's interest bearing debtentures and bonds, would that ensure Air Canada a rosy future. Absolutely not.

[B75/76]

“Prior to 2000, Air Canada was modestly profitable. Westjet was small. Canjet and Jetsgo didn't exist. Royal and Canada3 were less focussed on domestic scheduled operations. With all due respect, I suggest that up to 2000, Air Canada did pursue a market share driven strategy, and with rare exception, it was successful.”

To maintain modest profits while pursuing the market share driven strategy required the sale of many assets. I would suggest that this made the strategy less than successful and weakened AC’s financial foundation when the current economic pressures mounted.

[dagger]

In as much as the government required Air Canada to maintain an unduly large infrastructure, notably three major maintenance bases. it was more advantageous for Air Canada to maintain its prevailing size and economy of scale. Had it shrunk, it would be required to shoulder a much larger infrastructure for its reduced size. The move of late to build up third party maintenance work at ACTS with a goal of spinning off that operation was part of the strategy to get out from under that mandated and costly infrastructure without requiring a change in the law.

[Guest M. McRae]

I suspect that the monies spent to counteract any threat from Canadian also contributed to the overall debt load. Seems that during the battle between the two corporations, AC was selling off assets to fund their efforts. The NW shares come to mind. (D)

[Guest Wilber]

I agree that other airlines are going through the same process but disagree that lease obligations are not real debt. It's tough to operate an airline without aircraft. The only difference between leasing and buying is you don't own anything at the end of the lease.

[dragon]

"Prior to 2000, Air Canada was modestly profitable."

I must have missed something dagger. Modestly profitable or less unprofitable, pre 2000?

[dragon]

”Prior to 2000, Air Canada was modestly profitable.”

I’ll be the first to admit that I am certainly not the sharpest knife in the drawer, however;

Rather than ‘modestly profitable’, did you not really mean ‘just less unprofitable’, comparatively speaking?

I am sleepy and please correct me if I’m wrong, but was it not two winning hands in . . . . how many played? Did the profit of stock acquisition play any role in either of those two winning hands?….

[dagger]

Actually, many of today's leasing structures include purchase options, some quite advantageous. The other feature of counting leases as debt is that in some leasing structures, you are required to include the purchase option on your books as debt even if you ultimately give back the aircraft without exercising the purchase option.

[Guest Wilber]

Maybe so but do any of those options count as equity. Two thirds of Canadian's debt was also in lease obligations. The point is that just like Canadian, by selling aircraft and leasing them back, this company has been turning equity into debt on order to survive and now there is not a heck of a lot of equity left, just the debt. I know there are some pretty major extenuating circumstances these days, but to go from the so called toast of the industry to near bankruptcy in less than three quarters, hardly seems like stellar management. Present management has to bare a great deal of responsiblity for putting the company in a position where this could happen so quickly.

Quite a few airlines went through massive fleet expansions in the nineties in pursuit of market share, thinking either the party could go on forever or the last man standing would have all the marbles. I'm just saying Milton was no different, so what makes him ao special?

[Guest Aer Nfld]

Milton rebuttal:

1. First of all this is not only about Milton as he has his share of deputies to blame, somewhere around 30 VP's I believe was quoted. Either Executive VP's or VP's, that does not include the Subs like Jazz, ACV and ZIP.

Ok to the rebuttal:

1. Hostile take over or not, this was part of doing business. Yes it was a bad hand to be dealt right of the bat. However with some vision there may have ben opportunity, however this seems very much like a story written on the fly.
2. Noone said merging was going to be easy. However that is what he fought for in item number one. This was simply handled poorly, not to mentiomn the fact that he himself agreed to no layoff clauses. Over and above those imposed by the Gov't. And as recently as a couple of months ago signed another one although useless now under the CCAA filing.
3. Sep 11th. Undoubtedly a huge blow to the industry. But what it really showed was that the old model was severly broken. Costs were way to high, surplus staff was evident,they ran out of things to sell, or reemortagag, and with no vision and an archaic yield management system and reliance on legacy systems well, Sep 11th was just one of the straws, albeit a big one.
4. All of the business world has hgad to deal with this issue.That is why these folks get paid the big bucks. It certainly isn't when we are in boom time.
5. What was that about putting all of your eggs in one basket.
6. Ask Milton about Hedging with respect to fuel. Although undoubtedly everyone's issue, right to you and I as we fill up our vehicles.Although there are plenty of opportunities to save on fuel to counter attack the hike. Reduction in taxi times, better alternate selection, tighter fuel planing from dispatch etc.
7. No comment. OAG and all of those awards are airline folks breaking their arms patting themselves on the back. Sort of like "We are the best airline!" Just ask us! Ask yourself where are we getting hammered. Mostly in Canadian press, domestically he has done a horrible job, plus chalk one up to the competition by offering a cheap choice, so that consumers can suddenly see that they no longer have to pay 1600 dollars to fly from YQY-YYT.
8/ Low cost carriers. Just another facet of the business. Here Milton and his team have an identity crisis, Jazz, Tango, and ZIP, infrastructure, staff etc, doesn't seem on the surface anyway to be the right way to approach low cost. Nice names though. How much did Target Marketing get paid for these??
9/ The Gov't piece is a failure as well. A failure in the sens that he could not get his point across. Maybe it is the apparent arrogance in the approach. Perhaps he and Collenette dislike each other who knows the fact remians this is very real and this company has done a poor job influencing the Govt on the need for change. Perhaps AC shoudl drop the political wing of the company and hire a good lobbyist, ther are lots of them for hire. How about a National Transporation policy to addresss this, and while at it disband ATAC, or get rid of everyone on it and start over, firts criteria give them a backbone and some teeth.
11/ Like to see the stats on Transborder traffic, as it appears all traffic is down and the most affected was the Asian routes, which by the way have been in sharp decline for a while, and SARS has provided yet another straw.

Now Milton or whoever it is hopefully they have a sound plan this time, Is he all to blame no, we all share the blame here. Unions because of greed and job protection, management becasue of a lack of vision because the old way doesn't work anymore. Issues like Scope, fleet,wages,workrules, mainline, ZIP, Jazz, Gov't fees, fuel prices, lease rates etc all have to be addressed lets hope for everyones sake it happens this time. People always say the airline industry is a cycle, there is a reason for that, it is aclled patchwork fixes, lets hope this time there is a more permanent approach.

[Guest GDR]

Good post, and I agree with a lot of it. My point was that the majority of the 12 items are things that you would expect to happen to an airline at one point in time or another.
In this case they all happened in a relatively short time span.

I maintain that Milton was dealt an impossible hand. I personally believe that if all unions had agreed to a total reduction of 650 million in cuts and productivity improvements that we could have pulled it off, that is, if SARS hadn't reared its ugly head.

Other than that we are reportedly losing 3 million a day. Our load figures and thus our revenues must now be abysmal. Who knows where we go from here.

Greg