Industry Expert says Northwest Airlines Cost Structure Is Not Competitive

The managing director of LECG, LLC and head of the firm’s transportation practice, Daniel M. Kasper, said that the economics of the U.S. airline industry have changed dramatically, and Northwest Airlines must address the new economic realities or face an uncertain future.

Kasper’s remarks were prepared for presentation at a hearing in U.S. Bankruptcy Court for the Southern District of New York regarding Northwest’s motions, filed under Sections 1113(c) and 1114 of the Bankruptcy Code, asking the court to reject the company’s collective bargaining agreements with the Air Line Pilots Association (ALPA) and the Professional Flight Attendants Association (PFAA). The hearing also begins on the company’s motion under Section 1114 to modify its retiree employee benefits.

The International Association of Machinist and Aerospace Workers (IAM), which represents Northwest’s ground employees, has agreed to present the company’s contract settlement proposal to its members for ratification. As a result of this agreement, IAM and Northwest will ask the bankruptcy court judge to postpone IAM’s portion of the 1113(c) proceedings.

“The past four years have been the worst period in commercial aviation history, particularly for the legacy network carriers. During this period, the legacy network carriers have suffered record financial losses, lost market share and have been forced to furlough thousands of employees. Likewise, during this period, four of the country’s legacy carriers—United, US Airways (twice), Delta and Northwest—which collectively account for just under half of U.S. domestic mainline capacity, have all filed for Chapter 11 bankruptcy protection, while the remaining legacy carriers (American and Continental) have significantly restructured their labor and other costs outside of bankruptcy,” Kasper said.

“The financial problems experienced by Northwest and other legacy network carriers during the past several years resulted from a number of factors. Chief among them has been a series of major changes in the U.S. airline industry that undermined legacy carriers’ ability to charge prices sufficient to cover their costs and depressed the demand for commercial air service.”

“These and other factors have caused industry-wide airline ticket prices to fall sharply during the past several years. Because low-cost carriers (LCCs) now set pricing in markets accounting for the vast majority of domestic origin and destination (“O&D”) passengers, and because this is a trend that is almost certain to continue, Northwest has little choice but to reduce its costs to levels that will enable it to effectively compete against LCCs,” Kasper said.

“To survive in the face of reduced demand, depressed yields and increased competition from LCCs, all legacy carriers have found it necessary to make significant cost reductions. Northwest has made aggressive efforts to cut its costs, but … it has not yet been able to reach agreement with all of its unions and retirees to secure the labor cost savings necessary to restore Northwest’s competitive viability.”

Kasper added that, “At the heart of Northwest’s uncompetitive cost structure are labor costs that are now the highest in the industry. Total compensation per Northwest employee is more than 66% higher than LCC average employee compensation.”

He continued, “Average compensation at carriers such as United and US Airways has fallen dramatically since 2002, while average compensation per employee at Northwest has actually increased.”

Northwest’s Current Financial Position is Untenable

Discussing Northwest’s current financial position, Kasper said, “The overall effect of Northwest’s deteriorating competitive position--both vis-à-vis the LCCs and other legacy carriers-- has been a long string of large net and operating losses. Northwest’s pre-tax losses between 2001 and the third quarter of 2005 have totaled approximately $3.8 billion. Faced with dwindling cash reserves and unable to obtain sufficient labor cost relief as it entered the traditionally weak fall and winter seasons, Northwest was forced to seek Chapter 11 bankruptcy protection.”

“Notwithstanding its portfolio of valuable assets, Northwest’s cost structure generally - and its labor cost structure in particular - are unsustainable in today’s economic and competitive environment. Unless Northwest can quickly and substantially lower its labor costs, Northwest’s financial position will continue to deteriorate.”

“Northwest’s unit operating costs (excluding fuel and stage-length adjusted) were second highest in the industry during the third quarter of 2005 and 61% above the average of the LCCs. Including interest payments, Northwest’s stage- length adjusted unit costs are the highest in the industry and 67% above the LCC average,” Kasper said.

He continued, “Northwest’s unit labor costs are far and away the highest in the industry. Northwest’s unit labor costs are significantly higher than those of the other restructured legacy carriers and 71% higher than the LCC average.”

Kasper added that, “Restrictive work rules limit the productivity of Northwest’s workforce.”

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