The level of wage settlements are already causing concern in the US market and labour negotiations are now raising alarms in Europe. Chris Tarry of Commerzbank asks whether the airline industry can afford to pay?
The impact of pilot pay settlements has already become clear in the USA. Now attention has become focused on Europe and there appear to be the first warning signs of unrest in Asia too. There is room for plenty of debate about the merits or otherwise of these wage claims and the generosity of the settlements that follow, but there is also a more basic question to ask, especially as markets turn down: can airlines afford to pay?
The recent experience at Lufthansa graphically demonstrates how much damage a wage dispute can quickly cause. The carrier's running dispute with its pilots' union and subsequent settlements has already cost the group dear. The basics of the three-year deal are a 3% pay rise now and another 2.8% next year, plus adjustments to the salary scale which average another 9% rise.
An immediate result of the award was a profits warning from Lufthansa. That was hardly surprising given that the settlement is expected to cost some €120 million ($112 million) this year and that the cost of three days of strike disruption is being put at €28 million a day. Add on top some other bad economic news and the group was left warning of a €250-300 million drop in operating profits this year.
Even this, however, is not the whole story. There are two effects that are likely to have a longer lasting impact than the profits warning suggests. First, there is the need to "recover" those passengers who have booked away during the disruption. Second, there is the potential effect on the rest of the workforce which saw their pay settled at only 3.5%. This can too often show through in service delivery - as British Airways learned to its cost - as well as storing up a tough future negotiation when their representatives sit down with management to discuss pay the next time round. So for Lufthansa the real difficulties may have only just begun.
Indeed the most recent news from American Airlines, providing for rises of 8-22% in the base pay of their maintenance and related employees seems to reinforce the view of the re-emergence of what could be called the domino theory of wage determination. In this case, there is not only an internal knock-on effect as a wage win by one group results in differentials being re-calibrated throughout the business, but also an external effect as the wage settlement ripples throughout the sector.
There can be a lot of emotive language surrounding pay negotiations and salary structures. Leaving that to one side perhaps leaves only the common sense tests of affordability and reasonableness. Whether a pay claim meets those criteria can depend on exactly where you are standing. There is always a degree of cynicism expressed when management begins to talk of how difficult the trading environment has become just at the time wage negotiations are about to start. However, this time around, it is a real issue.
At the start of the year there was a reasonable degree of comfort over the likely rate of underlying traffic growth based on the forecast state of the economy. However, what has materialised is a far sharper and deeper decline than expected and furthermore the newsflow may well get worse for at least the next few months.
From a European perspective the most recent statistics from the Association of European Airlines revealed the first monthly fall in traffic for a decade. There are clearly several factors that have come into play - such as foot and mouth disease in the UK. However, it seems that the fall, at least in part, relates to a change in the behaviour of customers. Their anticipation of an economic slowdown seems more pronounced than in the past. In other words, customers are acting as though a downturn were already a certainty. This has brought forward not just a slowdown in traffic growth but a fall in the absolute volume.
Firmer clues as to the extent of this slowdown should become clearer as the half-year performance figures and financial forecasts roll in. They will help to reveal whether the industry has the ability to pay more in salary costs. The cost base of the industry is effectively fixed on a six monthly basis and even after that costs are generally sticky in a downward direction. So any fall in revenue essentially comes straight off the bottom line.
From a stock market perspective the industry is often seen to be in a state of knife-edge instability. The constant hope is that its profitability will structurally improve so that it is able to weather the down swings a little better than in the past. Following the pain of the last recession, the industry has indeed been more prudent. But this is not a good time for that prudence to run out.
Source: Airline Business
