Working together worked! So says the banner headline on the front cover of Continental Airlines' annual report.
The carrier's chairman and chief executive, Gordon Bethune, is now hoping to use the same philosophies which transformed employee morale within the airline to make its growing array of alliances with other carriers work effectively.
In trying to persuade the Spanish and Argentinean governments to accept Continental's bid for a stake in Aerolineas Argentinas, Bethune has made a great deal of capital from his mantra that 'we're all going to win together or lose together.' He offers the chance of an equal partnership, rather than domination, and if he succeeds with the Aerolineas deal he makes it clear that Iberia would be a welcome partner too.
As this giant game of chess continues, Continental might end up being a more significant player than observers have predicted. First take its major hubs at New York/Newark and Houston and relatively small but growing networks in Europe and Latin America. Then add recently concluded alliances with Air France, Alitalia, Virgin Atlantic, China Airlines and Aeroflot, plus established partnerships such as America West. Finally, add in Aerolineas and Iberia, plus another Asian partner, and you have a global alliance to be reckoned with.
Bethune's promises of fair treatment and equal shares of the spoils should go down well with potential alliance partners. So far, it has certainly gone down well with employees who, boosted by profit sharing schemes as well as encouraging slogans, have enabled Continental to recover its dignity.
Those employees remain poorly paid by industry standards despite pay rises of 25 per cent since 1994, but Bethune insists that he intends to address that. He promises to bring Continental's pilots, who have requested the equivalent of a 38 per cent pay rise, to parity with the rest of the industry within three years. This suggests that a deal can be made - with the assistance of the National Mediation Board - in time for the July deadline. Bethune says he will fund higher pay through lower capital costs and savings from electronic ticketing.
Continental has firm orders for 127 Boeing 737s, plus 90 options, at a cost of $4.3 billion, as well as 25 Embraer 145s. At press time the carrier appeared close to placing a $4 billion order for 40 Boeing 767-400s and 777s. The average age of the carrier's fleet is set to fall from the present 13.9 years to 7.6 years by 1999. Bethune is confident the airline's finances can stand this, since many of its present lease rates are very high, and there will be savings on fuel and maintenance expenses.
Continental's turnaround has been remarkable, but Bethune still has ambitious targets. With $1 billion in cash and a market capitalisation of $2 billion, the company's debt:equity ratio has gone from 50:1 to 7:1, but Bethune wants 3:1. Net profits reached $314 million last year, but he is confident that profits can grow through growth and higher yields, alongside stable unit costs.
The carrier is adding Rio de Janeiro, Sao Paulo, Düsseldorf, Lisbon and Birmingham to its network this year, and wants to serve Caracas, Santiago, Munich and London/Heathrow, as well as more US cities.
Bethune brushes aside suggestions that he might be interested in taking over from Ron Allen as chairman of Delta Air Lines, even though he proposed a merger with Delta last year. 'I enjoy what I do, I'm paid well and enjoy some measure of success, so I'm not looking to move anywhere. I haven't played all my cards here. We have a few challenges and some other things that will make us an even better carrier in the future, so I'm looking forward to implementing those.'
The following pages contain Bethune's responses to questions on key issues like alliances, costs, growth, the fleet and profitability.
A global chess game
The US markets are divvied up. We own Houston, Cleveland and New York. American owns Miami and Dallas. Denver and Chicago are United. Minneapolis, Detroit and Memphis are Northwest. Delta are in Atlanta, Salt Lake City, Cincinnati. Now that's all divvied up, what's left? Well, how about the world?
The capital commitment and the way that governments and politics work say you just can't go buy France, it's not for sale. You can't start your hub there, so go find somebody that is and be partners. So Germany, Sweden and Canada are joining United. American counters with British Airways and Aerolineas. They need to counter; this is a chess game. We say, we'll take Alitalia, Air France and Virgin.
We have New York and Houston, and we've emerged now as the second biggest US carrier in Latin America in terms of destinations - maybe not in size because United still owns a lot of route authorities we can't have. United is getting its head cut off in Miami because it's trying to compete with American, and they ain't going to let 'em make it. American will be the dominant guy but we'll be a strong second.
The alliances that are being formed today will continue to consolidate and be refined so they're almost seamless. Companies like IBM will be able to get the same discounts flying from Sydney to Tokyo as they do from Amarillo to Los Angeles. They don't want to screw around with individual deals, they want to go to a consortium and make a deal. And I think that's good.
Continental has positioned itself to have what alliances most desire, which is geographical strategic value for a good product. Alitalia wants us to fly to Rome twice a day and to Milan once because, with Continental's airplane flying from Newark to Rome once a day, in the first year we made 20 per cent more profit than they did flying from Rome to JFK, which they've been doing since 1946!
Because we bring the tremendous synergies of a hub operation into Newark, and we tap into New York's local market as well as the feed, we can outperform anybody out of New York. More people want to join us in Newark because they know the best way to make Athens-New York profitable is not to land at JFK, it's to tap into Continental's beyond as well as the local traffic.
The reason Virgin left its former partner was because of the disparity in service and quality, as well as the ease of doing business. We're more culturally like Virgin, and our product is very similar to Virgin's.
So we're going to be part of a strategic alliance. We've kinda picked the main players already and we think the Pacific is still something we need to refine, although uniquely we offer our presence in Micronesia.
We fly to more Japanese cities than any other US air carrier; we just do it from Guam and Saipan. But we're in those areas and we understand the Japanese distribution system and we have a lot of value to bring. We fly from Honolulu to Tokyo. We'd like to have that doubled so we can fly twice a day and we'd like to do Honolulu-Osaka. But ultimately we'll have an Asian carrier like we have Air France. We've talked to some of the Koreans and the Chinese and we've had some preliminary discussions with Japanese carriers.
We're going to be really selective in what we do. We say, 'Don't do things that lose money, fly to places people want to go'. So that's why we're really putting a lot of focus on Latin America and Europe. We are the most profitable airline across the Atlantic as a percentage of revenues, and that's because we're very selective about where we go.
Aerolineas and Iberia
We've made a formal tender for a minority stake in Aerolineas Argentinas. We believe that our only competitor can't complete the transaction. It doesn't matter what they offer, because the consolidation of Aerolineas and American would even be more anti-competitive than BA-AA. Aerolineas runs about 70 per cent of the northbound traffic out of Argentina, and American carries about 70 per cent of the North American traffic into Argentina. Those two guys get together, and there's no competition. Our government is never going to allow that to happen.
Aerolineas is in a fairly precarious financial position and needs some pretty rapid help, so if you want to take this through the courts for the next year and a half, the patient may have died by the time it's resolved that the doctor can't come!
We've had discussions with the Spanish government and they've pretty much come to the same conclusion. Financially we have to be responsive. We've had further discussions on what the value should be. I feel confident it will be resolved our way.
We've said that we would bring half of the money and Newbridge Partners, a fund controlled by the Bonderman Group, would provide equity. We would also provide the management expertise and the market synergy. Neither one of us would have 100 per cent control. We want Bonderman because we know his group and they won't interfere. [A Bonderman fund owns 10 per cent of Continental.]
The real deal of course is that you've got Iberia sitting up there as a minority shareholder and they're trying to determine what alliance they want to belong to. It's pretty hard for Iberia, let's say, to join the Air France-Alitalia-Continental alliance, which is the one they'd like to join, if American gets controlling interest in Aerolineas and Iberia is still a shareholder.
When you join an alliance with American, unless you're BA, you really aren't a partner, you're just an employee. Small carriers that ally themselves with American really have not seen themselves as equals, nor are they treated as such. Continental has a theme that says that we're all going to win together or lose together. We offer the Iberias, which would certainly be subordinate in a BA-AA alliance, the chance to be equals. I think the people of Spain see themselves as equals. They don't see themselves as the employees of a big American company.
The Latin speaking parts of Europe should have some affinity - Italy, France, Spain. Geographically, it's contiguous. Some of these companies are weak financially, but so were we. The weak won't always be weak. And guys like [Air France chairman] Christian Blanc are turning water into wine. If anybody's got a chance, [chairman Fausto] Cereti has a chance with Alitalia; I think they've got the right team. And I think [Iberia chairman Xabier de] Irala is certainly not a government hack; he is a businessman. They've got the people in place, just like the people came into Continental and turned this place around. That alliance will be a very strong one.
British Airways-American
Our Virgin alliance is a pretty good defensive move to make sure we have a large presence in New York-UK. When you look at the mass of 20 frequencies a day that BA-AA will put into the New York-London market, those guys running out of JFK a couple of times a day aren't going to be very competitive.
The facts are that it's going to be bad for the UK consumer - it's a horrible thing for the UK consumer. They're going to get really royally screwed here. The American consumer stands to be disadvantaged, too. We're never going to be for this and we don't think either government should be for screwing their citizens. What's so healthy for consumers is that in the North Atlantic British Airways' biggest competitor is American, and American's biggest competitor is BA. If you let those giants get together, let me tell you, the consumer is not going to win.
More yield, stable costs
We've gone from roughly 33 per cent business traffic to 43-44 per cent at the end of last year. We have targeted 50 per cent. Our competitors, American, United and Delta, run more traditionally up to 55 per cent. We believe 50 per cent is a reasonable number for us. That's a tremendous revenue differential and one of the opportunities our company has.
We track our revenue per available seat-mile against the industry average. We have run as low as a 20 per cent deficit. We're now running at about 103 per cent of industry average RASM, stage length adjusted. We believe we can get the same kinds of premiums ultimately that American and United have. They run to as much as 120 per cent of industry average.
A couple of things are going to help us with our costs. One, our ability to use E-Ticket and reduce our distribution cost. We're having significant savings, and we believe E-Ticket can provide as much as $70 million a year in reduced distribution costs when we get to where we want to go. Additionally, our cost of capital is declining. We're going to use those cost savings to fund our increase in labour costs, so our costs should remain essentially flat. There is a slight variable cost with higher yield passengers. And then as we become more profitable, we'll make more profit sharing, but those are good costs, I think.
The pilots' pay claim
Our pilots ought to be paid more. Period. We agree. This place shouldn't run on the backs of labour. The average employee's got a 25 per cent raise since 1994. The pilots have had significant raises last year, again this year. We would agree that they still need more money. Over the next three years, I think we can take them up to parity.
We're doing good, but we're not United, American and Delta. Our long-term leases at very high interest rates are still around. When I have an MD-80 here at $250,000 a month and American's got one at $130,000 a month, and a customer won't pay another nickel for the ticket, where does that money come from?
Our pilots don't mind working and we should pay them to work. I'm all for paying them industry standards as soon as I get the industry standard in revenue and the industry standard in cost of money. We won't be able to give it today, but over the next three years we will.
Growth prospects
The analysts who forecast flat earnings are very short-sighted because they fail to differentiate the opportunities we have to raise revenue significantly in our hubs as we grow capacity in our strength cities without growing the same overhead cost. Newark, Cleveland and Houston are all under-sized.
The greatest potential is international. As we hub, we can take advantage of the local strength of the market in New York City, and we can make markets like Lisbon, which we just added, pay very quickly. There are other cities in Europe - Munich is an example - which are targets for us. The same thing is true in Latin America - we just announced service to Caracas from Houston nonstop; very, very low risk.
We've taken those extra 20 gates in Houston because we would like to serve at least 20 US cities that we don't serve today from Houston.
We had 34 dedicated gates. If we want to make a small market like Sacramento work on a nonstop, we've gotta have the feed from 33 other cities. The problem is, we're full at the peak banks. By getting the extra gates and having the potential to take our gate feed up to 55, cities start making sense that don't make sense today.
Our fleet plan allows us to go back to zero growth if the economy does not bear out what we think. I feel really good from a zero to 8 per cent overall, with a higher number in the international than the domestic.
The DC-10 replacement
Our choice is between the A330 as standard and a mixture of B777s and B767-400s. I don't believe that the 767 in two years' time is going to be timely enough to handle our growth, and I don't want to wait two years to address the DC-10-30 replacement. We're talking with Boeing about a mixture of airplanes - accelerating our five B777s, which we have on order today with deliveries in 2002, maybe to bring them in as early as next year, so that we can have a filler until the 767-400 is certified in the year 2000.
My opinion is that the 777 is the new standard across the North Atlantic, so I can't envision Continental not operating that airplane, regardless of whether we pick the 767 or the Airbus. Maybe if we were to pick the A330 we would not have to accelerate the 777s into next year.
Boeing's single-source supplier proposal is very interesting. Having the most favoured contract on all models of the airplanes is a pretty nice floor - you're not going to be paying more for your airplanes than your competitors are, and that's really what all this is about. It's not a big thing for us - we're committed to the 737-700/800, 757 and 777, so if we buy the 767-400, I don't know what else we need. For only a marginal risk, I wanted to see what kinda reward I got, and it appears to be substantial.
Continental's recovery
Compared to three years ago, the only thing that's the same about this company is the name on the plate. It doesn't have the same credit rating, balance sheet, cash balance, employee morale, and product ranking. We went from a $200 million market cap to more than $2 billion today.
What's the same is the employees, the airplanes and the cities. How we work and what we provide are dramatically different. Now we know the secret of success - it's us, and how we work.
The Go Forward Plan is nothing but a dynamic business plan. We use names so people can identify and understand what we're talking about. Fly to Win is our market strategy. We've long since stopped doing things that lose money. 'Fly to places people want to go' is a continuing part of Go Forward. Fly to Win today means the alliances with Air France and Virgin, our entry into Latin America, and our evolving fleet plan.
Fund the Future was trying to get cash balances to achieve liquidity and take a debt:equity of 50:1 to today's 7:1. This is now evolving to a 3:1 debt:equity ratio. Our average cost of capital has gone from greater than 12 per cent to less than 8 per cent. The cash balances have grown from $200 million to $1 billion. That was achieved with refinancing old debt, recapitalising the company, and earning rather than burning cash.
This is not, 'let's go and show Wall Street some dynamic earnings', it's 'put some structure in the company, so it's going to be around here for the next 20 years.' We've done that now. We've set ourselves a cash target of $750 million, and we've just been beating that, but we're going to continue to use excess moneys to pay down debt and get that leverage down to 3:1.
Make Reliability Reality was articulated when we were the 10th best on time, and we needed to get to the top half. Today, we're the only airline to rank in the top three by the four DOT measures. Continental has become a consistent, reliable, dependable airline.
Working Together was a Boeing term I borrowed. From the sordid past here, when Frank [Lorenzo] broke the unions and played people off and wage-cut, we needed to involve our employees so that they felt like this is a nice place to work, and enjoyed coming to work. We measure things like attrition, sick leave, on the job injuries. We even measure how many people are buying logo stuff at our company store - it tells you how they feel about the company.
It's a continuing challenge for every company because expectations always rise. Our wages since 1994 have all increased on average 25 per cent, when you include profit sharing and on-time performance bonuses. While we've gained some financial success, we no longer feel that labour should have to carry the brunt of the load.
We've been able to demonstrate that we can get people lined up, working together, with common goals. We all win or nobody wins; that's the secret. With the on-time performance pay, when we beat United, American and Delta and the rest of these guys and rank in the top three, everybody gets paid or nobody gets paid. Everybody knows that the only way we're going to win is not beat up on each other, but beat those other guys. With profit sharing, at the end of the year everybody gets a cheque or nobody gets a cheque. Employees don't generally care about profitability, except our people get 15 per cent. Aha. Now they do care. So when shareholders win, employees win. The team wins or loses together.
Five years ago, we had a crap product and had to discount our fares to $19 to fill up our airplanes. Now, the flight attendants are working harder at 100 per cent load factor than they were at 50, but you know what they think? 'Some of this is my money.' That's the difference. 'We're making money and getting paid more to work a little harder'. And that's OK with them.
People tell me Continental's successful because of the economy. Well, there were a lot of good economies in the US from 1985 to 1995; how come they never made any money then? The answer is, the old rising tide doesn't lift all boats - only the ones with no holes. Some people like TWA are not making any money this year.
We keep the $1 billion or $750 million in cash because we know that economies do go up and down. When the economy goes down, Houston, Cleveland, New York, and the Marianas Islands will still be there when it comes back up. With the cash reserves, so will we.
I'm pretty confident that employees will react favourably when we don't make money and understand the need to compete harder.
Merger talk
I've always thought we could stand perfectly well as we are. Last year I saw the industry possibly being triggered into further consolidation by the potential for American to acquire USAir as a result of the BA-AA merger. If that happened, I think we would be a target as we're such a good company and we have more strategic value than any other company in the US. I proposed the discussions with Delta because I didn't want to wait for the phone to ring and maybe be picked by the wrong dance partner. Delta wasn't interested, so we haven't pursued those talks.
I don't see any reason today to resume them. We are very capable of being around for another 20 years as the best airline in the US operating from Houston, Cleveland and New York, with almost unbeatable franchises across the North Atlantic and Latin America, and of course that little operation in Guam.
Source: Airline Business
