MIDCONTINENT PERSPECTIVES Midwest Research Institute Kansas City, Missouri

Transcription

1 MIDCONTINENT PERSPECTIVES Midwest Research Institute Kansas City, Missouri October 16, 1986 Richard D. Pearson Former President, Trans World Airlines* Kansas City, Missouri * On November 18, 1986, Mr. Pearson joined American Airlines as Vice President of Operations Administration. Deregulation An Insider s View Airline deregulation has probably had more written and said about it than either you or I have cared to read or hear. Although it is not an ageless topic, it is one that we have spent a lot of time looking at. Those of you in other industries such as banking, transportation, and communication certainly are going through the same kind of experience. I don t propose to dwell on deregulation as an overall transitional or political concept, but simply to speak as a senior manager with an airline, telling how we saw deregulation as it began and as it transpired. I hope that I ll be able to answer your questions as to why we didn t do some things we should have done, and did do some things that we probably should not have done. In a sense, we viewed it rather like the story about the one lady member of parliament who came upon Prime Minister Churchill late in the day. Sir Winston had been imbibing and was kind of weaving down the hall where he fell into a chair. She very indignantly said to him, Sir, you are drunk. To which he replied, Madam, you are ugly. But in the morning I will be sober and you will still be ugly. That is probably the way we viewed deregulation, as a shortterm intoxication, certainly not a physical impairment that would last the rest of our lives. The Deregulation Act of 1978 was some time in coming. The airlines fought very diligently for about four years, first to prevent it, and second to change the concept of deregulation. As the old major airlines viewed them, the concerns of the Act were several. First of all, would it destroy the national transportation system? Would deregulation create small individual carriers? The networking and connection systems and the complexes of cities tied together by the nation s airlines, which had created the greatest transportation system in the world, would simply, in our estimation, not be there. And, the traveling public would no longer share in the great national transportation system. We felt that the government was responsible for creating a national transportation system in our country, and with the elimination of the railroads as the major vehicle, airlines should certainly take over that role. Secondly, we were concerned about the loss of our routes. Basically under regulation, routes were an asset. Those airlines that had New York, Chicago, or Kansas City owned that route by rights under the Civil Aeronautics Board (CAB). The CAB was able to create competition, but at the same time never create too much competition or too much capacity in any given market so that we generally could predict market share. We knew who was going to have MRI, 2000 Richard D. Pearson, October 16, 1986 Page 1

2 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 2 what share of the pie in each market. Interestingly enough, during those years TWA was one of the opposers of deregulation, and yet in the ten years from TWA had not been given a major route award. Thirdly, there was the loss of service to smaller communities. We knew that most of the services to many of the smaller communities would cease. We were able to serve the marginal size cities because, through the fixed price that the airlines charged, the overall yield covered the losses. It made the connections work. And, under deregulation these cities would not be provided scheduled air service. We were also concerned about safety, new airlines coming in, the opening up, of the skies, and the saturation of the trafficways. We questioned whether the entrepreneurs starting airlines were committed to safety; knew enough about it; and had enough capitalization to support the enormous costs related to maintenance and safety. We were also concerned about losing antitrust immunity. That may seem insignificant to most of you. But in the airline business, particularly on the operational side, we continued to exchange data openly on safety, on mechanical things, on improvements, and on reliability of the aircraft. Loss of antitrust immunity created major barriers for us to exchange information openly. Even though we were not in the marketing department, it was considered to be in violation of some of those rules. Those were the concerns as deregulation began. That is what we fought against. In addition, the Act initially allowed any new carrier coming into the market to go into a city or a pair of cities and to lock out major carriers from going into that city for two years. We were subsequently able, through committees in the House and the Senate and lobbying done by the Air Transport Association, to change that rule so that it was truly a free and open sky policy. Anyone who applied for any route certainly could get it whether another company had just recently applied or not. The Act was passed and was effective in January We found ourselves looking at something I call the four freedoms. We had the opportunity to up the price of our product anyway we wanted without the other guy having to match it or use the same pricing technique. We had the ability to change our route structure at any time. That is, if we were flying into certain locations that were not profitable, we could go to new locations that we felt would be more profitable. There was freedom for new people to come into the airline business and not have to demonstrate the need for service or the good of public convenience. They could simply open up, get a charter, buy an airplane, and go to work. Finally, we had the freedom to fail. We can see now that the freedom to fail was as alive and well as the other three freedoms. Looking back at the condition of the marketplace as deregulation began, we see an interesting scenario that brings us to where we are today. Beginning in , which was really the opening gun of deregulation, we had the OPEC oil crisis. We had the beginning of the most significant economic downturn in the United States since the crash of We had the PATCO labor problem and, subsequently, the striking and firing of most aircraft controllers. We had the most powerful and cooperative labor unions in the United States and a weakening dollar in the world market. Fleet sizes and market shares of the major U.S senior carriers were traditional and known. No one carrier had any real advantage over another or was at a disadvantage. There were no significant aircraft orders in place, so no one was, in that short period of time, going to be receiving a large number of new airplanes and, therefore, flying to more new cities or making significant inroads into the competition. We had a costly and

3 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 3 inefficient work force, created mainly by regulation, poor earnings performance over the previous ten years, very high debt, and a rigid labor contract. So, when it all began, major carriers were in the midst of trying to manage fuel costs and were really diverting their attention away from this new form of operation known as deregulation. To give you some understanding of trying to manage fuel costs, in 1979 TWA flew 465,000 hours and our fuel bill was $480 million. In 1980, TWA flew the same 465,000 hours and our fuel bill was $100,000 more than a billion dollars. Fuel a little more than doubled in one year. And that cost obviously went right to the bottom line as a negative. We were trying to manage that cost and create enough earnings power within the airlines to continue to operate, which really distracted us from the process of deregulation. At the same time, new entrants were raising capital-venture capital being somewhat available and acquiring used aircraft. They were filing for routes and beginning operation. In fact, in the first six years of deregulation, 87 new scheduled airlines were created and operating. We went from 36 scheduled airlines in 1979 to 123 in It diverted the competition. And while we were distracted by the fuel prices, the economic crisis was going on and we were not really looking at what was developing. Many in the industry had high expectations that deregulation would last two years, three years at the most. They thought that the government would find that the system didn t work, that the transportation system had been torn apart, and it would step in and reregulate the industry. Probably the best example of this thinking was Harding Lawrence, then chairman of Braniff International, who began the most extensive flying growth ever seen. That was an airline that was very profitable. It had one kind of airplane, a 727, and it flew in all the major markets and had a good, low cost/earnings ratio. But Harding felt that deregulation was not going to last. He bought 747 s. He thought that if he could go to Europe, and to South America, and build an around-the-world international carrier and provide service to some of the additional major markets in the United States, when re-regulation occurred, it would freeze everyone and he would have the largest airline in the world. Unfortunately, to do the flying that he was doing, he used well above his contract fuel availability. So he had to go into the spot market and buy fuel. The fuel on the spot market was 20 to 30 percent higher than the fuel we were buying under contract prices. Between the cost of his new equipment and the cost of spot market fuel, Braniff International in a very short time became the first major airline victim of deregulation. Along with the economic situation, we were having a declining market, which in our business creates over-capacity almost immediately. Unfortunately, if an airplane has 200 seats and you only need 100 seats, it s not possible to break the fuselage apart and take that section out, along with the operating cost to support it. So, we had another way to fill up the airplane and that was to offer incentive discount fares. As over-capacity began to creep into the business, as new entrants came in, as the economic condition continued to deteriorate, fewer people were flying and the capacity became greater and greater. At some point, the incentive discount rate was no longer being used to create more passengers, it was really chasing cash flow. We began to see the cash flow erode. Obviously the cost of flying that airplane from point A to point B doesn t change a bit whether you have fifty people or one hundred. But the economics change drastically. We began offering the first discount fares trying to encourage traffic, trying to prove that the elasticity of the marketplace really works; that is, for every dollar that you drop the price, you will open the market to more people. At the same time, we had PATCO, and a new word came

4 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 4 into play in the airline industry called slot control. Slot control refers to the slots in and out of an airport and who owns those slots. The PATCO struggle and the subsequent laying off of air traffic controllers probably slowed deregulation a little bit, because with fewer controllers they couldn t handle the traffic in and out of the slots. They had to begin to restrict it. It may have helped the major carriers in the sense that the process of deregulation slowed. On the other hand, it began to take another form because the government, after looking at this problem, decided to force the major carriers who owned them to open up some of their underutilized slots so that the new carriers and the new entrants could have an opportunity to position themselves into the market. So, while slowing this process, it did initiate what we now call universal slot control, which means the slots are becoming access slots like routes used to be. They are open for sale on the marketplace and open to the highest bidder. Just recently, TWA sold slots in Chicago for $300,000 apiece. That is a considerable amount of money when talking about a slot of time in which an airplane has an entry into O Hare Airport. There is no tangible asset or anything, simply a recording on the air traffic control schedule that allows that airline that slot of time to bring an airplane in and down. At that time, we were distracted by the fuel costs, the economy, and over-capacity, and we were not really thinking about the changes we needed to make under deregulation. At the same time, the new kids on the block continued to get stronger. They had young labor forces, mostly nonunion, and low operating costs. When they bought used airplanes, those airplanes from a maintenance standpoint were zero time, which meant no maintenance costs. You see, there is a honeymoon period on any aircraft, whether new or used, that has been rehabilitated; therefore, for the first two years there are no major maintenance requirements and no major maintenance costs. We moved from the early years into the period from , which I would call the period of enlightenment. It began with the term fare wars. We called them discounts or incentives at first, but the real fare wars soon came. Over-capacity still existed in 1982 and we began to see the new entrants come in. As an example, in TWA s case, People s Express came in and put in a new fare from New York to Columbus, which we had owned for years, that was a third of the fare TWA was charging. We traditionally carried a 90 percent load factor and charged about $250 a roundtrip. They came in and offered it at $39. There was no way that People s Express was going to drive us out of the New York-Columbus market, so we matched the $39. And, we thought we had made a magnificent stroke when People s pulled out of Columbus. We probably lost half a million dollars in that market during that short time. But they simply moved over to Dayton and put the $39 fare in there. If you are familiar with all those airports up there in the Ohio Valley, you know you can drive to any of the three. The people continued to drive to Dayton, and we continued to ask our $250 in Columbus and lost even more money. The point I am stressing is that, at that time, the major airlines were point-to-point operators. We went from point A to point B. Kansas City under TWA at that time probably enjoyed more nonstop service than any city of its size in the United States. And in that regulated environment, when you left Kansas City, shut the door, and tunneled out the runway, all the people on board were all you were going to get. If People s Express comes out with its $39 fare and sits beside you, then you are going to get fewer people than you normally would have gotten. You begin to realize that you could approach People s Express in Columbus and New York City, but then they hit you in Chicago, and in Kansas City, and in Washington. There is no way you

5 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 5 could control the traffic or keep going at them head on because of the losses that you are incurring in four or five major markets. The new kids on the block were smart. They didn t go to the lower populated markets. They flew New York-Chicago, New York-Washington, Washington-St. Louis. They were picking at our very high profit routes. So we began to look at how we could control traffic, how we could determine the people who ride on TWA, and how we could control their needs throughout their travels. Whether you like it or not, the industry found a wonderful way to do just that. It is called the hub and spoke system, better known as the hub. Any one of you who has been at a hub lately, whether that hub is St. Louis, Dallas, Atlanta, or Chicago, knows that it works great for the airline but it is not very convenient or very nice for the traveler. The hub works great for the airline because it controls traffic and keeps the traveler from having a choice. Very simply it works this way. TWA s hub is in St. Louis. Omaha and the other spoke cities surround the hub. At 8 a. m. eighty people are on the airplane from Omaha going to St. Louis. TWA offers eighty destinations out of St. Louis and, just for a drill, say that the eighty people all want to go to a different destination (one of the eighty destinations) offered from St. Louis on a one-stop connection. If all the other eighty flights coming into that hub that morning did the same thing, all of our airplanes would be full all of the time, and everyone would be able to go to their destinations. That is the strength of the hub. That is the way the hub works. The fact that we tried to put twelve pounds in a ten-pound bag is what causes the traveler a problem. The other objection, of course, is that when you have those people on the plane from Omaha going to St. Louis, and they all want to go to those destinations, and the airplanes don t all quite arrive as scheduled, they have to wait. I see many of you nodding your heads. I realize, also, that it is not always your airplane that is late. You can walk down two gates and there will be a passenger there that is madder than you. But that is the way that we began to control the traffic; we could match airplanes and airplane capacity. Certainly, we didn t fly a 747 from Omaha to St. Louis. You don t need a 600- seat airplane in that market. But you could fly a 727 or a DC-9, a 100-seat airplane, in that market. And you could fly more frequencies because of the way that you were moving your aircraft around. We have learned that having one flight at 8 a.m. and one flight at 4 p.m. in many cities is fine. But having flights at 8 a. m., noon, 2 p.m., and 4 p.m. is a lot better because that is when people want to go. By matching the size of the spoke cities and the frequencies of spoke cities with the size of the various complexes of airplanes, you get much better utilization of the aircraft and much better matching of capacity with demand. So began the proliferation of hubs. The only hub anyone used to think much about was in Atlanta. Now we have hubs in St. Louis, Chicago, Dallas, Denver, Newark, as well as in Atlanta, and in the West, and in Salt Lake City, and in Charlotte, and in Memphis. Within the same period of enlightenment we began to see problems in maintenance as well as utilization. The press was concerned about whether the struggling airlines would spend the money to maintain their aircraft. Well, the press totally missed the problem; there was never any question that airlines would spend money for maintenance. Even the struggling carrier will spend his last dime to keep his airplane maintained because it is very difficult to make any money if your airplanes don t fly. What was forgotten with the hub and spoke concept was that the airplane never landed in a maintenance base. Airplanes never overnighted in a hub. They were in Omaha, Sioux City, or

6 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 6 Little Rock. Under the labor agreements that most of the airlines had, there was no way to put mechanics in those stations. If you put them there at eighteen dollars an hour, they got paid for eight hours, whether it was a one-, two-, or four-hour job. At that time, we were flying point to point and had maintenance operations covering thirty-five cities in the United States. Today, we are operating at seventy-five cities and have maintenance coverage in eleven. We had to find a way to maintain an airplane where we had people qualified to do the work. Before, the airplane came to Kansas City and we did the eight hours in a one- to eight-hour period. Now, we had to find ways to do the work in one hour, or two hours, or three hours. And we had to learn, through our engineering, to make sure we could do it in separate steps so that we could keep the airplane maintained and control the costs involved. So, that was the problem with deregulation; the problem was not that we were spending less money or more money or that struggling carriers were not going to maintain their planes, causing planes to crash and people to die. By the way, let me tell you how interested the traveling public was in the safety factor. Many of us senior carriers thought that deregulation would not be a big problem. We thought you wouldn t get on the fly-by-night airlines. But let me tell you something. If my price is forty dollars and fly-by-night is twenty dollars, you can bet your boots you will get on fly-by-night. You may complain and you may wonder why they don t maintain their planes, but you buy your ticket anyway. It is a credit to the industry that the mature airlines had developed an air transport system so successful, so committed, that it was safer than driving your car. So it did not concern most passengers that an entrepreneur could come in, buy an airplane, and begin service. If his price was cheaper, you simply bought your ticket and got on his airplane. At this time during the enlightenment period we had again two major failures, Braniff and Continental. Continental was a failure only in the sense that, like so many of us, it had high labor costs and very structured labor agreements and was not able to compete effectively with the fares that the marketplace was forcing all of us to charge. Remember, the revenue side is deregulated, the cost side is not. And at Braniff, they could not get their labor unions to give them any help, which essentially forced the company into bankruptcy. Continental fought until the very last day to solve its labor problems and make changes in that agreement to keep the airline flying. When they realized that they could not, they did file for Chapter 11 and relief and two days later brought the airline back up and changed the operating costs in forty-eight hours by $560 million a year. They simply threw out the labor agreements with their pilots, flight attendants, and ground service people and put in their own. When the rest of us thought that was an awfully good idea, the bankruptcy laws were changed, and you couldn t do it quite that fast. So, the key to Continental s success was not only the ability to change and to reduce costs, but also timing. The airline was down only forty-eight hours. There was no loss of people or loss of recognition and no loss of travel agents nor those revenues. Braniff, on the other hand, was down a year and a half, and had very little following when it came back, except in Dallas, a great place for Braniff to restart their airline all they had to do was take on American and Delta. There was one more development. We call them Peter carriers, you call them commuters, and the new term coming out is co-designators. We found that if we went all out we could control traffic in the hub and flow you through one place where all you could see was the familiar red and white, blue and white, or green and white. We call it a co-designator because the commuter is licensed to be a TWA express. If you are in Joplin, Missouri, and you want to go to London, you can book your flight, get your boarding pass, check your baggage, and buy your ticket from Joplin, Missouri. Your flight will be in the flight schedule, and it will show Joplin to

7 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 7 St. Louis, and St. Louis to London. This service began to fill the void that deregulation had left in smaller communities when airlines pulled out the jet. Most of these cities are within the mileage range of the hub in which a jet is not allowed to fly any faster than a piston plane because of air traffic control. So we re talking about the same flying time, but with a nineteenseat airplane that I can schedule six times a day instead of the once or twice that the big airplanes are allowed. I offer better service, it looks like me, and it costs less because we have young and nonunion people. Now I want to spend a few minutes talking about labor in transition. Where was labor when this all started and where is labor today? You really have to look at it from 1979 to the present. The Deregulation Act of 1978 was conceived under a Republican administration, Ford. It was subsequently passed under a Democratic administration, Carter. And the Reagan administration really is the one that has nurtured and administered the process across its eight years. That is very important in the sense that with the sunset of the CAB, the transition to DOT, and a friendly Congress and administration, we were able to get into the act with labor and not be faced with horrendous labor protection provisions. The initial Act had a labor protective provision. But thankfully that provision was tied to supporting or paying for employees who were disenfranchised from jobs as a result of deregulation. Now if anyone ever sues for that and it goes to the Supreme Court, it will take the next hundred years for anyone to figure out whether they were disenfranchised by deregulation. I mean, how can anyone say that a mechanic at TWA who works on 727 s in the overhaul base in Kansas City is disenfranchised because TWA decides to change the flying pattern to reduce the maintenance requirements. How can anyone ever say that it was a result of deregulation? There simply are no teeth in the rule. The unions have not made a great case out of it. We have set up a common furlough roster among the airlines that says these people have been furloughed. There is, therefore, a cadre of workers who might be available to an expanding airline that needs help. When deregulation began most unions said very simply that it was a management problem and management should figure it out. We (labor) will help figure it out, but don t affect our working conditions or our wages or our benefits. Unfortunately the only problems we (the airlines) had were the working conditions, the wages, and the benefits. If we could have changed those, we would not have had any significant problems. But labor s basic attitude was, we would rather see you fail than give up our hard won working conditions. We have seen what happened. We saw it at Continental. Continental labor would not budge from their contractual requirements. They went on strike. Subsequently, Continental was forced into bankruptcy, and out of the bankruptcy the unions lost not only their working conditions, wages, and benefits, but two of the unions did not reappear on the property. None of them have, in fact, as of right now. Today, IAM represents the mechanics on Continental property under a contract negotiated by Continental telling them what their wages are, what their benefits are, and what their working conditions are. The only thing that IAM controls is the return of furloughed people who come back whenever there is an opening and they can then regain their seniority. Thus, the airlines began to find a way to solve their labor costs and their labor problems. Our utilization was up. We were using the hub and spoke system, and we were beginning to drive the unit cost down because we were flying more hours more efficiently and offering more seats to the market. The economy was beginning to rebound, and we were able to pull our unit cost closer to the new airlines. But without continuing to reduce costs we couldn t get close

8 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 8 enough to stay in the kind of fare environment that was being offered competitively. So, we began to reduce costs with concessions, another new term in the airline business. If you and I want to change our operating costs we want permanent change. Permanent change means today you make two dollars an hour, and tomorrow you make one dollar an hour, and that is all you make. You make it forever or until we renegotiate. Concessions basically had a committed life and a snap back. I will give you the situation TWA has. The union reduced their hourly rate by two dollars an hour for three years, and then the rate will snap back to its original price. And most of these agreements had an equity offset. Labor wanted to make an investment. They said they would reduce their rate by two dollars an hour but they had to get stock to offset the two dollars. So essentially I m trading savings for equity, and I am really not solving the problem. We kept asking the union how we could manage an airline in today s environment with an operating cost that makes us competitive now, but uncompetitive three years from now. How do you manage, plan, advance, grow, compete, and make plans. You can t. So the two-tier system came into being. Some of you in the room are old enough to remember when we had a very smooth transition into skilled jobs. You came in as a junior apprentice, became apprentice mechanic second grade, apprentice mechanic first grade, and finally mechanic. It was a very natural transition. Two things happened. As you improved in grade, you improved in your wage rate. You also improved in your experience and your ability to do the next job. Today at TWA you can be a ground service helper, which is an unskilled job in the company, bid for mechanic, get your licenses, and in ninety days be at the top grade for mechanic. The only reason that there is a ninety-day wait is because we have a probation period. If the airline ever wants to fire you, it must be during those ninety days. Once you get past that, you are a senior mechanic in the same position as the guy who has been working as a mechanic for thirty years. The new two-tier concept was a way to return to the pay for experience concept. The old employees who were there and had contributed to the airlines kept the wages and benefits that they had negotiated. But the new people who came in as the airline expanded, who had not made a significant contribution to the airline, were paid at a lesser rate, half; that is, eighteen dollars an hour for a mechanic-senior A player, and eleven dollars an hour for a mechanic-senior B player. Most of the major international unions, like IAM, would not buy that kind of strategy. However, at American under the transportation workers union (TWU), they reached an agreement to work that way. The way the agreement was negotiated the eleven dollars an hour people would catch up in fourteen years. That gave American a great opportunity to grow rapidly because they effectively added every additional employee at half the cost. Today at American that s the way they still operate the airline. There is both the core airline, which consists of the senior people at the higher rates, and the new airline, now double the size of the old one, with people working at the half rate or less. Certainly, as you drive your operating cost down, significantly down, you have a very competitive product. Labor continues to grind. TWA was able to make an agreement with its pilots and mechanics that is really quite different than would be done in regular negotiations, but nevertheless, they were able to do it. But TWA had a flight attendant union, which even as an independent union, not an international union, and certainly not with the power and clout of an international union, could not understand two things: first, the TWA rate for flight attendants was

9 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 9 23 percent ahead of the industry; and second, management wanted to bring it down at least equal to the industry. As a result, TWA was forced, through a major work stoppage with that union, to reduce costs. About five thousand of those people no longer have jobs. But the union represents a mentality that does not understand a deregulated marketplace, and thus it does not effectively represent the rank and file members to keep them not only employed but secure in their jobs. After that, we moved into what the airline industries face today, a period I ll call from now till whenever it is over, an industry in consolidation. It s driven by a need for efficiency and better margins. Size becomes a dominant player. As we saw the hub and spoke concept work, as we saw the commuter interfaces work, as we saw that the profitability margin within airlines was so small, and as we gained efficiency by increasing our ability to interconnect hubs, we realized that size was the only way we could make a reasonable return. And it was the only way to make the kind of earnings that would allow us to expand and continue to operate and replace the aircraft in our fleets. As a result, we see today all the mergers and acquisitions that have been going on: Pan Am-United, Northwest-Republic, Texas Air-E1 Al, TWA-Ozark, Delta- Western. The mergers that we see today would have come significantly earlier if we had not had the fuel problem in the front, the low economy in the middle, and had the CAB not sunset until the end of The great concern of most airlines was that the CAB simply would not agree with some of the merger acquisitions. Once the transition to DOT began, it was obvious to all airline leaders, particularly after the Pan Am-United sale of the Far East, that this administration and certainly the DOT would look favorably on those kinds of transactions as long as competition was not materially reduced. Those of us in the industry felt that the reduction of competition was not taking place in any given city but was occurring between the hubs. That was where the real competition was. So you have seen the maturation of the mergers. They have all been approved, and they certainly have given us more structure. Let me close by talking about what lies ahead. I think we are going to continue to seek consolidations. U.S. Air is still out there, Piedmont is still out there, certainly Braniff, the littler fellows who can t really have enough structure to compete effectively without some kind of a consolidation. The competition will continue as each tries to increase the size of its hub structure. We are going to see continued pressures on earnings because fares will not return to the kind of deals that we in the industry came to expect. The cost savings we re seeing now in fuel will not be transferred to the bottom line. In conclusion, let me ask, is deregulation a success? I would have to say it is. Certainly for the consumer it has been a success. It has brought more people to the marketplace because more people can afford to fly. It has reduced some of the cost of business flying. It has not been as fair to us in the Midwest, however, as it has been to the Coasts. It seems somewhat inequitable to fly ninety-nine dollars New York Los Angeles and two hundred dollars to St. Louis. But those fares will be adjusted, and I think we will see a fare in the future that will be more mileage driven but still very competitive and reasonably priced. I think also it has been a success from the airlines standpoint. They are more efficient. The unit price of the product is certainly cheaper and more efficient. Flying is more stark. It is not as romantic as it was in the old days when we had the good looking airplanes, the leisurely schedules, great meals, and all the other things that go with what we remember as a world class

10 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 10 airline. But it is no different from having a Cadillac or an old Ford. What you are trying to do is get from point A to point B. The airlines are doing that for you very well. Let me conclude by saying thank you. I hope these observations have given you some insight into where we are. Air transportation today is efficient, the price is good, and certainly it is as safe as it has been anytime in the twenty years that I have been in the industry. QUESTIONS AND ANSWERS QUESTION: Why did TWA pick St. Louis instead of Kansas City for its hub? ANSWER: That is very easy to answer. It would have been an emotional decision to have picked Kansas City. The population of Greater St. Louis is about 4.2 million and Kansas City is about 1.5 million. The guy who lives in the hub gets 90 percent of the local passengers. I would like to have had it in Chicago since they have 12 million there, but United and American were already in Chicago. Generally speaking, you try to place the hub, your primary hub, in the largest populated metropolitan area that you can get. Clearly, the airport, the runways, and the ramps are far superior here in Kansas City. Those of us on the operating side were arguing for Kansas City, but the marketing people were certainly arguing for more passengers. QUESTION: Would regulated traffic within a city fare work? ANSWER: Essentially, that is what we had before. Take the New York-Baltimore market as an example. The CAB allowed three airlines in there. United, American, and TWA were the only three that could fly. And, we were restricted to three to four frequencies a day, each of us. The traffic in that market essentially could have been carried by those three airlines at something above a reasonable load factor. Unfortunately, it doesn t do anything for the traveler because we charge the same price that everyone charges. In other words, there s no room for efficiency or one airline who could charge less because it could operate cheaper. The marketing difference was simply that we had a better steak than the other airlines, or the airplanes were better. QUESTION: What do you see in the future for the international airport as it relates to a hub? ANSWER: You have what is called a secondary hub with Eastern. I don t know what Eastern will do once the consolidation with Texas Air occurs. My opinion would be that it would probably reduce some of its service because it will have hubs in Denver, Houston, and Miami. You would be better off if you could have a hub in two different time zones. I think that Kansas City will always be right on the verge of being one of the secondary hubs. It will simply be a matter of when the airport comes up as these big consolidations occur. Because, quite frankly, when this thing is over you will have four or five big airlines and everyone of them will have at least three or four major hubs, and they will all connect. And, Kansas City will have to be one of the secondary hubs because it is one of the better airports in the United States. QUESTION: Did you say that it is not good to have your maintenance base in your hub? How does that affect TWA and Kansas City? ANSWER: I did not say that it was good or bad to have your maintenance base in your hub. What I said was that your airplanes finish their day away from the hub, on the West Coast

11 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 11 or East Coast. They fly to the hub the first thing in the morning and begin their connecting service. If you have your maintenance base at the hub, there are no airplanes there to work on. On the other hand, having it there means that you can schedule your aircraft such that they come through there so you can work on them. Ideally, the coast is the place to have your maintenance bases if your hub is in the center of the country. The airplanes finish there in the evening, and you have a dead period usually from 10 p.m. unti1 7 a.m., which is idle time to work on airplanes. But, in the case of TWA, with the maintenance base here and St. Louis, I don t think there is any threat to the overhaul base. Building an overhaul base would cost a billion dollars, and secondly, it is not that difficult for us to move aircraft from St. Louis to Kansas City. However, you may end up flying St. Louis-Kansas City some day on a 747 simply because we are moving an aircraft out of the international market into the overhaul base for maintenance, and we won t deadhead with a crew. QUESTION: What is the conflict between a regulated international environment and a deregulated domestic environment? ANSWER: There is not much conflict, really, because we have always operated in a regulated environment in Europe. But it does restrict those of us who have learned how to operate in a deregulated environment. For instance, in TWA s case, hubbing in Paris is ideal because of the seasonality of Europe. It allows us to fly from St. Louis to Paris, New York to Paris, Boston to Paris, and to fan out of Paris to Frankfurt, Cairo, Athens, and all the other points. Through your hub in St. Louis, where you are collecting people, if you had one flight to Paris and it connected to Frankfurt, Madrid, Barcelona, Cairo, Rome, Athens, you would be selling seven European destinations all out of St. Louis. Your chances of getting that airplane filled up are a lot better than if you sold in Paris point to point. So it has restricted us from doing key things that we would do, now that we know how deregulation works. On the other hand, it depends on the rights that you hold. We happen to hold a right in Paris to operate the freedom traffic there, and so we have somewhat of a hub in Paris, but we can t do it in Germany. Ideally you would want to do it in London, but you can t get in there at all. QUESTION: How are you dealing with security? ANSWER: Security is much better than it was when we had the hijacking in June of last year. Our security was good then, but it is better now. Before, in Europe, we operated our security through the Italian government, the French government, or whichever government. We simply told them that we wanted certain security measures and they did it. Their government workers are just like our government workers. They were not getting paid by TWA so why would they care whether TWA was a big deal or not. Now we are able to employ our own people, our own agencies, live by our own procedures, have our own x-ray, and our own special security devices. And we have all learned a great deal from E1 A1. We have more control and flexibility than we ever had before. We all know that it is not going to be totally foolproof. You couldn t spend that much money. But it is a lot better. QUESTION: How would you have done things differently with People s Express and the Columbus market? ANSWER: I think I would have continued to charge the same price, started flying to Dayton, and not taken them head on. Essentially we were trying to figure a way not to take them on. We knew prices were going to come down. They had to. But their $39 fare in that market

12 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 12 was no more realistic than the $250 that the scheduled carriers were charging. As I said, we were carrying a 90 percent load factor in the market, and the day they opened their doors with the $39 fare we had no one on the airplane. I am sure we should have moved in, particularly in the Ohio Valley, because the customers there will drive to any of the three airports to get the best service or the best fare. QUESTION: You said that there will be four, five, or six big carriers at the end of the transition period. Will that cause reregulation? ANSWER: I think not. The competition among those five or six big airlines is going to continue to be as intense as it is now with all the other airlines in there. And that should hold the fares down and continue to create opportunities for profitability and efficiencies and all the other factors that drive deregulation. Consumers continue to benefit. QUESTION: Do you see fares going up? ANSWER: Every fall when traffic slows down from summer, the fares go up. Then we have over-capacity. So when we put the 30 percent discount on fifty dollars instead of forty dollars, we get two dollars more than what we would have gotten had we left it at 30 percent. Airlines are very smart. We lower the airfares during a demand period and increase them during a non-demand period. We have been doing that for years. QUESTION: How do you think the fares should work? ANSWER: In this industry there should be three fares: a first class, a coach, and a discount fare. There ought to be a fare that is substantially cheaper because you purchase it in advance, because that is the way you fill the plane on the day of flight. There ought to be a coach fare for people who have to go somewhere. And there ought to be a fare for those folks who want to enjoy the luxury of a wider seat, free drinks, and all the other things that come with it.

13 MRI, 2000 Richard D. Pearson, October 16, 1986 Page 13 RICHARD D. PEARSON is a veteran airline executive whose career has encompassed both the regulated and deregulated phases of commercial air transport. He says, On balance, the new look in airlines has greatly benefited the consumer, with lower fares and much wider choice of travel schedules. On the other hand, it has imposed more stringent burdens on airline managements, especially on the long established carriers such as TWA, American, United, Delta, among others. During his twenty years with TWA, Dick s posts included vice president of Data Processing (with PARS responsibility) and then vice president worldwide maintenance and engineering, headquartered at MCI. In 1984, he was elected executive vice president and chief operating officer and moved to New York City. He was named president of TWA in September He resigned in June 1986 and is now vice president of operations administration with American Airlines headquartered in Dallas. Dick was born in Ottawa, Kansas, and is a 1958 graduate of Kansas State University where his experience as a three-year varsity linebacker was a fine preparation for the challenges of deregulation. Top MIDCONTINENT PERSPECTIVES was a lecture series sponsored by the Midwest Research Institute as a public service to the midcontinent region. Its purpose was to present new viewpoints on economic, political, social, and scientific issues that affect the Midwest and the nation. Midcontinent Perspectives was financed by the Kimball Fund, named for Charles N. Kimball, President of MRI from 1950 to 1975, Chairman of its Board of Trustees from 1975 to 1979, and President Emeritus until his death in Initiated in 1970, the Fund has been supported by annual contributions from individuals, corporations, and foundations. Today it is the primary source of endowment income for MRI. It provides front-end money to start highquality projects that might generate future research contracts of importance. It also funds publicinterest projects focusing on civic or regional matters of interest. Initiated in 1974 and continuing until 1994, the sessions of the Midcontinent Perspectives were arranged and convened by Dr. Kimball at four- to six-week intervals. Attendance was by invitation, and the audience consisted of leaders in the Kansas City metropolitan area. The lectures, in monograph form, were later distributed to several thousand individuals and institutions throughout the country who were interested in MRI and in the topics addressed. The Western Historical Manuscript Collection-Kansas City, in cooperation with MRI, has reissued the Midcontinent Perspectives Lectures in electronic format in order to make the valuable information which they contain newly accessible and to honor the creator of the series, Dr. Charles N. Kimball.