The Management Lessons of a Beleaguered Industry

Airline companies may be the businesses everyone fantasizes the most about trying to fix. (In the case of that other I-could-run-it-better favorite, restaurants, at least plenty of excellent efforts counterbalance the bad.) And just now the fixing would require more work than usual. A new round of mergers, a new climb in costs and a new wave of customer dissatisfaction all pose fresh challenges. Add to that an industry work force whose wages have plummeted by $15 billion since 2001 and whose morale is at a low ebb and an air traffic infrastructure that both experts and customers realize is overstressed, and the overall industry repair problem can seem impossible.

Thomas A. Kochan, along with Greg J. Bamber, Jody Hoffer Gittell and Andrew von Nordenflycht, takes up the task in the forthcoming book, Up In the Air: How the Airlines Can Improve Performance by Engaging Their Employees (Cornell, New York: Cornell University Press, January 2009). Kochan, the George Maverick Bunker Professor of Management at the MIT Sloan School of Management and a longtime leading analyst of workplace relations, identifies the need for utterly altered employee/ employer relationships as the critical opportunity and threat that the airline industry faces. It could go either way, he admits. And movement along the positive path won’t be easy.

In this interview, Kochan explores the airline industry models that have worked (and are working) along with those that haven’t. And he suggests that the airline industry isn’t alone in encountering fundamental choices about how collaborative their workplaces will become. He spoke with MIT Sloan Management Review editor Michael S. Hopkins.

In the News: Delta and Northwest

The Continental Airlines and United Air Lines merger was shelved earlier this year, but it appears that the Delta Air Lines and Northwest Airlines deal is on track to happen. Will it be a success?

KOCHAN: Ultimately — and inevitably — there’s going to be more consolidation in the airline industry, but unless Delta and Northwest begin to address the differences in their cultures, the differences in their employee relations, the fundamental differences in their labor relations, this is a merger destined to fail.

Why wouldn’t Delta and Northwest manage those differences? Don’t leaders on each side understand the problem?

KOCHAN: It’s not that they don’t understand it. My experience in the airline industry is that the managers always say, “We’ll get to those issues in due time. But first we’ve got all these financial issues around the merger, we’ve got to get our networks in order and then we’ll get to employee relations.” The reality is they never get to them, and even when they do, by that time it’s too late.

What do they think the merger will do for them, integration challenges notwithstanding?

KOCHAN: The first thing they think of are the tremendous advantages of the route network integration — the fact that they get access to each other’s networks. Turns out they complement each other very nicely. Access to Europe on the one hand for Northwest. Access to Asian markets for Delta. The second thing they get — or think they’ll get — is considerable cost reduction because they believe they can get more efficiency by linking their organizations and reducing some of the overhead associated with running an airline.

When they do get to organizational integration, how do you think they’ll fare? On the basis of their histories, do either Delta or Northwest seem suited to attack the kinds of cultural issues you describe?

KOCHAN: Neither has been successful in attacking those cultural issues in the recent past. Northwest has some of the most adversarial union relations in the industry. Delta has difficult relations with its pilots, but it also has a large group of nonunion employees. When you bring the two together, somehow there’s going to have to be an integrated work force with a single employee relations and labor relations process, and neither of them has figured out how to do that.

Why are employee relations and culture so important in the airline industry in particular?

KOCHAN: Because, as our airline research over a decade has shown, a high level of engagement and a good labor relations system are the keys to increasing productivity and service quality. And productivity leads to profitability. In the airline industry, productivity requires two things from the work force. First, it requires that workers use their discretionary effort to solve problems for us as passengers, which means they must be motivated and authorized to do so on the front lines. Second, it requires labor peace — no prolonged conflict over new contracts, no slowdowns, sickouts or stoppages. In so cost-driven an industry, productivity is all. With employees, there’s a virtuous cycle and a disastrous cycle that airlines can follow, and the only question is, Which one are they going to choose?

Are there airlines that have figured out employee relations issues?

KOCHAN: There are several airlines that do it well. The premier example — the one that people always turn to — is Southwest Airlines Co. Southwest is the most highly unionized airline in the industry. It has had 25 years of successful financial performance and good labor relations. It does so because it has been very clear in building a partnership with its employees and its unions around its strategic objective of turning planes around quickly in airports. It designs its operating system to achieve that objective. It designs its employee relations system to achieve that objective. It gets everyone working together, it avoids complicated work rules. So Southwest is the most visible example.

But there are others. Continental Airlines came back from a disastrous decade in the 1980s and early ’90s when Frank Lorenzo took them into bankruptcy, and then they went into bankruptcy a second time and he fought unions and tried to break them. In 1994, new management comes in, recognizes the old strategy didn’t work and says, “We’re going to learn somewhat from Southwest but we’re going to do it our way. We’re a more complicated airline. We’re a hub-and-spoke airline. We have to rebuild relationships with our employees so we can communicate effectively with them, and build some shared financial incentives so that they can improve their standard of living as we begin to meet some of our operational objectives — and, by the way, we’re going to do this in partnership with our unions, but again we’re going to avoid the complicated work rules that sometimes impede productivity.”

To the outsider, that sounds optimistic. As you note in your book, the industry has lost 100,000 jobs and $30 billion since 2001. So when you write about the need for employees to have good jobs, good wages and successful partnerships with their companies, the lay observer has to wonder, How can that happen when it appears there’s no room for gains, only for cuts?

KOCHAN: First of all, the deep cuts in jobs and wages have been made. You can’t really go any lower without expecting to lose so much human capital that it could become impossible to operate. Over time, I believe that as the industry recovers, as it begins to get its capacity close to the level of demand, begins to raise a bit more revenue and begins to engage employees and rebuild trust, then you can design a compensation system that says, “As we improve, so too will rewards for employees.” We will never get back to the premium pay that pilots were earning at the peak of 2000, and we may not get back to the day when passenger service agents and other employees are made whole at old levels. But I would argue that if we don’t start to rebuild employee compensation, we will never get a renewed and successful airline industry again.

Two Different Models: Southwest vs. Ryanair

But you describe at least two very different paths to growing a successful airline, and only one of them matches your view of the healthiest way to build an industry future. What are those currently successful competitive models?

KOCHAN: The two most financially successful airlines in the world are Ryanair Holdings plc, in Europe, and Southwest, headquartered in Texas. Both emphasize low unit costs. That is, providing a service at low cost. The fundamental difference is that Ryanair gets there by minimizing labor costs, by squeezing employees, by adopting very harsh working conditions, by high levels of turnover so that costs don’t build over time. Whereas Southwest gets to low cost by emphasizing improved productivity [and] loyalty on the part of employees so they stay a long time and use their skills and knowledge to build a successful airline that meets customer service needs [and] that is designed with a work system that maximizes employee ideas and discretion for solving problems and achieving their financial objectives.

So you have two highly successful airlines in financial terms but, on the one hand, Southwest does it by engaging employees and ends up being mentioned in Fortune’s “100 Best Companies to Work For” in the United States, and Ryanair does it by squeezing employees, by having constant fights with their work force and by paying minimal benefits and wages. They’re doing well financially, while their employees are not doing well at all in terms of their work experience.

You say Ryanair keeps wages depressed. How does Southwest’s employee compensation compare to industry standards?

KOCHAN: By industry standards in the United States, Southwest employees are among the highest paid. They’ve moved to that position as the legacy carriers — United, American, Northwest and so on — have either gone into bankruptcy and lowered their wages or cut wages through concessions outside of bankruptcy, as American Airlines Inc. and Continental have done. So, as those airlines have brought their wages down, Southwest has not cut its wages, and now it finds itself right at the top of the distribution — whereas it used to be in the middle.

Now that they’re at the top, that’s going to pose some challenges for them. Can they maintain the same kind of employee commitment and engagement and loyalty when they know that if they go too much higher they perhaps run the risk of becoming uncompetitive? So they face some challenges — no organization is perfect, and nothing that seems perfect will stay that way. But they’ve been successful over 25 years doing this, they work hard at these issues and my hope and my sense is that they will find ways to work through the next few years and will continue to get the most out of their employees.

So they will have to find a way to gainshare with their employees while their employees recognize that the ceiling is now lower on their individual compensation growth?

KOCHAN: That’s right. They already have some forms of gainsharing. They may have to expand on that. My sense is that these will be difficult choices for both the company and for employees and for union leadership there, but I think that they will move in that direction even more than they have now. There’s room for some modest compensation increases over time, but they’ll have to be careful not to get too far out ahead of the rest of the industry.

Ryanair is a comparatively recent entrant, as are many small airlines these days. Have recent entrants tried more often to have relationships with their work forces like that of Ryanair or like that of Southwest?

KOCHAN: Almost all the new entrants have tried to learn from Southwest, because they were the paragon of innovation. Even Ryanair says they’ve learned some things from Southwest. What you find is that just about every new entrant wants to open up by having a more committed work force, by engaging employees, by making sure that they are really the ambassadors of the airline to the customer. That aspect of Southwest, at least in theory, has been adopted. The use of technology and information technology and making sure they stay focused so they don’t have multiple types of airplanes and large diversity in terms of training requirements and so on — that strategy also has been something from the Southwest model that’s been adopted.

Not all the airlines have accepted unions the way Southwest did — in fact, most don’t, even in countries in Europe where you might expect it. And that’s where Ryanair differs. Ryanair has taken some of those same attributes from Southwest but said, “All right, we’re going to do this but we’re going to do it bare bones and make sure we don’t get unions. We’re gonna stay nonunion and we’re going to keep our labor costs down by keeping wages down.” That means they get higher turnover and higher conflict (for example, with the European community and some of their labor relations); they got conflicts in Ireland when they tried to take over Aer Lingus Group plc and the political forces blocked them because they don’t want to see replication and see their practices spread across the country. Ryanair has certainly been successful in keeping their costs down, just in a very different way from Southwest. But they have learned from and imitated Southwest, too, in terms of some of the focused aspects of their business model.

Unions don’t get a lot of good press. Are people surprised when you remind them that Southwest has been unionized nearly from the beginning?

KOCHAN: Maybe, but the truth is that Southwest faced many fewer challenges by being unionized right from the start than do companies that are now trying to fix a broken relationship with employees. If as an organization you don’t go through a long battle over organizing, then it’s easier to build the kind of high-trust relationship that’s needed to be successful. If you go through a long battle over whether there’s going to be a union or not, then you get the union you deserve — nobody trusts each other, and all the work rules and all the litigation and all of the prolonged conflict gets built in right from the beginning.

Southwest avoided all that. They looked around and said, “Look, we’re in the airline industry, just about everyone is unionized, we need to get off the ground, we need political support, we don’t want to have these battles.” And I think philosophically they said, “We should respect employees’ decisions on this; if they want to get a union, then we’ll respect it. We’re not going to go out to look for one” — that’s not legal under American law and it shouldn’t be, it’s not management’s decision to make — “but we’re going to work very closely with them. However, we’re going to be very firm about what we’re not going to do — we’re not going to have standard adversarial, high-conflict, strict work-rule labor relations. Because that won’t work for our business model.”

To Unionize or Not to Unionize …

Imagine for a minute that somebody calls you and says, “I’m starting up a new global airline, and I’m thinking about how to ensure the right relationship with my employees.” Would you advise that caller to unionize or not?

KOCHAN: I would not advise a company to go out and create a union. I would advise a company to be very transparent about what their objectives are, what their business model is, the kind of employee relations that they want to build, and work with their employees to build that. And then if a union begins to organize or if employees express an interest in organizing, then you respect workers’ rights, you respect the processes. If that leads to a union, then that’s part of the process. If it doesn’t, then that’s the way you manage. You can manage in a union or nonunion setting.

Now, American labor law is a little complicated on some of these things. But I believe what you really want to do is engage employees, and you want to engage them not just as individuals but sometimes in groups and collectively — so you would create a series of forums to make sure you were processing their ideas, make sure you’re hearing them, make sure that they have an opportunity to challenge management, to say, “Hey, you’re not treating us fairly…” or, “If you did this over here, we could be much more productive, but it’s going to require resources that you’re not allocating, so why aren’t you doing it?” That kind of open challenge has to be part of engaging the work force because that’s where the value comes from.

Is there an example of an airline that is taking that approach to its work force but is not unionized?

KOCHAN: I think that JetBlue Airways Corp. has done that. They were created in 2000 as a nonunion airline, but they have engaged their employees. Now, they’ve had some bumps along the road, they’ve had some operational issues, but by and large they have a work force that I think is well-trained, is engaged, is working very hard — and gets very good ratings for customer service, which is not an accident. That’s because they believe in what they are doing. Doesn’t mean that they’re perfect, nor does it mean that any other union or nonunion company doesn’t have bumps along the way, as we’ve said, but I think JetBlue has done a quite good job at trying to engage their employees. Now, what would happen if a union tried to organize, I don’t know. But so far, they’ve been successful in attracting high-quality employees, engaging them and retaining them.

In your book, you wonder, “Do low fares inevitably mean low-quality jobs?” I think the public generally believes the answer to that question is yes. What’s your answer?

KOCHAN: The answer is no. Southwest is a low-fare competitor, and they’ve had high-quality jobs. I believe it’s a bit more of a challenge for management. They have to be willing to invest in ways that build organizational capability to get high levels of productivity. They have to work with their labor force, they have to train their managers to do that. They have to make sure they hold their employees accountable for providing the productivity that warrants a higher wage. That’s what’s required. On the other hand, that’s what builds not only a financially successful organization, that’s what builds you an organization that gets you on the list of the 100 best places to work. It’s more sustainable than what we see in the other companies in the industry.

What’s Next for Airlines? (Three Paths)

Where do you think the airline industry is headed?

KOCHAN: I think there are three potential scenarios. The first one is the most negative and maybe the most likely, and that’s that the status quo continues.

If the status quo of highly adversarial relationships continues, then in the current environment I think we’re headed toward what might be called a perfect storm. The contracts in this industry start to come due in 2010, and many of them for the first time in the history of the industry come due at the same time because concessions were made at the same time (by pilots, baggage handlers, flight attendants, etc.) during bankruptcy. When that happens, you’re going to see all the pent-up pressures of this highly demoralized work force just explode. And that’s when we’ll also be facing an overstressed air traffic control system; we’re not currently able to hire enough air traffic controllers to replace retirees fast enough. And so I worry that we’ve built ourselves a potential disaster situation where all these pressures come together and we have a meltdown of the system. That’s the most likely scenario because you have a very demoralized work force in the industry right now.

What’s the second scenario?

KOCHAN: The second, more positive scenario is that company by company we start to work on these workplace relations issues. These mergers that are being discussed are the natural opportunity to do that. If Northwest and Delta said, “We’re going to have a different approach here. As we go through this merger, we’re going to build a business plan for engaging employees, we’re going to figure out who’s representing whom in our merged organization and we’re going to insist that our managers and our union leaders work with us to build a single, positive workplace culture to negotiate contracts over a period of time that help employees step by step regain some of the losses they’ve incurred as we begin to rebuild our profitability,” then I think one could see a much more positive scenario. And if one or two of the companies do this and are successful, then it will put pressure on the others.

OK, and is there a more hopeful scenario as well?

KOCHAN: A third possibility is that we get a sensible transportation policy and that we have the government begin to say, “Look, this is a disaster. This industry is very important to the security of our country and to the overall economy and certainly to the economies of many of our communities around the country.” We have a stake in making sure that the industry starts to deal with these issues and starts to take the kind of leadership that I think is possible and that is absolutely necessary in order to deal with them. Because right now the government is just turning a blind eye to it and letting the mess continue.

That has not always been the case. We’ve had government leaders before who’ve said, “We’ve got to improve the performance of this industry, and labor and employee relations are a part of it and as part of an overall transportation strategy we’re going to insist that we start working on these issues.” And government officials have the leverage to do that if they want. They can hold up mergers until the companies show that they’ve got a business plan to address these issues. They can hold up investments in infrastructure that are needed; they can hold that out as a carrot. That’s the kind of policy that I think would really bring about change and build a more sustainable airline industry.

Not re-regulation?

KOCHAN: I’m not talking about re-regulation of any kind. We should not re-regulate in the sense of determining who can fly into what market, what companies can enter the industry and whatnot — that would be a mistake. We’re talking about sensible aviation transportation policy — one that reflects an understanding that human resources are part of the overall structure for a successful industry. We’ve seen this in other industries and we can do it here, in airlines, as well.

Do you foresee the forces playing out in the airline industry also coming into play in other industries? Are we looking at a changed environment for the ways that employees and companies relate?

KOCHAN: We are in a service economy, and in a service we can’t have high-quality services unless we have an engaged, well-trained, well-educated, motivated work force. That means we have to have a management system that supports that kind of environment and draws out those talents of the work force. That means we have to have a labor-management relations policy and environment that also supports that. I think we will see this more and more put on the table — whether we will be successful, I’m not so sure — but we’ll see it put on the table in critical industries like health care, where we obviously need to improve quality and control costs.

I think that as we as a nation begin to debate health care, we’ll see an issue emerge about how we build the work force. We’re seeing it also in industries outside the service sector where we have the need for “high-reliability organizations” — oil refineries, petrochemical plants, nuclear power plants, air traffic control systems — those places where a safety culture is so critical to reliability and to high levels of performance.

And finally I think the American work force is going to demand this changed employee/employer relationship. We’ve gone through now two decades of stagnant wages where we haven’t been able to raise rewards. The only way we’ve been able to keep our family incomes from falling is we’ve had more wives and mothers in the work force and, unfortunately, we don’t have another set of wives and mothers to go around, so we’ve exhausted that option as a road to more income. We’re going to have ask, “How are we going to improve the real incomes of working people?” And that means we have to improve their productivity and we have to have a way of sharing those gains. I think the pressures that will bring that issue to the fore are about to explode.

How much room is left for productivity gains in the industries you’re most familiar with? Or, asked another way, based on your research findings, by what percent would top-quality labor-management practices improve productivity in the airline industry?

KOCHAN: If you look at the evidence across industries, we see productivity differences between 20% and 35% among companies that have high-quality employee-management relationships and those that have standard labor-management relations. That’s an enormous number. Closing that gap, getting there, doesn’t happen overnight. It takes sustained effort, and it takes time and it takes energy, but that’s the prize that’s out there. And in some industries, the way that American companies are performing, that prize is even greater. That prize could be double that number for some companies that are underperforming in the United States today — but achieving those gains would require massive change in their management systems and in their labor-management relations systems.

Whether we’ve got the energy and the leadership to get there is another story, but that’s the size of the prize that’s out there.