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Northwestern University

2006 Patterson Lecture: 25th Anniversary

Peter McDonald
Executive Vice President & COO,
United Airlines

1. United's Crises in an Industry Struggling with Competitive Challenges

United's story isn't simply business for me; it's personal, too. Some of you may know that I've been with the company for 36 years. In modern corporate America , that's a long time to be at the same place. I started working for United on the ramp while I was going to college here in Chicago . I was in my senior year, and I had a job offer from a financial services company in Minnesota . My supervisor convinced me to stay, and I have been here ever since.

The point is: I've spent my adult life at United, and navigating through the last few years has been a very personal mission for me. That mission was to get United out of the ditch we were in. To do that, we knew we had to work day by day and decision by difficult decision.

President Kennedy once answered the question about how he became a war hero by saying, “They sank my boat.” In other words, he didn't have much of a choice. At United, our options were also limited. With our boat sinking -- for us, for our 57,000 employees and our millions of customers -- failure simply wasn't an option, so we rolled up our sleeves and got to work.

Today, United Airlines has a strong financial foundation in place, we have positioned the airline to compete, and United is leading the recovery for U.S. airlines. Three years ago, that wasn't the case. United was in the middle of a crisis…one that continues in our industry today. Virtually every major U.S. carrier has entered Chapter 11…and American Airlines continues its struggle to restructure outside the courtroom.

And it's not just the major network carriers that are having a hard time:

Southwest would be losing money if it weren't for some very opportunistic fuel hedging.

In February, JetBlue reported a fourth quarter loss of 42 million dollars– its first quarterly loss since its initial public offering in 2002.

ATA has shrunk significantly. And Independence Air has disappeared.

Our experience at United tells the story. In 2002, United was losing 3 billion dollars a year. We were burning through 5 million to 6 million dollars in cash every day . United's cost structure was among the highest in the industry.

The landscape was changing: The Internet made pricing transparent. A surge in low-cost carrier growth was prompting some to question whether a traditional network model like United's, with its higher costs, could survive. These changes drove even more competition and lower fares. Today, air fares are 50 percent lower than they were 25 years ago, when you adjust for inflation.

In any other industry, this intense competition and pressure to control costs would have resulted in a round of constructive consolidation. You need only to look at our local phone company, which has been through a couple of mergers and acquisitions in the last several years, to know what I'm talking about. But regulatory authorities have set the bar very high for any kind of airline consolidation in America .

Add to this already challenging situation the tragedies of 9/11, SARS and the Iraq war. And fuel costs we thought were catastrophic at 30 bucks a barrel, and you have an airline industry that's lost more than 40 billion dollars since 2000.

With all that, and after being turned down in late 2002 for a federal loan guarantee, United had no choice but to file for bankruptcy.

2. United's Restructuring Positions the Company to Compete

The task you are facing in Chapter 11 is to prove that the enterprise is worth more to creditors as a going concern than it would be if you sold off the company's assets at auction. Said differently, are you worth more dead or alive?

The process to determine that is complex. There are thousands of relationships and contracts to restructure. There are the rules of the court, the needs of the creditors, and issues with your employees. And, throughout the experience, you're working everything out in a very public, corporate fishbowl. Massive press coverage of every move you make gives your competitors a remarkably clear view of your plans and, in fact, provides them a play book for restructuring themselves. Just ask my friends Gerard Arpey and Doug Steenland. And once you slog through all that and exit Chapter 11, you don't have a free ride out of financial trouble.

Of the166 airline bankruptcy filings since 1978, only 5 passenger airlines and 1 cargo carrier have successfully restructured and exited. Of the 15 largest U.S. carriers in 1980, only 5 survive today, and 2 of those just entered Chapter 11. But if you take your time and you do it right, you have the opportunity to rebuild the company from the ground up.

We took that opportunity and, at the end of our bankruptcy, we had achieved approximately 7 billion dollars in durable average annual cost savings through 2010 – reducing our CASM ex fuel by 20 percent across the board. Twice, we came to consensual agreements on new labor contracts with our unions and employees. We restructured fleet costs, looked at every supplier contract, examined business processes and increased productivity 27 percent.

All that work led to substantially improved financial performance: unit revenue improvements that are outpacing the industry average; steadily improving operating earnings; credit ratings and an exit facility that were better than expected.

While you may know some of those financial details, the story of our employees' performance has not been told adequately. I can't say enough about the great work they did to insulate our customers from our restructuring. They kept this airline running smoothly, through an incredibly difficult three years in which they made significant personal sacrifices. In fact, they delivered the best operational and service performance in our history, setting records for on-time departures and arrivals, improving baggage handling dramatically and posting customer satisfaction ratings that we've never seen before. Throughout it all, they demonstrated great competitive spirit and dedication to a fight they could win for their futures.

Building on their efforts, we spent an equal, or greater amount of time changing the way we do business, introducing new routes and products and innovating to meet our customers' needs. Those innovations not only provided our customers with new travel alternatives, they gave our employees tangible examples of success and innovation. This was something they hadn't seen before from United, much less from United in bankruptcy. With the changes we were making, we set out on a different path than our competitors. We launched p.s., our premium transcontinental service, which connects New York with Los Angeles and San Francisco and provides the only lie-flat seats in the market. Explus, our new regional jet experience, brings 70-seat jets and First Class to smaller cities. Ted, our leisure market service, delivers an experience tailored to price-sensitive fliers; and Economy Plus enhances economy class by providing more space.

Our competitors these days tend to think of their service as a commodity that people purchase on price alone. We don't. We kept the pillows and blankets. And we're segmenting the market … we're maximizing margins from high-yield business travelers…. and controlling costs by offering price-sensitive leisure travelers the right service at the right price.

We can do this because, as we restructured, we didn't burn the furniture to keep the fire going. We maintained or improved on our historic strengths – our network, our frequent flier program, Star Alliance – and made certain that when we exited bankruptcy, we'd still have a solid company to run.

3. Executing Successfully on Our Plan

On February 1, 2006, United officially exited bankruptcy.

Exit was a major step for us, but nobody gave us a “get out of bankruptcy free card.” We can't just pass go and leap-frog our competition to “best-in-class.” All we earned in our restructuring is the opportunity to compete in what continues to be a highly competitive industry. Right now, United is concentrating on continuous improvement, on getting the basics right consistently. We want to deliver a high-quality product and a positive travel experience to our customers. We're working smarter and more efficiently every day in our operations. We've put programs in place that improve processes, solicit employee input and then work to streamline and enhance everything we do.

United has even begun to send teams of ramp workers to Pit Crew University . At Pit Crew U, they learn from NASCAR racing pit crews the importance of cooperation, standard work and attention to detail. That translates into helping our ramp crews reduce the time it takes to turn an aircraft arrival into a departure. Pit Crew training is just one example of the detailed work of making every aspect of United the best it can be.

For example, by improving our aircraft turns at the gate – chocking the wheels, unloading and loading bags and cargo, cleaning the cabin, refueling faster and boarding passengers – we can literally fly more routes with the same number of planes. We're already well on our way at our Denver hub. By June of this year, we will have added 32 new flights a day – an increase of 7 percent over last year. We're aggressively expanding capacity, serving new destinations and competing for every customer -- more than holding our own against both Frontier and Southwest.

Systemwide, we expect our resource optimization projects will free up at least 25 mainline and United Express aircraft in 2006. When we're finished, we'll be able to add 125 more flights to our schedule. We're applying the same analytical approach to continuous improvement of revenue management and distribution, corporate sales, customer service systems and fuel conservation, as we have to operations. We're also taking a broader view of United's assets. We have one of the most widely respected aircraft maintenance operations in the world in San Francisco . We're taking that asset and turning it into a revenue producer for the company. Across both our line and base operations, we're implementing Lean principles to free up capacity that we then sell to other airlines around the world.

Our flight training center in Denver is one of the largest and best around. But, even with that reputation, we had downtime on simulators. Classrooms and office space were going empty. We've started to turn that around and we were recently approved by the Chinese government—the only company outside of China to receive such approval-- to train Chinese pilots. We also train the pilots who fly Air Force One. We've even branched out into the small jet market and are training pilots for Eclipse, a manufacturer of very light jets. These types of outside training contracts help offset our costs for training United personnel.

Cargo is another terrific story for United. Cargo has always been considered an add-on to the passenger business. Cargo was just “gravy in the belly. Now we're running our cargo business as a true P&L. When you approach it as a business, you think differently. And the trick with cargo is it only goes one way. You can't just sit back and sell space out of the U.S, and expect a full belly on the return. You have to be out there where the business is – all over the world, focusing on matching high-yield traffic to United's schedule of passenger flights. To get cargo to our flights, we're building a trucking network in Europe and the U.S. We're also securing agreements with partners like Gulf Air and Sri Lankan Airlines to move cargo from India and the Middle East to London and on to the U.S.

In three years, United Cargo profitability has doubled.

We're continuing to expand our international network and relationships on the passenger side of the business as well. We introduced the first flights from the U.S. to Vietnam in thirty years. We are seeking new routes to China and entering code share agreements that offer our customers seamless air access to growth markets throughout Asia Pacific. We're also building our network in Latin America with our new code share agreement with TACA Group.

4. United's Opportunities for the Future and Remaining Barriers to Business Success

We're competing head on everywhere we fly, here in the US and around the world. But, there continue to be barriers that prevent carriers like United from competing freely everywhere there's opportunity.

The airline crisis we've been talking about today is purely an American phenomenon limited to passenger carriers. In virtually every other region of the world, the airline industry is profitable. Overseas competitors are merging across borders to become super-carriers, investing in aircraft and initiating new, globe-circling routes. There's a revolution taking place in this industry as it becomes truly global in scale.

Unfortunately, for the first time in history, the U.S. airline industry is no longer on the leading edge of change. In fact, we're hardly in the game at all. Instead, we're burdened with outdated regulations, and taxes and fees that take more than 26 dollars out of every 100 dollar ticket we sell. While the five U.S. network carriers are still among the largest carriers in the world, we are no longer at the top of the list when you're measuring revenue. Lufthansa, Air France-KLM and JAL are numbers one, two and three. No U.S. airline even makes the list of the Top Ten Most Profitable Airlines in the world, and not one of us breaks into the top ten on Skytrax's ranking of the best airlines in the world for 2005.

Look at the change in revenue passenger miles between 2000 and 2004. While U.S. airlines stagnated or lost RPMs, Lufthansa gained 19 percent…Air France gained 84 percent…Jet Air in India is up 84 percent….Emirates jumped 151 percent and Air China is up a whopping 179 percent. While U.S. network carriers lost billions of dollars in 2004, the international carriers were making money. Quantas reported a profit of 758 million dollars, Singapore Airlines 821 million dollars, British Air more than a billion dollars and Lufthansa's profit was almost 1.4 billion.

So the obvious question is why can't U.S. airlines compete on the international stage?

Much of our failure can be attributed to our own mistakes and our unwillingness or inability to work through the competitive challenges. Each U.S. airline must be responsible for putting its own house in order, as we've done and continue to do at United.

But no matter how effectively we transform our businesses, we won't be equipped to compete globally unless we meet a number of challenges both domestic and international. The U.S. airline industry continues to be plagued by over-capacity, yet the U.S. government's only consistent policy is to continue to introduce more service from more airlines to the market. While our international competitors consolidate across boundaries, here in the U.S. a kind of half-baked deregulation prevents consolidation. We rely on complex measures like DOT anti-trust immunity, code-sharing and alliances to achieve some kind of integration and just a few of the efficiencies we could get with true consolidation.

Instead of believing that “more is always better,” our government should encourage growth through constructive consolidation – or at least not stand in the way as U.S. carriers gain the scope and scale they need to compete on a global stage. 

The government should also repeal the 1938 federal law that bars foreign ownership of more than one-quarter of a U.S. air carrier. The fact that the Department of Transportation has proposed a new policy to relax tight restrictions on foreign control of U.S. airlines is a positive step in the right direction. But it's just a step, and with Congress now taking a position in the debate, the outcome is far from certain. This regulatory roadblock is strangling the flow of foreign capital, and excluding the U.S. industry from participating in the evolution of super-carriers in the global market.

On the international regulatory front, despite efforts over the last decade to loosen international commercial and operating restrictions, many international markets remain highly restricted.

The European Commission and U.S. negotiators have agreed on the text of a new transatlantic aviation agreement. The agreement starts with U.S. “open skies" principles and then goes beyond them. If it's ratified, it will immediately lift most regulatory constraints on the world's largest international aviation market.

The negotiation of a comprehensive air services agreement between the U.S. and all of Europe promises to create a new model for worldwide regulatory reform. We believe it could be the change the industry is looking for.

Whatever the future may hold for this industry, at United we're making sure we're positioned to meet the challenges and seize the opportunities.

Winston Churchill said in 1942 when the U.S. was entering the war, “This is not the end. This is not the beginning of the end. But perhaps it is the end of the beginning.”

At United, that's what we believe about ourselves. We've made a good start in transforming United into the airline we want it to be . . . into the airline you want it to be. We know there's more to do. But when you're focused on continuous improvement, your work is never done.

Thank you very much.

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