Air Canada's plan to shake things up by launching yet another discount airline

Can it learn from past mistakes?

The cheap seats

Air Canada

The late 1990s were heady days for penny-pinching North American air travellers. Southwest Airlines, Frontier and WestJet were shaking up the industry with rock-bottom airfares and an army of fresh-faced employees in golf shirts prone to making jokes over the cabin public-address system. Suddenly finding themselves under attack, big, bloated network carriers attempted to respond by rolling out their own discount outfits, splashed with spirited names like Ted (United Airlines), Song (Delta Air Lines), MetroJet (U.S. Airways) and Tango and Zip (Air Canada). The idea was to not only mimic their new rivals’ low prices (although not necessarily their low cost structures), but also the look and feel of a fresh upstart—sometimes with amusing results.

“Somebody at United determined that one of the reasons Southwest was so successful was because they wore shorts,” says Marc-David Seidel, a professor at the University of British Columbia’s Sauder School of Business, recalling a visit to the California operations of Shuttle by United, another big carrier discount attempt. “So, you know the classic pseudo-military United uniforms that are made out of polyester? They basically just took those and cut off the legs.” It gets worse. “One day management decided employees were supposed to have more ‘fun,’ so all these poor people were running around San Francisco airport wearing those little beanies with a propeller on top.” Needless to say, the strategy didn’t work, and Shuttle was scuttled in 2001. Most of the other “airline-within-an-airline” efforts met a similar fate.

Now, a full decade later, Air Canada is once again toying with the idea. It’s trying to convince its unionized workers to support the creation of a new discount airline that would fly all-economy-class planes to various vacation destinations. But can Air Canada really make money on the cheap seats this time around? Though it’s far from clear whether the project will come to fruition after a key agreement with the airline’s pilots got bogged down last week, the reality is that Air Canada, which has seen its stock plunge nearly 90 per cent to around $2.40 since its post-restructuring IPO in late 2006, is steadily losing market share to younger, cheaper competitors such as WestJet, Transat and Toronto’s Porter Airlines. All this at a time when fuel prices, typically the second-biggest expense for an airline after labour, threaten to eat into already thin profit margins. It has no choice but to attempt a little shaking up of its own.

The proposed carrier would compete head-on with low-cost packaged holiday sellers such as Montreal’s Transat AT, WestJet Vacations, Sunwing and Thomas Cook’s Sunquest Vacations to destinations in Europe, the southern United States, the Caribbean and Mexico, although some less profitable domestic routes could also be included, according to people familiar with the plans. The business model calls for the use of four of Air Canada’s older Boeing 767s and six Airbus A319s, although the fleet could eventually grow to 50 planes. That would likely include more of Air Canada’s older 767s, which are scheduled to be replaced with newer Boeing 787s beginning in 2013. The yet-to-be-named carrier would ideally be launched within the next 12 months, according to recent statements by Air Canada CEO Calin Rovinescu.

“There’s a huge segment out there that Air Canada still has difficulty going after, and that’s the price-sensitive traveller,” says Steve Smith, who ran Air Canada’s last discount effort, Calgary-based Zip, until it was shuttered in 2004. “Take Florida, for example,” Smith says. “Everyone is looking for $99 fares and if they don’t get them, they don’t fly.” The long-term risk, argues Smith, is that some of the big players in the packaged holiday market, such as Montreal’s Transat, could one day become a viable long-haul alternative for travellers who aren’t wearing Bermuda shorts. And Air Canada, which managed a profit of $107 million in 2010, bouncing back from a loss of $24 million a year earlier, simply can’t afford to lose any more customers to its rivals. While Rovinescu is pitching the proposal as a growth opportunity, others suggest it is mostly a defensive manoeuvre. “You don’t make a lot of money flying people in flip-flops to Florida,” said one person with knowledge of the airline’s plans. “But maybe that helps you grow somewhere else.”

The key ingredient is driving labour costs low enough to make the effort profitable, or at least a break-even proposition. “There are razor-thin margins in this market,” says Rob Kokonis, the president of Toronto-based airline consultancy AirTrav Inc. “That’s why so many leisure carriers have come and failed.” WestJet is one of the few exceptions. It has managed to stay mostly profitable despite high fuel prices and increased competition because its costs are roughly 30 per cent lower than Air Canada’s on any given route. In part, that’s because WestJet’s workforce is non unionized, but also because the airline operates a single aircraft type, helping to save on pilot training and maintenance costs.

As a result, Air Canada is seeking a lower pay rate and more flexible work rules for pilots who work for the proposed discount carrier. But while negotiators for the two sides had hammered out a deal, officials at the pilots’ union called off a planned ratification vote last week because of members’ objections. Air Canada is also in talks with its other employee groups, including ground workers, ticket agents and flight attendants.

Getting everyone on board will not be easy. Bill Trbovich, a spokesperson for the International Association of Machinists and Aerospace Workers, made it clear that the union’s 11,000 Air Canada maintenance and other ground personnel are more interested in clawing back previous concessions. “We took a pretty healthy pay cut to keep this airline afloat,” he says, criticizing concessions Air Canada’s pilots made with regard to pension plans for new hires. “The pilots have thrown their young to the dogs,” he says. “That’s not going to happen with us.”

There’s also the significant challenge of building and marketing the new discount carrier. “All these airlines-within-an-airline, no matter the rationale, ended up duplicating too many of their costs, and it took management’s eyes off the ball, which is the parent corporation,” Kokonis warns. One of the few exceptions frequently cited by people familiar with Air Canada’s thinking is Australia’s Jetstar Airways, owned by the parent of Qantas Airways. Jetstar was launched in 2003 in response to the arrival of low-cost competitor Virgin Blue, and has since thrived alongside its bigger sibling.

The bottom line is that Air Canada has much to gain and little to lose. Even if its third attempt at a discount airline turns out to be another flop, it won’t have shelled out extra money on new planes or back-end infrastructure. And it will have given itself a chance to experiment with new discount strategies and products that can later be incorporated with the mainline carrier. That’s what happened with Tango, launched in 2001 with its own planes and purple colour scheme. It was folded back into Air Canada as a fare class just two years later.

Perhaps most importantly, creating a new discount carrier promises to usher in a new model of employee pay, benefits and work rules at Air Canada. While the new airline would be operated separately from the main carrier, likely with labour agreements that prohibit it from flying routes occupied by Air Canada’s better-paid pilots, Rovinescu is no doubt hoping that, if the gambit is successful, all of Air Canada’s unionized employees can be convinced that further cost-cutting is the road to the future. “It appears to me that they are trying to get lower-cost structures on the books,” says Seidel, emphasizing the need for Air Canada to more closely resemble its low-cost competitors. Minus the shorts and propeller hats, of course.

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