Sticky situation: The British Airways crisis

Published on Saturday 13 June 2009 14:50

WHEN Willie Walsh arrives for work next month at the airline's futuristic headquarters off the north-west of Heathrow airport he will be leaving his £61,250 wage packet for July in the company's bank account. The Irishman in charge of British Airways has forgone that month's salary in recognition of the difficulties facing the company and its staff.

When it comes to self-imposed pay cuts, Walsh has form. Last week he decided not to take his bonus, the third time in as many years. He failed to meet the performance criteria last year, when BA dived to a record 401 million pre-tax loss, and waived his bonus the previous year after the Terminal 5 fiasco. It's little wonder that Walsh recently revealed he had forgotten to tell his wife. But given the task he faces over the next few months one suspects domestic strife is the least of his worries.

The next three weeks are shaping up to be the hardest of Walsh's career as he grapples with an in-tray spilling over with problems as tough as any in the FTSE 100.

First up is having to agree pay cuts and possible redundancies across the airline's 40,000 staff, who have already threatened a summer of disruption with widespread strike action. This comes on the back of a fuel bill that has soared by 1bn to top 3 billion, a dramatic fall in business class and first class passengers, and rumours that the proposed merger talks with Spanish carrier Iberia are making little progress. On top of this, British Airways has one of the largest pension deficits in the FTSE 100. In the words of airline analyst Andrew Fitchie at Collins Stewart, the situation is "dire". "Consensus estimates of a 200m operating loss (for the year] look optimistic," says Fitchie. "This could at least double if current trading persists."

Walsh has no illusions about the difficulty of the task. Writing in the firm's annual report published on Wednesday, he said it was "hard to exaggerate" the severity of the current economic conditions.

"Airlines across the world are being battered by this storm," he said. "We have seen some 35 carriers go out of business or forced into rushed mergers. Despite some fantastic progress in our business, our profits went into reverse, falling to a pre-tax loss of 401m.

"Meanwhile, competition remains fierce, particularly at Heathrow and on important transatlantic routes. The need to deliver world-leading customer service and operational performance, to invest boldly and meet stringent environmental standards are, if anything, more acute than ever before."

The International Air Transport Association has warned that the global airlines are on course to lose 5.6bn this year, almost double the previous level forecast by the industry's own body. It had predicted in March that 2009 losses for the airline industry would total 2.9bn. The body has also revised its estimate of last year's losses to 6.5bn from 5.3bn.

Given the severity of the economic climate, with the airline industry embroiled in its most transformational period since the creation of the commercial jet airline, analysts are now asking what next for Britain's national carrier?

David Wragg, aviation expert and author of The World's Major Airlines, says: "British Airways has the same problems as most legacy airlines, in that over the years they have suffered from economic drift. When airlines such as British Airways, Air France and Swiss Air first launched they enjoyed a cosy cartel. All the airlines offered the same deal at the same price. On top of this they had bilateral agreements between the countries which owned them. But over the years these have all been slowly chipped away. As new aircraft have been introduced a raft of new salaries have accompanied them which has resulted in the legacy airlines suffering a high wage bill. All these factors have crept up on them over the years."

Reducing the wage bill is key to BA's survival. Data from the Civil Aviation Authority shows that the airline is paying its cabin crew and pilots up to twice as much as rival airlines, a factor analysts put down to the carrier attracting high calibre personal who look to BA as a viable lifetime career. But the comparison with other airlines is marked. The average salary for BA's 14,000 cabin crew, including bonuses and allowances, is 29,900, compared with 14,400 at Virgin Atlantic and 20,200 at easyJet. BA's pilots earn an average of 107,600, compared with 89,500 at Virgin and 71,400 at easyJet.

The unions have already said they will fight any compulsory redundancies and BA ground staff have reportedly rejected proposals by six to one to cut pay or face compulsory redundancy. Pilots are also to be balloted, although they are reportedly "more flexible" and are considering a pay cut – a move that could see crippling strikes.

"Significant staff cost savings are needed," said Fitchie. "Negotiations with staff over changes to pay and conditions are key. There are a range of legacy issues which need to be eliminated for BA to rebuild returns. Walsh has set the end of June as a deadline. So far the ground staff and cabin crew are unreceptive. There is the possibility of significant industrial unrest over the next month."

But some analysts argue that Walsh has timed this particular battle badly. "Six months ago when there was even less passenger traffic it would have seemed a sensible time to reduce staffing levels," said one analyst. "To go into the busiest time of year with the threat of strikes is simply crazy."

Nor can the situation be good for any possible merger with Iberia. Although the airline insists talks are ongoing, analysts say they are making little progress with BA languishing under one of the largest pension deficits in the FTSE 100, with a new valuation of the shortfall estimated at about 3bn. Iberia has its own problems, having reported a first-quarter loss of 127.6m.

In October the US Department of Transportation is expected to give its approval on BA's alliance with American Airlines.

Under the "open skies" agreement the two airlines would be able to jointly set fares, market their services, coordinate their schedules and frequent-flier programmes and take other actions that US antitrust laws now prohibit. Coupled with the Iberia merger, analysts say it could yield cost savings of more than 400m. "If Walsh can reduce the wage bill, satisfy the unions and pull off the merger with Iberia, the outlook come the autumn will look significantly better," said one analyst.

The next five months are shaping up to be the toughest of Walsh's career.