Two Northern Birds On The Endangered List

As symbols of pride, airlines for some countries rank right up there with sports teams, beer, and the national cuisine. Such is the case in Canada, where more than a quarter of the recession-wracked populace would support a government bailout of the country's two global carriers, according to a recent Gallup poll. A mere 9% felt that the airlines, Air Canada and Canadian Airlines International Ltd., should merge with powerful U.S. carriers.

Alas, alliances with U.S. competitors may be the fate of Canada's carriers. Canada's airlines suffered record losses last year, and they have weak balance sheets. Both face growing competition from more powerful U.S. airlines. And with the industry increasingly dominated by megacarriers, even most Canadians concede that their two relatively small airlines can't survive much longer in their current form.

TOOTH AND NAIL. Canadian Airlines, the smaller of the two, is in talks with AMR Corp.'s American Airlines Inc. about a sweeping alliance. Air Canada is fighting tooth and nail to block that. Ironically, the man leading the charge is an American: Hollis L. Harris, a former executive at Continental Airlines and Delta Air Lines Inc. Since becoming Air Canada's CEO in February, the Southerner has wrapped himself in the Canadian flag. If Canadian hooks up with American, Air Canada may have no choice but to seek a similar link with a U.S. carrier, says Harris. And he warns that as U.S. carriers gained control of these alliances, Canada's airlines could be reduced to mere feeder status.

Harris has instead championed a "made in Canada" solution in which Air Canada would swallow Canadian and emerge as Canada's surviving global player. But Rhys Eyton, CEO of Canadian Airlines and its parent, PWA Corp., says a merger would bring many layoffs without solving fundamental problems.

The immediate crisis is financial. The two carriers lost a combined $315 million on revenues of $5.4 billion last year. By contrast, AMR lost $240 million on $12.9 billion. In the first quarter, Canadian dropped an additional $61 million, while Air Canada stunned analysts with a $136 million loss. Both airlines have made valiant efforts to succeed by paring staff and improving service. But many problems are beyond their control. In Canada, taxes raise fuel costs 30%, and higher interest rates raise the costs of buying aircraft. Plus, Canada's market of 27 million people simply does not provide a big enough base to feed passengers to international routes. "We've done everything we can to make Canadian lean and efficient," complains Eyton, "but our costs are still 15% higher" than U.S. carriers'. Air Canada's are higher still, and domestic overcapacity of 20% to 30% has led to damaging price wars.

The view on the horizon is not necessarily much brighter. Canada and the U.S. are deep in negotiations to liberalize the archaic rules restricting flights between the two countries. With 13 million passengers a year, the U.S.-to-Canada market is the largest between the U.S. and any country. But the agreement allows direct service among only eight Canadian and 25 U.S. cities, leaving many routes unserved. There are no direct flights between Ottawa and Washington, D.C., for example.

Both countries are eager to give their citizens greater access to each others' cities and to satisfy demand, especially from business travelers. The problem is, the new treaty will make it easier for U.S. carriers to lure Canadian passengers across the border--and then fly them to international destinations. Canada complains that U.S. carriers already reap two-thirds of the $1.5 billion in annual scheduled flights between the two nations. If this isn't rectified, says Harris, a new agreement "will jeopardize the viability of Canada's airlineindustry."

So Canada is pushing for a transition period to let its own carriers establish new markets before U.S. carriers can increase service. It is jealously guarding access to Canada's three main airports--Toronto, Montreal, and Vancouver--trying to phase in additional U.S. access over 10 years. A dispute over the issue could stall talks, but negotiators say they hope to reach agreement this fall.

Yet the crisis facing Canada's carriers won't wait. The first choice for Canadian is a partnership with American. Under a proposed alliance, American would invest $170 million into cash-starved Canadian for a 25% stake. American would gain more Canadian passengers, a rich contract to provide administrative services to Canadian, and access to its Pacific routes.

WHO'S IN CHARGE? Canadian and American hope to have a deal by early summer. It must then be approved by Canada's National Transportation Agency, which is concerned that control of Canadian remain in Canada. On paper, it will. But in a recent interview with Toronto's Globe and Mail, Air Canada's Harris said of American CEO Robert L. Crandall: "I know him. . . . If Crandall is into an arrangement--5%, 10%, 15%, or whatever--he is going to be in control." Still, the Canadian government is likely to approve the deal, in part because it wants to preserve domestic competition within Canada. For Canadian, the bigger danger is that the talks could falter.

Right now, Air Canada appears the more vulnerable. So Harris is pursuing a three-pronged strategy. He's trying to block the proposed Canadian-American linkup. And he's stepping up efforts to tie Air Canada into strategic alliances with other carriers. Harris has been talking with USAir and with other carriers in Europe and Japan. To bolster Air Canada's attractiveness, Harris is pressuring Ottawa to give him authority to fly to Tokyo. And on Apr. 30, he unveiled a program to push Air Canada into the black by next year by cutting operating costs 10%, or $250 million.

But few industry observers feel USAir is powerful enough to match the clout American would give Canadian. Ultimately, some say, Air Canada will be forced to link with United Airlines or Delta--a suggestion Air Canada resists, for fear it might lose its independence.

For now, they will keep operating. But over time, predicts York University economist Fred Lazar, both may end up in similar roles, as "commuter carriers" to big U.S. airlines. That may shock some Canadian nationalists. But in the airline industry of the future, it may be their carriers' best hope of survival.

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