What You Can Learn from the Airlines

The airline business is truly the school of hard knocks. There is always something—high fuel prices, the threat of terrorism, epidemics, storms, cyclical passenger gluts and droughts, labor issues, accidents, and government intrusion—to upset operations, disrupt aviation economics, and spark a chorus of critics from consumers to government.

It's hard for deregulated airlines to make money, and if one does, within five years a cyclical downturn will likely drain away accumulated earnings. The airline business embodies much of the complexity, volatility, uncertainty, and challenge that more and more businesses are getting a taste of in the current economy, and that's why it offers some tough but helpful lessons for other industries about corporate governance.

You are never completely in control of your business. You need to prepare for what you can't control. Airline executives are hardened early in their careers to expect the unexpected and respond accordingly. Few other industries live on the edge of virtual meltdown the way airlines do. For example, many well-reputed airlines hedged the price of jet fuel last year as it was rocketing out of control, only to see those hedges serve as loss-making ventures when oil prices tumbled in the recession. The losses, of course, happened at a time when all airlines were struggling for passengers, with business and leisure travel going into steep decline.

Boards should understand that business plans and strategy can be disrupted by uncontrollable events. CEOs and managers should plan well and thoroughly, but directors should be patient during implementation. The key is how management responds to the unexpected in order to keep implementation on course. This calls for operational flexibility and responsiveness at all levels. Directors should ask whether their companies have that kind of flexibility, and they should observe how well an organization responds to the unexpected. They should also insist on good contingency planning. Align key constituencies in a multi-stakeholder world. In the airline industry, it is important to coordinate and align the interests of customers, shareholders, employees, governments, regulators, suppliers, and special-interest groups. In the airline industry especially, stakeholder misalignment quickly spells trouble. For example, when airline employees oppose management, they take it out on customers, who in turn stop flying the airline, which, in turn, affects shareholder returns—a vicious cycle.

As Southwest Airlines (LUV) has demonstrated, aligning stakeholder interests can create a virtuous cycle. Despite being the most unionized airline in the U.S. and proudly offering nothing to eat or drink in the cabin, Southwest enjoys outstanding customer service ratings and loyalty as well as the best financial returns in the industry. The delicate balance between employees, customers, shareholders, and other stakeholders enforces good discipline on airline management. Boards should be asking whether their companies have similar stakeholder balance and alignment. Many CEOs focus sharply on short-term returns to shareholders without an equivalent focus on the long-term interests of all stakeholders. With the Internet and increasing transparency, CEOs can no longer isolate constituencies from one another, nor should they try. Sometimes, industry and company insiders are better choices. Over the past few decades, the airline industry experimented with CEOs coming in from outside the sector. With a few exceptions, most have not fared well. There is good reason for that. The airline industry requires specialized knowledge in a variety of important domains—labor relations, regulation, and even technology—and, simply put, it is impossible to learn it all quickly enough. An outsider to the industry may not be aware of the many "handcuffs" on his or her hands, such as scope clauses in labor contracts that strictly forbid certain otherwise logical commercial actions. Subtle details can make or break service, profitability, or labor peace in an industry that teeters on the brink.

While outsiders can and do provide fresh thinking, just as often they can stumble when they fail to grasp what makes a complex business such as the airline industry function well. The most recent high-profile CEO appointment in the industry—Delta's (DAL) Richard Anderson, who was the architect of the successful merger with Northwest Airlines—goes to show the benefits of appointing a seasoned industry veteran. A board should ask how easy it is for an outsider to master the details of its own industry or company when searching for the right leader. Anticipate and overcome barriers to growth. The airline business unites the globe, yet it hasn't become a truly global business. Regulatory restraints on ownership inhibit the type of global industry consolidation we see in other large sectors such as automotive. There are even limitations on the movement of leadership capital—one must be a U.S. citizen to run a U.S. airline. Add to this that the airline industry is the most regulated in the world, especially when it comes to safety.

To circumvent such limitations, airlines have resorted to quasi-consolidation measures such as global alliances: Star, Oneworld, SkyTeam. Boards in other sectors may need to be equally creative and resourceful when they encounter barriers to growth of the companies they govern. Balance talent renewal with continuity. The natural cycle of the airline business is aggravated by the economy. In the airline industry, it takes 18 to 24 months to become a good director and a complete five-year cycle to become a great one.

It is hard to fully grasp the industry until a director has been through a complete cycle. This suggests directors should not turn over frequently. Yet shareholder activism is causing more frequent turnover than might be ideal. While annual election of directors is designed to give shareholders more voice, boards in any industry should consider as well the depth of experience needed for directors to function effectively as well as the benefits of director continuity. Seize the moment. Sometimes companies are presented with extraordinary opportunities to make fundamental change, and too often they don't capitalize on them. In the airline industry, at least in North America, that "opportunity" is Chapter 11 bankruptcy protection. The only large North American carrier not to have tasted Chapter 11 is American Airlines, and it, too, has been "on the court steps" more than once.

Yet despite the opportunity to fundamentally reshape the company within the cocoon of Chapter 11, many carriers fail to take a deep enough bite, only to falter again when the next industry shock comes their way, often sending them right back into bankruptcy. Directors should keep their antenna up for such sea-change moments of opportunity in their own industries—a change in regulations, a deep recession, a technological innovation—and urge management to seize the moment and make real, lasting, and fundamental change while the time is ripe.

The intensity and frequency of board meetings, fear of liability, reputational issues of being associated with a perennially money-losing industry, and intense and complex regulation combine to give some candidates for airline directorships pause. Such concerns are now emerging in other industries as well, especially in financial services.

Directors today work harder than they ever did before, and the work will only intensify, especially with the continued rise of shareholder activism and intrusion into the boardroom. From a governance perspective, the airline industry is one of the most challenging in the world. But hard lessons make for better training in what can and will go wrong in an organization despite the best-laid plans. For that alone, the airline industry is worth closer study.

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