Canada Airlines Corp

• CA needs to cut costs by 14% (325M annually) by June 30, 1995 deadline
• Two competing strategic options:
  • Plan A: Growth with cost reduction
  • Plan B: Major downsizing and restructuring
• Current status shows 110M in improvements secured (of 325M target)
• Labor-management relations strained by history of restructurings

1. Context

• Transformed from regional carrier to national airline through acquisitions
• Industry deregulated in late 1980s, leading to intense competition
• Operating in challenging duopoly with Air Canada
• Previous financial rescues included AMR Corp (American Airlines) deal

2. Financial Position (early 1995)

• Operating margins thin/negative
• High debt load from acquisitions
• Cash flow insufficient for fleet renewal
• Cost per ASM ~14% too high vs targets

3. Competitive Position

• Strong international routes (especially Pacific)
• Weaker domestic network vs Air Canada
• Alliance with American Airlines provides US market access
• Cost disadvantage vs low-cost charter carriers

4. Key Strengths

• Pacific Rim routes
• American Airlines alliance
• Employee ownership stake
• Leaner operations vs Air Canada

5. Key Weaknesses

• High cost structure
• Weak domestic network
• Strained labor relations
• Limited financial flexibility

CA must choose between:

1. Pursuing aggressive cost cuts to enable growth (Plan A)
2. Major downsizing to focus on profitable routes (Plan B)

The decision is complicated by:

• June 30 deadline pressure
• Need for labor buy-in
• Risk of losing domestic feed for international routes
• Competitive pressure from Air Canada and charters

1. Competitive Dynamics

• Intense rivalry with Air Canada continued into 1990s
• Both carriers suffered substantial losses
• CA nearly faced bankruptcy
• Failed merger attempts between CA and AC
• Major capacity wars damaged profitability

2. Critical Events

• 1992: CA announced 15% domestic capacity reduction
• 1992: CA lost 500M, eliminating accumulated equity
• 1992: Failed merger attempt with Air Canada
• 1992: 246M strategic alliance with AMR Corp/American Airlines
• 1994: Air Canada awarded Osaka route after dropping Gemini appeal

3. Global Context

• International traffic growing 5.6% annually
• Domestic traffic growing 4.7% annually
• Pacific Rim and Latin America fastest growing regions
• Global airline consortiums emerging
• Neither CA nor AC part of major global alliance

4. Open Skies Agreement (1995)

• Immediate access to US destinations
• Chicago O’Hare and NY LaGuardia restricted
• US carrier access to Toronto delayed 3 years
• No cabotage rights granted

5. Charter Competition

• Dramatic growth 1989-1993
• Lower cost structure (4.5-7¢ vs CA’s 12.5¢ per ASM)
• Captured significant market share on key routes:
  • Vancouver-Toronto: 5.5% to 31.4%
  • Montreal-Vancouver: 3.0% to 28.3%

1. Key Factors Contributing to CA’s Financial Difficulties

   Intense Competition with Air Canada (AC): Post-deregulation rivalry led to price wars and overcapacity, eroding profitability. CA’s 1992 lawsuit against AC for flooding markets exemplifies this.

   Debt Burden from Acquisitions: The acquisitions of CP Air and Wardair strained finances. Wardair’s integration failed to generate expected cash flows due to unprofitable fleet sales.

   High Unit Costs: CA’s unit costs (12.5¢/ASM) were higher than charters (4.5–7¢/ASM) and AC (see Exhibit 4). Labor costs and inefficient fleet utilization exacerbated this.

   Weak Domestic Performance: CA’s domestic routes (e.g., Eastern Triangle) underperformed compared to international routes (Pacific Rim).

   Dependence on Unions: Plan A required 125M in union concessions, but strained labor relations and CUPE’s absence created uncertainty.

   External Shocks: Rising fuel prices (1990s) and economic downturns worsened cash flow.

2. Feasibility of Plan A vs. Plan B

   Plan A (Growth)	Plan B (Downsizing)
   Pros: - Preserves jobs and domestic network. - Leverages alliances (e.g., AA) for trans-border growth. - Modernizes fleet (Stage 3 noise compliance). - Targets profitable international routes (Pacific Rim).	Pros: - Immediate cost reduction by exiting unprofitable routes. - Simplifies fleet (wide-body focus). - Reduces debt via asset sales.
   Cons: - Requires $325M$ savings ($66M$ gap unresolved). - Union concessions ($125M$) may face resistance. - Summer 1995 initiative ($27M$) showed mixed results.	Cons: - Massive layoffs (12,060 union employees at risk). - Loss of domestic feed for international routes. - Brand erosion and reduced market share.

   Feasibility: Plan A is risky due to unresolved savings and union skepticism. Plan B offers short-term relief but sacrifices long-term growth. A hybrid approach (partial downsizing + phased growth) might balance risks.

3. CA vs. AC: Operational & Financial Comparison

   • Financial Health (1994):

     • CA: Net income = -38M; Debt/Equity = 2.47:1.
     • AC: Net income = 129M; Debt/Equity = 3.63:1 (but better cash flow).

   • Operational Efficiency:

     • Load Factor: CA (69.3%) > AC (63.2%).
     • Unit Costs: CA (7.1¢/ASK) < AC (8.5¢/ASK) (Exhibit 4), but AC’s newer fleet improved long-term efficiency.
     • Market Reach: CA had more Canadian destinations (109 vs. 74) but fewer U.S. routes (7 vs. 19).

4. Role of Alliances

   • CA & American Airlines (AA):

     • Benefits: Code-sharing expands trans-border reach post-open skies. AA’s CRS (Sabre) enhances yield management.
     • Risks: Dependency on AA; loss of Gemini CRS weakened domestic control.

   • AC & Continental: Provided limited synergy (few overlapping hubs), but AC’s Osaka route win signaled government favoritism.

5. Impact of Open-Skies Agreement

   • Opportunities:
     • CA could expand into U.S. markets (e.g., Chicago, NYC after slot restrictions lift).
     • Leverage AA’s hubs (Dallas, Chicago) for international feed.
   • Threats:
     • U.S. carriers (Delta, United) may demand cabotage, intensifying domestic competition.
     • Low-cost charters (e.g., Canada 3000) could exploit price-sensitive travelers.

6. Risks & Benefits of SPSC Collaboration Benefits:

   • Open-book transparency built trust (e.g., pilot union audits validated financials).
   • Joint problem-solving identified 78M savings (e.g., fuel efficiency).

   Risks:

   • CUPE’s absence delayed critical negotiations.
   • Employee skepticism due to past failures (e.g., AMR deal underdelivered).

7. Recommendations for Senior Management

   1. Negotiate with CUPE: Offer incentives to join SPSC to close the 66M savings gap.
   2. Prioritize International Routes: Redirect capacity to Pacific Rim/Latin America, leveraging CA’s existing strengths.
   3. Optimize Fleet: Sell older 737s to fund Stage 3-compliant aircraft, reducing maintenance costs.
   4. Strengthen AA Alliance: Expand code-sharing to offset domestic weaknesses.
   5. Contingency Planning: Prepare a phased hybrid model (Plan A+B) to mitigate risks if June 30 deadline is missed.

8. Conclusion

CA’s survival hinges on balancing union cooperation, cost discipline, and strategic alliances. While Plan A offers growth potential, its success depends on closing the savings gap and restoring employee trust. If negotiations fail, a controlled downsizing (Plan B) with retained international focus may be unavoidable. The open-skies era demands agility, making CA’s alliance with AA a critical lifeline.

Difference Between Regulated and Deregulated Industries

• Regulated Industry: Government controls routes, fares, schedules, and market entry/exit. Example: Pre-1985 Canadian airlines operated under the Canada Transport Commission, which allocated routes (e.g., AC dominated transatlantic routes, CP Air focused on the Pacific).

• Deregulated Industry: Market forces drive competition; airlines set fares, choose routes, and expand freely. Post-1985, CA and AC engaged in price wars and aggressive acquisitions (e.g., CA buying Wardair).

Implications of Deregulation

Companies:

• Pros: Opportunities for expansion (e.g., CA acquired CP Air and Wardair to become national).
• Cons: Overcapacity, price wars, and financial strain (CA lost 547M in 1992). Government:
• Reduced fiscal burden (privatized AC in 1989).
• Lost leverage to enforce industry stability (e.g., rejected CA’s plea for temporary re-regulation during overcapacity crises). Customers:
• Pros: Lower fares due to competition (e.g., charters captured 31% of Vancouver-Toronto traffic by 1993).
• Cons: Service instability (CA’s near-bankruptcy) and reduced loyalty programs during restructuring.

Assessment of CA’s Strategic Initiatives

1980s (Regulated Era): As PWA, regional collaboration with AC (e.g., Air Ontario joint venture) was prudent.

Post-Deregulation (1985–1990): Aggressive acquisitions (CP Air, Wardair) expanded reach but created debt (300M for CP Air) and integration challenges (mixed fleets, cultural clashes).

1990s Crisis:

• SPSC Initiative: Innovative labor-management collaboration (78M savings) but undermined by CUPE’s absence.
• AMR Alliance: Secured 246M equity but sacrificed Gemini CRS control.

Verdict

Growth strategies were overambitious; cost management and union relations lagged.

Retrospective Recommendations for CA

Avoid Wardair Acquisition: Its Airbus fleet sale fell short of projections, worsening debt.

Prioritize Cost Efficiency: Earlier focus on unit cost reduction (e.g., simplifying fleets) could have mitigated losses.

Collaborate with AC: Merge earlier (1992) to consolidate routes and reduce destructive rivalry.

How the Airline Industry Makes Money

Revenue Drivers:

• Passenger tickets (90% of revenue) with yield management (e.g., discounted fares for VFR travelers).
• Cargo (10%).

Cost Structure: High fixed costs (fuel, labor, aircraft leases). Profitability hinges on balancing load factor (CA: 69.3% in 1994) and yield (CA: 10.4¢/RPK vs. AC: 13.2¢/RPK).

Airline Differentiation Strategies

Network and Alliances: CA leveraged Pacific routes and AA partnership; AC focused on U.S. hubs.

Loyalty Programs: FFPs retained business travelers (e.g., CA’s alliance with AA’s AAdvantage).

Cost Leadership: Charters (e.g., Canada 3000) undercut majors with 4.5–7¢/ASM vs. CA’s 12.5¢.

Service Tiering: Business class premiums (15–30% higher fares) on key routes.

Nature of CA-AC Rivalry

Pre-1990: Cooperative under regulation (e.g., PWA fed AC’s western routes).

Post-Deregulation:

• Price/Capacity Wars: AC flooded markets to crush CA (e.g., 1992 lawsuit over 20% overcapacity).
• Alliance Battles: CA partnered with AA; AC invested in Continental.
• Cultural Hostility: Employees resisted mergers (“Better dead than red” CA pilot sentiment).

Financial Disparity: AC’s stronger balance sheet (129M net income in 1994 vs. 38M) let it outlast CA.

Outcome: A zero-sum rivalry that nearly bankrupted CA and eroded industry profitability.

1. Threat of New Entrants

   • Barriers to Entry:

     • High Capital Costs: Significant investment required for aircraft, maintenance, and infrastructure (e.g., CA’s 300M acquisition of CPAir, 900M projected from Wardair fleet sales
     • Regulatory Hurdles: Even post-deregulation, slot allocations (e.g., restrictions at O’Hare/La Guardia under the open skies treaty) and safety certifications limit new entrants.
     • Brand Loyalty: Established FFPs (e.g., CA’s alliance with AA’s Advantage) and CRS dominance (e.g., Sabre) deter new competitors.

   • Emerging Threats:

     • Charter Airlines: Canada 3000, Royal Air, and Air Transat grew rapidly (789,000 passengers by 1993) by offering low-cost alternatives.
     • U.S. Carriers: Open skies increased the risk of cabotage demands (e.g., Delta, United entering Canadian markets).
     • Overall: Moderate threat due to charters and potential U.S. incursion, but high barriers protect incumbents.

2. Bargaining Power of Suppliers

   • Aircraft Manufacturers (Boeing, Airbus):
     • High Power: Limited suppliers; CA’s mixed fleet (737s, Airbus A310s) led to inefficiencies and dependency on manufacturers for fleet renewal.
   • Fuel Suppliers:
     • Volatile Power: Fuel costs spiked in the early 1990s (e.g., CA’s 11cent/barrel increase). Geographic fuel price disparities (cheaper in Western Canada) offered minor relief.
   • Labor Unions:
     • High Power: CA’s unionized workforce (12,060 union members in 1995) demanded concessions (125M in Plan A). CUPE’s absence stalled negotiations.
   • CRS Providers:
     • Moderate Power: CA’s shift from Gemini to Sabre (via AMR) reduced control over distribution channels.
     • Overall: High supplier power due to concentrated inputs and union influence.

3. Bargaining Power of Buyers

   • Passengers:

     • Price Sensitivity: Charters captured 31% of Vancouver-Toronto traffic by 1993 by undercutting fares.
     • Loyalty Programs: Business travelers valued FFPs (e.g., CA’s partnership with AA) but leisure travelers prioritized cost.

   • Corporate Clients:

     • Negotiated Discounts: Large corporations could demand bulk fare reductions.

   • Cargo Clients:

     • Limited Influence: Cargo contributed only 10% of revenue, reducing buyer leverage.
     • Overall: Moderate to high power due to price transparency and competition from charters.

4. Threat of Substitutes

   • Domestic Routes:
     • Trains/Buses: Viable for short-haul trips (e.g., Eastern Triangle), but irrelevant for transcontinental flights.
   • International Routes:
     • Limited Substitutes: No practical alternatives for long-haul travel (e.g., CA’s Pacific Rim routes).
   • Virtual Communication:
     • Low Threat: Minimal impact in the 1990s context (pre-internet boom).
     • Overall: Low to moderate threat, primarily from ground transportation for short distances.

5. Intensity of Competitive Rivalry

   • Price Wars: CA and AC engaged in destructive fare battles (e.g., Wardair’s failed expansion triggered industry-wide losses).
   • Capacity Battles: AC flooded markets to suppress CA (e.g., 20% domestic overcapacity in 1992).
   • Alliance Competition:
     • CA partnered with AA for trans-border code-sharing.
     • AC invested in Continental and secured Osaka rights via government deals.
   • Cultural Hostility: Employee resistance to mergers (“Better dead than red” mentality) deepened rivalry.
   • Financial Disparity: AC’s stronger balance sheet (129M net income in 1994 vs. 38M) allowed aggressive tactics.
   • Overall: Extremely high rivalry, driving both airlines to near-collapse (CA lost 547M in 1992).

Conclusion

The Canadian airline industry post-deregulation was highly unattractive due to:

• Intense rivalry between CA and AC, exacerbated by overcapacity and price wars.
• High supplier power from unions, aircraft manufacturers, and fuel costs.
• Moderate buyer power and substitute threats pressuring margins.
• Emerging entrants (charters, U.S. carriers) eroding profitability.

CA’s struggles reflect the industry’s structural challenges. Survival required cost discipline, strategic alliances (e.g., AA), and avoiding overexpansion (e.g., Wardair acquisition).