Kevin Benson, President and CEO, Canadian Airlines International Ltd. and Canadian Airlines Corporation
THE CANADIAN STORY AND UPDATE
Chairman: Gareth S. Seltzer, President, The Empire Club of Canada
Head Table Guests
Edward Badovinac, Professor, Electronics Telecommunications, George Brown College and a Director, The Empire Club of Canada; Rev. Philip Philips, Founding Chaplain, Lester B. Pearson International Airport and National Chaplain, Canadian Airports; Henry Eaton, Vice-President, Strategic Planning and Business Development, Baton Broadcasting Incorporated; Dominic D'Alessandro, President and CEO, Manulife Financial; Thomas Peddie, President and CEO, CTV Television Network Limited; and David Isrealson, Business Reporter, The Toronto Star.
Introduction by Gareth Seltzer
To be president of this organisation is to be constantly interacting with various companies, their executive officers and frequently associates at every level. Some I am surprised get their doors unlocked in the morning and others are overwhelmingly organised and enthusiastic. Today, I cannot say enough about how impressive it is to work with the associates and employees of Canadian Airlines. We are hear to listen to Kevin Benson, but you all deserve to be thanked.
The Canadian airline business has been revolutionised over the past decade and like any renewal, it takes time to know who the players are and what market segment they can efficiently and profitably serve. Having just been out helping a friend's child look for a Hallowe'en costume, 1 came across a caution label from the Kenner products' batman costume. "caution: [it says] cape does not enable user to fly."
And herein lies the lesson--planes are only a small part of running an airline. Capital is required to operate. But to survive, to flourish, you must have something else. You must have market savvy and an eager audience. And there are two audiences here, those who look to Canadian Airlines to meet their travel needs and shareholders who look to Canadian management to meet their financial objectives.
Our guest, Mr. Benson, was born in South Africa and immigrated to Canada in 1997. He was Chief Executive of Trizec before joining Canadian in late 1995. He is on the board of Manulife Financial and the Jim Pattison group and, I am told, loves anything fast. Interestingly enough, when Mr. Benson was first approached to serve as the Chief Financial Officer of Canadian Airlines, he said he was interested--but only if they promised not to make him CEO. I am very pleased today to welcome as our guest at the Empire Club of Canada, the President and CEO of Canadian Airlines--Mr. Kevin Benson.
Good afternoon and thank you for your interest in the Canadian story.
I would like to start with a few words about the industry, follow with an outline of the restructuring plan that we put together last year and an update on the first nine months of this year, and finally reconfirm our commitment to Toronto.
In about three days' time I will celebrate my second anniversary in the airline industry. For some reason, it seems much longer but certainly the two years have been exciting ones. Apart from issues that are unique to Canadian, the industry itself is a captivating one and one with more than its share of challenges. A number of characteristics contribute to this environment and I'd like to touch on them before I talk about Canadian.
Firstly, the industry is a high-capital industry. A "small" wide body costs US$80 million and a 777 or 747-type costs US$140-160 million. Even smaller transcon types like the A320 or B757 cost about US$50 million. Given the issues at stake, preventative maintenance is essential but also costly.
Secondly, it is a low-margin industry. Despite the fact that the industry is labour and capital intensive, margins are low--in the single-digit range. At the same time our cost of capital is high, reflecting both industry volatility as well as our own credit risk which means operations have to be focused on efficiency. Last year our EBITDAR was 13 per cent and we lost $180 million. Our target now is an EBITDAR of 18 per cent and for the first six months of this year we made 15 per cent.
Thirdly, it is a highly competitive industry. Domestic competition is, for all intents and purposes, unlimited. It is relatively easy to start a new domestic airline in Canada with a cost base that is considerably lower than with existing carriers. With a few restrictions, trans-border travel is the same but international routes are more restrictive to newcomers as they are subject to agreements with the country in question as well as to slot availability at often crowded airports.
The fourth point is that there are high operational risks. Safety requirements are extreme for obvious reasons. Equipment is highly sophisticated and premier passengers are highly mobile (no pun intended). The average sale is under $300. It is highly people intensive. We own 125 aircraft but employ 16,500 people. Customers rank the attitude of flight attendants as the factor that most decides their opinion of the airline, but they are also the group that management has the least contact with.
Clearly the airline industry is not an industry for the faint of heart. Why are we still in it?
Airplanes are exciting and it is a very fast-moving and stimulating environment to be in. Seeing 800,000 pounds of metal and sundry other objects leap into the air to emerge 15 hours later on the other side of the world is pretty heady stuff. People who come into this industry love it and tend to stay in it for a lifetime which perhaps explains why our employees are so determined to see Canadian return to profitability.
Our employees have needed that determination in the last few years. The past 12 months in particular have been difficult. However, we have made significant progress and hope the days of seeing the headline, "Cash-strapped Canadian..." are passed. Unfortunately that reputation was well founded. In 1992 and then again in 1994, Canadian experienced cash-flow problems. These received the wide publicity that seems to reflect public fascination with the industry and steps were taken to reduce and control costs while improving revenues, but these did not go far enough and the airline continued to bleed.
In 1994, American Airlines invested in Canadian and, in addition to cash, brought something Canadian needed even more--major improvements in technology. The industry has become very competitive and detailed route profitability information is essential for prudent decision making. Over the next year American Airlines also provided a number of key executives who understood how to use complex systems and the copious information they produced. As a result a number of new initiatives were developed, designed to win back business customers lost over the years.
The results for the first half of 1996 showed the benefit of these initiatives, revenue being 18 per cent ahead of that of 1995.
However, as the third quarter developed, it became clear that the benefit of improvements was offset by a number of factors and that second half-year was well short of expectations. It was obvious that we needed to re-examine long-term prospects for Canadian and determine if the airline had a viable future.
Last September was an intense time as we looked at these realities. We came to the conclusion that Canadian could not only make itself competitive within its existing network, but in fact its Asian routes and experience represented a unique opportunity for exceptional growth if it could position itself to take advantage of them.
Our new systems had pinpointed those routes which were profitable as well as those on which we did not make any money. The opportunities with American Airlines were greatly enhanced by the granting of an antitrust immunity by the U.S. in June 1996. Open skies restrictions on American Airlines' flights into Vancouver would end in March 1997, greatly strengthening our U.S. point of sale and allowing us to re-deploy our 737 fleet onto higher-yield trans-border markets. However, the real opportunity in fact was Asia and our relationship with American Airlines. American handles a quarter of U.S. domestic traffic but has few rights to Asia. Canadian carries nearly a third of Asia/Canada traffic but less than 1 per cent of U.S. traffic to Asia. Our opportunity was to become the carrier of choice to Asia for American Airlines' passengers. Picking up only 15 to 20 per cent of American Airlines' potential share of traffic to Asia would more than double our current loads.
Attracting more of American Airlines' customers would help address another challenge for Canadian carriers--seasonality. In most of our key markets, including Asia, nearly two-thirds of traffic flow occurs in five summer months which means we have excess capacity in the other seven months. The U.S. has more winter destinations than Canada and traffic flow has a winter/summer split of 45 per cent/55 per cent. Increasing our share of U.S./Asia traffic evens out the peaks and valleys, producing an improved utilisation of our fleet. As we grow our share of the Asian market we also benefit from rapid growth of the market. The North America to Asia traffic is predicted to grow 10 to 12 per cent a year over the next five years compared to only 2 to 4-per-cent growth from Europe. IATA forecasts that by 2010 fully 50 per cent of internationally scheduled trips by air will take place to, from, or within the Asia-Pacific region.
Clearly this was a great opportunity but first we had a liquidity crisis to fix. A short-term profitability and liquidity solution was required as a first step towards our long-term goals, one that was decisive with immediate results. On November 1 last year, we announced our Operational Restructuring Plan to fundamentally reshape the company. Our objective was to improve the bottom line by $200 million a year for the next four years and in doing so to provide the time to develop our Asia/U.S. traffic with American Airlines.
The first part of the plan was realignment of our network. Using new planning models, we looked at opportunities made possible by deregulation, open skies and the broadening of our commercial alliances. As a result major changes were made:
1. Domestic capacity was reduced by 24 per cent without affecting frequency as half-full Boeing 737 aircraft were moved to service growing U.S. markets and were replaced by smaller F28 jets.
2. Routes to France and Germany, each losing $10 million per annum, were cancelled.
3. Capacity to Asia increased over 20 per cent.
4. Trans-border capacity increased by 160 per cent.
5. Alliance with British Airways stepped up to include full code sharing to London from Vancouver, Calgary, Montreal and Toronto.
6. Canadian code was put onto 1,350 American Airlines' flights and American Airlines' code onto 350 Canadian flights every day.
7. A concerted effort was made to make American Airlines/Canadian service seamless.
8. Stage length increased 16 per cent and aircraft utilisation improved by as much as 10 per cent for 737s.
The result of these changes was a bottom-line improvement of $60 million which was significant but inadequate. Additional savings were required. Another $140 million was needed and had to be quick and certain. We approached groups with a direct financial stake in the future of the airline--employees, creditors, American Airlines and various levels of government. If you remember from the press of last year, no one was enthusiastic but we were given the backing needed for our four-year plan. Employees contributed salary and wage reductions of $32 million per annum. Overhead reductions contributed another $22 million per annum, growing to $30 million. Governments agreed to reduce taxes on fuel, giving a savings of $38 million per annum. American Airlines agreed to cut fees for processing, telecommunications and development by $48 million per annum. In total the four-year plan was worth $800 million to the bottom line.
The plan was used as a base with which to approach creditors. We asked for deferments, not reductions, and got them. Now nine months into our 48-month plan we are comfortable with our progress to date. As is to be expected, some markets changed for the worse but others have outperformed our estimates. The Eastern triangle that lost $40 million last year is now profitable. New trans-border routes are outperforming expectations and London routes had their best summer ever (with British Airways). South America was above target and Hong Kong and Tokyo were down but Taipei, Beijing and Manila had good growth. Overall, the changes made have met or exceeded forecasts. The focus now is on growing Asian routes by building traffic into Vancouver as a stepping point to Asia.
To do this, we are building the operations in Vancouver into a fortress hub from which our network can fan out worldwide on our own metal and with alliance partners. One of our hidden assets is the strength of the alliance team we have developed over the past 20 years, a team that includes:
American Airlines with their North and South American dominance;
British Airways with their strength in Europe, Africa and Middle East;
Qantas the major carrier to the South Pacific; and Japan Airlines, the premier Japanese carrier.
One-third of our capacity is now devoted to Asian flying and more than one-third of our revenues are linked to the Asian hub. Accordingly we've increased trans-border flying in co-operation with American Airlines and focused flights on routes into American hubs in Dallas, Chicago and Miami. We have aligned policies and procedures with American so that services and priorities are seamless to premium passengers. Our U.S. service has grown from 13 daily flights between Vancouver and the U.S. two years ago to more than 40 flights. We plan to publicise the benefit of Vancouver's location on the great circle routes that aircraft fly. It means shorter travel times to Asia of one to three hours from any point east of the Vancouver/Dallas line and up to one hour from west of the line.
With the basics of the plan confirmed, we are now able to devote resources to the opportunities that will arise as Toronto comes free from open skies restrictions in February of next year.
Toronto is no stranger to Canadian. We employ 4,200 people here and pay $220 million in salaries annually. We also spend approximately $125 million on goods and services. We fly 130 flights a day from Toronto to 27 destinations on five continents. We carry 40 per cent of the traffic on these routes and believe that our ability to add the American Airlines code to our service from next February will open up a number of new opportunities in this market. We are using models to test these now but our commitment to Toronto remains strong. We are the official carrier for the Toronto Maple Leafs, the Blue Jays and SkyDome.
The actions we took to correct losses in the Eastern triangle did not include any cancellation of service. We moved to smaller and faster aircraft. We are determined to increase our market share here and in the process to ensure that you continue to have choices in selecting air service. We know we will have to fight to get your business, but we are ready and willing to compete aggressively for our future. More importantly we have a much clearer vision of what that future is and hope your support will indicate that you agree. We are no longer just in the race; we're in it to win.
Thank you for your time.
The appreciation of the meeting was expressed by Edward Badovinac, Professor, Electronics Telecommunications, George Brown College and a Director, The Empire Club of Canada.