Massive marketing and management blunders almost destroyed Continental Airlines, but in only a few years, with a remarkable turnaround by new management, Continental became a star of the airline industry. The changemaker, CEO Gordon Bethune, wrote a best-selling book on how he turned around the moribund company, titled From Worst to First. In this chapter we will look at the scenario leading to Continental's difficulties, and then examine the ingredients of the great comeback.
Frank Lorenzo was a consummate manipulator, parlaying borrowed funds and little of his own money to build an airline empire. By the end of 1986, he controlled the largest airline network in the non-Communist world: only Aeroflot, the Soviet airline, was larger. Lorenzo's network was a leveraged amalgam of Continental, People Express, Frontier, and Eastern, with $8.6 billion in sales—all this from a small investment in Texas International Airlines in 1971. In the process of building his network, Lorenzo defeated unions and shrewdly used the bankruptcy courts to further his ends. When he eventually departed, his empire was swimming in red ink, had a terrible reputation, and was burdened with colossal debt and aging planes.
After getting an MBA from Harvard, Lorenzo's first job was as a financial analyst at Trans World Airlines. In 1966, he and Robert Carney, a buddy from Harvard, formed an airline consulting firm, and in 1969, the two put together $35,000 to form an investment firm, Jet Capital. Through a public stock offering they were able to raise an additional $1.15 million. In 1971, Jet Capital was called in to fix ailing Texas International and wound up buying it for $1.5 million, and Lorenzo became CEO.
He restructured the debt as well as the airline's routes, found funds to upgrade the almost obsolete planes, and brought Texas International to profitability.
In 1978, acquisition-minded Lorenzo lost out to Pan Am in a bidding war for National Airlines, but he made $40 million on the National stock he had acquired. In 1980, he created nonunion New York Air and formed Texas Air as a holding company. In 1982 Texas Air bought Continental for $154 million.
In 1983, Lorenzo took Continental into bankruptcy court, filing for Chapter 11. This permitted the corporation to continue operating but spared its obligation to meet heavy interest payments and certain other contracts while it reorganized as a more viable enterprise. The process nullified the previous union contracts, and this prompted a walkout by many union workers.
Lorenzo earned the lasting enmity of organized labor as a union-buster by replacing strikers with nonunion workers at much lower wages. (A few years later, he reinforced this reputation when he used the same tactics with Eastern Airlines.)
In a 1986 acquisition achievement that was to backfire a few years later, Lorenzo struck deals to acquire a weak Eastern Airlines and a failing People Express/Frontier Airlines. That same year Continental emerged out of bankruptcy. Now Continental, with its nonunion workforce making it a low-cost operator, was Lorenzo's shining jewel. The low bid accepted for Eastern reinforced Lorenzo's reputation as a visionary builder.
What kind of executive was Lorenzo? Although he was variously described as a master financier and visionary, his handling of day-to-day problems bordered on the inept.[30] One former executive was quoted as saying, "If he agreed with one thing at 12:15, it would be different by the afternoon.[31] Inconsistent planning and poor execution characterized his lack of good operational strength. Furthermore, his domineering and erratic style alienated talented executives. From 1983 to 1993, nine presidents left Continental.
But Lorenzo's treatment of his unions brought the most controversy. He became the central figure of confrontational labor-management relations to a degree perhaps unmatched by any other person in recent years. Although he won the battle with Continental's unions and later with Eastern's, he was burdened with costly strikes and a residue of ill feeling that impeded any profitable recovery during his time at the helm.
In an environment of heavy losses and its own militant unions, Eastern in 1986, accepted Lorenzo's low offer. With tough contract demands and the stockpiling of $1 billion in cash as strike insurance, Lorenzo seemed eager to precipitate and then crush a strike. He instituted a program of severe downsizing, and in 1989, after 15 months of fruitless talks, some 8,500 machinists and 3,800 pilots went on strike. Lorenzo countered the strike at Eastern by filing for Chapter 11 bankruptcy, and replaced many of the striking pilots and machinists within months.
At first Eastern appeared to be successfully weathering the strike, while Continental benefited with increased business. But soon revenue dropped drastically, with Eastern planes flying less than half full amid rising fuel costs. Fares were slashed in order to regain business, and a liquidity crisis loomed. Then, on January 16, 1990, an Eastern jet sheared the top off a private plane in Atlanta. Even though the accident was attributed to air controller error, Eastern's name received the publicity.
Eastern creditors, now despairing of Lorenzo's ability to pay them back in full, pushed for a merger with Continental, which would expose it to the bankruptcy process. On December 3, 1990, Continental again tumbled into bankruptcy, burdened with overwhelming debt. In January 1991, Eastern finally went out of business.
Lorenzo was gone. The legacy of Eastern remained, however. Creditors claimed more than $400 million in asset transfers between Eastern and Continental, and Eastern still had $680 million in unfunded pension liabilities. The board brought in Robert Ferguson, veteran of Braniff and Eastern bankruptcies, to make changes. On April 16, 1993, the court approved a reorganization plan for Continental to emerge from bankruptcy, the first airline to have survived two bankruptcies. However, creditors got only pennies on the dollar.[32]
Despite its long history of travail and a terrible profit picture, Continental in 1992 was still the nation's fifth-largest airline, behind American, United, Delta, and Northwest, and it served 193 airports. Table 4.1 shows the revenues and net profits (or losses) of Continental and its major competitors from 1987 through 1991.
Continental was savaged in its long tenure as a pawn in Lorenzo's dynasty-building efforts. He had saddled it with huge debts, brought it into bankruptcy twice, and left it with aging equipment. Perhaps a greater detriment was the ravished corporate culture. The following Information Box discusses corporate culture and its relationship to public image or reputation.
Table 4.1. Performance Statistics, Major Airlines, 1987–1991
1987 | 1988 | 1989 | 1990 | 1991 | Percent 5-Year Gain | |
|---|---|---|---|---|---|---|
Source: Company annual reports. | ||||||
Commentary: Note the operating performance of Continental relative to its major competitors during this period. It ranks last in sales gain. It far and away has the worst profit performance, having had massive losses in each of the years in contrast to its competitors, who, while incurring some losses, had neither the constancy | ||||||
Revenue: (millions $) | ||||||
American | 6,368 | 7,548 | 8,670 | 9,203 | 9,309 | 46.0 |
Delta | 5,638 | 6,684 | 7,780 | 7,697 | 8,268 | 46.6 |
United | 6,500 | 7,006 | 7,463 | 7,946 | 7,850 | 20.8 |
Northwest | 3,328 | 3,395 | 3,944 | 4,298 | 4,330 | 30.1 |
Continental | 3,404 | 3,682 | 3,896 | 4,036 | 4,031 | 18.4 |
Income (millions $) | ||||||
American | 225 | 450 | 412 | (40) | (253) | |
Delta | 201 | 286 | 467 | (119) | (216) | |
United | 22 | 426 | 246 | 73 | (175) | |
Northwest | 64 | 49 | 116 | (27) | 10 | |
Continental | (304) | (310) | (56) | (1,218) | (1,550) | |
A devastated reputation proved to be a major impediment. The reputation of a surly labor force had repercussions far beyond the organization itself. For years Continental had a problem wooing the better-paying business travelers. Being on expense accounts, they wanted quality service rather than cut-rate prices. A reputation for good service is not easily or quickly achieved, especially when the opposite reputation is well entrenched.
On another dimension, Continental's reputation also hindered competitive parity. Surviving two bankruptcies does not engender confidence among investors, creditors, or even travel agents.
Domestic airlines lost a staggering $8 billion in the years 1990 through 1992. Fare wars and excess planes proved to be albatrosses. Even when planes were filled, discount prices often did not cover overhead.
A lengthy recession drove both firms and individuals to fly more sparingly. Business firms found teleconferencing a viable substitute for business travel, and consumers, facing diminished discretionary income as well as the threat of eventual layoffs or forced retirements, were hardly optimistic. The airlines suffered.
Part of the blame for the red ink lay directly with the airlines—and especially their reckless expansion efforts—yet they did not deserve total blame. In the late 1980s, passenger traffic climbed 10 percent per year, and in response the airlines ordered hundreds of jetliners.[35] The recession arrived just as the new planes were being delivered. The airlines greatly increased their debt in these expansion efforts: the big three, for example—American, United, and Delta—doubled their leverage in the four years after 1989, with debt at 80 percent of capitalization by 1993.[36]
In such a climate, cost-cutting efforts prevailed. But how much can be cut without jeopardizing service and even safety? Some airlines found that hubs, heralded as the great strategy of the 1980s, were not as cost-effective as expected. With hub cities, passengers were gathered from outlying "spokes" and then flown to final destinations. Maintaining too many hubs, however, brought costly overheads. While the concept was good, some retrenchment seemed necessary to be cost-effective.
Airlines, such as Continental with heavy debt and limited liquidity, had two major concerns: first, how fast the country could emerge from recession; second, the risk of fuel-price escalation in the coming years. Despite Continental's low operating costs, external conditions impossible to predict or control could affect viability.
In February 1994, Gordon Bethune left Boeing and took the job of president and chief operating officer of Continental. He faced a daunting challenge. While it was the fifth largest airline, Continental was by far the worst among the nation's ten biggest according to these quality indicators by the Department of Transportation:
On-time percentage (the percentage of flights that land within 15 minutes of their scheduled arrival).
Number of mishandled-baggage reports filed per 1,000 passengers.
Number of complaints per 100,000 passengers.
Involuntarily denied boarding, i.e., passengers with tickets who are not allowed to board because of overbooking or other problems.[37]
In late October Bethune became chief executive officer. Now he was sitting in the pilot's seat.
He made dramatic changes. In 1995, through a "renewed focus on flight schedules and incentive pay," he greatly improved on-time performance, along with lost-baggage claims and customer complaints. Now, instead of being dead-last in these quality indicators of the Department of Transportation, Continental by 1996 was third-best or better in all four categories.
Customers began returning, especially the higher-fare business travelers, climbing from 32.2 percent in 1994 to 42.8 percent of all customers by 1996. In May 1996, based on customer surveys, Continental was awarded the J. D. Power Award as the best airline for customer satisfaction on flights of 500 miles or more. It also received the award in 1997, the first airline to win two years in a row. Other honors followed. In January 1997, it was named "Airline of the Year" by Air Transport World, the leading industry monthly. In January 1997, Business Week magazine named Bethune one of its top managers of 1996.
Bethune had transformed the workforce into a happy one, as measured by these statistics:
Wages up an average of 25 percent.
Sick leave down more than 29 percent.
Personnel turnover down 45 percent.
Table 4.2. Continental Sales and Profits, Before and After Bethune, 1992–1997
Before Bethune | After Bethune | |||||
|---|---|---|---|---|---|---|
1992 | 1993 | 1994 | 1995 | 1996 | 1997 | |
Source: Company annual reports. | ||||||
Commentary: While the revenue statistics do not show a striking improvement, the net income certainly does. Most important to investors, the earnings per share show a major improvement. | ||||||
Revenue (millions $) | 5,494 | 3,907 | 5,670 | 5,825 | 6,360 | 7,213 |
Net income (millions $) | −110 | −39 | −612 | 224 | 325 | 389 |
Earnings per share ($) | −1.17 | −11.88 | 3.60 | 4.25 | 5.03 | |
These statistics suggest the fallacy of a low-price strategy at the expense of profitability in the 1992–1994 era. At the same time, we have to realize that the early 1990s were recession years, particularly for the airline industry.
Workers compensation claims down 51 percent.
On-the-job injuries down 54 percent.[38]
Perhaps nothing illustrates the improvement in employee morale as much as this: In 1995, not all that long after he became top executive, employees were so happy with their new boss's performance that they chipped in to buy him a $22,000 Harley-Davidson.[39]
Naturally these improvements in employee relations and customer service had a major impact on revenues and profitability. See Table 4.2 for the three years before and after Bethune.
Bethune's father was a crop duster, and as a teenager Gordon helped him one summer and learned first hand the challenges of responsibility: in this case, preparing a crude landing strip for nighttime landings, with any negligence disastrous. He joined the Navy at 17, before finishing high school. He graduated second in his class at the Naval Technical School to become an aviation electronics technician, and over 19 years worked his way up to lieutenant. After leaving the Navy he joined Braniff, then Western, and later Piedmont Airlines as senior vice president of operations. He finally left Piedmont for Boeing as VP/general manager of customer service. There he became licensed as a 757 and 767 pilot: "An amazing thing happened. All the Boeing pilots suddenly thought I was a great guy," he writes. "I hope I hadn't given them any reason to think otherwise of me before that, but this really got their attention."[40]
Bethune stressed the human element in guiding the comeback of a lethargic, even bitter, organization by doing the simple things: "On October 24, 1994, I did a very significant thing in the executive suite of Continental Airlines . . . I opened the doors . . . [Before this] The doors to the executive suite were locked, and you needed an ID to get through. Security cameras added to the feeling of relaxed charm . . . So the day I began running the company, I opened the doors. I wasn't afraid of my employees, and I wanted everybody to know it."[41] Still, he had to entice employees to the twentieth floor of headquarters, and he did this with open houses, supplying food and drink, and personal tours and chat sessions. "I'd take a group of employees into my office, open up the closet, and say, You see? Frank's not here.' Frank Lorenzo had left Continental years before; the legacy of cost cutting and infighting of that era was finally gone, and I wanted them to know it."[42]
Of course, the improvement in employee relations needed tangible elements to cement and sustain it, and to improve morale. Bethune worked hard to instill a spirit of teamwork. He did this by giving on-time bonuses to all employees, not just pilots. He burned the procedure manual that bound employees to rigid policies instead of being able to use their best judgment. He even gave the planes a new paint job to provide tangible evidence of a disavowal of the old and an embracing of new policies and practices. The new image impressed both employees and customers.
Better communications was also a key element in improving employee relationships and the spirit of teamwork. Information was shared with employees through newsletters, updates on bulletin boards, e-mail, voice-mail, and electronic signs over worldwide workplaces. To Bethune it was a cardinal sin for any organization if employees first heard about something that affected them through the newspaper or other media. The following Information Box contrasts the classic idea of Theory X and Theory Y managers. Bethune was certainly a Theory Y manager, and Lorenzo Theory X.
Now Continental had to win back customers. Instead of the company's old focus on cost savings, efforts were directed to putting out a better product through better service. This meant emphasis on on-time flights, better baggage handling, and the like. By giving employees bonuses for meeting these standards, the incentive was created.
Bethune sought to do a better job of designing routes with good demand, to "fly places people wanted to go." This meant, for example, cutting back on the six flights a day between Greensboro, North Carolina, and Greenville, South Carolina. It meant not trying to compete with Southwest's Friends Fly Free Fares, which "essentially allowed passengers to fl y anywhere within the state of Florida for $24.50.[43] The frequent flyer program was reinstated. Going a step further, the company apologized to travel agents, business partners, and customers and showed them how it planned to do better and earn their business back.
Continental queried travel agents about their biggest clients, the major firms that did the most traveling, asking how could it better serve these customers. As a result, more first-class seats were added, certain destinations were given more attention, volume discounts were instituted. Travel agents were made members of the team and given special incentives beyond normal airline commissions.
Table 4.3. Competitive Position of Continental Before and After Bethune, 1992–1997
Before Bethune | After Bethune | |||||
|---|---|---|---|---|---|---|
1992 | 1993 | 1994 | 1995 | 1996 | 1997 | |
Source: Company annual reports. NA = Information not available. | ||||||
Commentary: Most significant is the gradual increase in Continental's market share over its four major rivals. This is an improving competitive position. | ||||||
Revenues (millions $): | ||||||
AMR (American) | 14,396 | 15,701 | 16,137 | 16,910 | 17,753 | 18,570 |
UAR (United) | 12,890 | 14,511 | 13,950 | 14,943 | 16,362 | 17,378 |
Delta | 10,837 | 11,997 | 12,359 | 12,194 | 12,455 | 13,590 |
Northwest | NA 8,649 | 9,143 | 9,085 | 9,881 | 10,226 | |
Continental | 5,494 3,907 | 5,670 | 5,825 | 6,360 | 7,213 | |
Continental's Market Share (percent of total sales of Big Five Airlines): | 7.1% | 9.9% | 9.9% | 10.1% | 10.8% | |
This still left financial considerations. Bethune was aggressive in renegotiating loans and poor airplane lease agreements, and in getting supplier financial cooperation. Controls were set up to monitor cash flow and stop waste. Tables 4.3 and 4.4 show the results of Bethune's efforts from the dark days of 1992–1994, and how the competitive position of Continental changed. Remember, Bethune joined the firm in February 1994 and did not become the top executive until late October of that year.
Table 4.4. Profitability Comparison of Big Five Airlines, 1992–1997
Before Bethune | After Bethune | |||||
|---|---|---|---|---|---|---|
1992 | 1993 | 1994 | 1995 | 1996 | 1997 | |
Source: Company annual reports. NA = Information not available. | ||||||
Commentary: Of interest is how the good and bad times for the airlines seem to move in lockstep. Still, the smallest of the Big Five, Continental, incurred the biggest loss of any airline in 1994. Under Bethune, it has seen a steady increase in profitability, but so have the other airlines, although AMR and Delta have been more erratic. | ||||||
Net Income (millions $): | ||||||
AMR | −474 | −96 | 228 | 196 | 1,105 | 985 |
UAL | −416 | −31 | 77 | 378 | 600 | 958 |
Delta | −505 | −414 | −408 | 294 | 156 | 854 |
Northwest | NA | −114 | 296 | 342 | 536 | 606 |
Continental | −110 | −39 | −696 | 224 | 325 | 389 |
As the airline industry moved into the new millennium, external circumstances impacted negatively on the whole industry. The 9/11 disaster of 2001 had a profound effect, all the more because passenger planes were the instruments of destruction by the terrorists. Passenger traffic was down, restrictions and inconveniences were the order of the day. Then surging oil prices were the double whammy. U.S. airlines posted losses of some $8 billion in 2002, after 2001's record loss of $7.7 billion. The loss in the more profitable business travel was particularly acute. High-cost airlines faced enormous pressure from low-fare carriers, most notably Southwest and JetBlue Airways. United Airlines and US Airways fell into bankruptcy in late 2002, and were joined by Northwest and Delta in 2005, leaving only AMR and Continental of the six major carriers to escape bankruptcy. Airlines needed to slash billions in operating costs, notably through labor givebacks of extravagant union contracts and restructuring. In this climate, Continental's revenue rose, although red ink prevailed most years, Table 4.5 compares Continental's operating results for 2002 through 2005 with those of American Airlines (now AMR) and Southwest Airlines, the only carrier to make a profit every year.
Table 4.5. Comparison of Continental with Its Two Major Competitors Not in Bankruptcy, 2002–2005 ($ millions)
2002 | 2003 | 2004 | 2005 | |
|---|---|---|---|---|
Source: Company annual reports. | ||||
Commentary: Of particular interest is how Continental has improved its market share relative to these two competitors each year since 2002. Of course, it had other competitors—Northwest, United, Delta, and US Air—who were in bankruptcy with operating statistics not available. In the income comparisons, AMR shows up by far the worst, while Southwest alone of all the airlines was profitable every year. Continental's three years of losses, while erratic, show an improving picture. | ||||
Revenues: | ||||
AMR (American) | 17,299 | 17,440 | 18,645 | 20,712 |
Southwest | 5,522 | 5,937 | 6,530 | 7,584 |
Continental | 8,402 | 8,870 | 9,744 | 11,208 |
Continental's market share (Continental's sales divided by total sales of these three airlines) | 26.9% | 27.5% | 27.9% | 28.4% |
Net Income: | ||||
AMR | −2,523 | −1,228 | −761 | −861 |
Southwest | 241 | 442 | 313 | 548 |
Continental | −451 | 38 | −363 | −68 |
Gordon Bethune retired at the end of2004 after a distinguished career. He joined the lecture circuit, and his speaker's fees ranged from $30,000 to $50,000. In 2006, he became CEO of Aloha Airlines.
While Bethune was gone by mid-decade, his fine-tuning of Continental lived on. In 2006, awards continued to be showered on the airline. A survey of business travelers by Conde Nast Traveler found Continental running the best business-class of any U.S. airline on foreign routes, and the best premium service on domestic routes. Earlier in the year, it was ranked first in a poll by J. D. Power & Associates. While only the fourth-largest U.S. carrier, Continental flew to more international destinations than any other U.S. airline. It catered to business travelers, who paid the highest fares and flew most frequently, with more comfortable seats, special waiting areas, and bags tagged for first unloading. At a time when most airlines were drastically cutting back on amenities in coach, Continental still provided free blankets, pillows, and hot meals.
Continuing with the Bethune legacy, the airline valued its employees. After the 9/11 attacks hurt air travel, Continental's executives gave up their pay for the rest of the year. They later squeezed more than $1 billion out of operations before turning to employees for $500 million in pay cuts when fuel costs soared. The result was peaceful labor relations, higher morale, and better service.[45]
Invitation to Make Your Own Analysis and Conclusions
Gordon Bethune's approach to salvaging Continental seems almost too good to be true. Surely he must have shown some management flaws or missteps. What could he have done better? Your recommendations, please.
Could Lorenzo's confrontation with Continental's unions have been moreconstructively handled? How?
Compare Bethune's handling of employees with Kelleher's at SouthwestAirlines on Chapter 13. Are there commonalities? Contrasts?
Compare Bethune's management style with Lorenzo's. What conclusions can you draw?
Bethune gave great credit to his open-door policy when he became CEO. Do you think this was a major factor in the turnaround? How about changing the color of the planes?
How do you motivate employees to give a high priority to customer service?
Evaluate the causes and the consequences of frequent top-executive changes such as Continental experienced in the days of Lorenzo?
How can replacement workers—in this case, pilots and skilled maintenancepeople hired at substantially lower salaries than their unionized peers atother airlines—be sufficiently motivated to provide top-notch service and aconstructive esprit de corps?
It is 1994 and Bethune has just taken over. He has asked you as his staff adviser to prepare a report on improving customer service as quickly as possible. He has also asked you to design a program to inform potential business and nonbusiness customers of this new commitment. Be as specific as possible in your recommendations.
You are the leader of the machinists' union at Eastern. It is 1986 and Lorenzo has just acquired your airline. You know full well how he broke the union at Continental, and rumors are flying that he has similar plans for Eastern. Describe your tactics under two scenarios:
You decide to take a conciliatory stance.
You plan to fight him every step of the way.
How successful do you think you will be in saving your union?
What is your prognosis from the latest developments for Continental?
Bethune was quoted as saying, "You can make an airline so cheap nobody wants to fly it."
Debate this issue, and the related issue of how an airline can make itself so unique that it can command higher prices than its competitors.
What is Continental's current situation? Have all the major airlines emerged from bankruptcy? Is the U.S. airline industry healthy now? Whatever happened to Lorenzo? How is Bethune doing with Aloha Airlines?
[30] See, for example, Todd Vogel, Gail DeGeorge, Pete Engardio, and Aaron Bernstein, "Texas Air Empire in Jeopardy," Business Week, March 27, 1989, p. 30.
[31] Mark Ivey and Gail DeGeorge, "Lorenzo May Land a Little Short of the Runway," Business Week, February 5, 1990, p. 48.
[32] Bridget O'Brian, "Judge Backs Continental Airlines Plan to Regroup, Emerge from Chapter 11," Wall Street Journal, April 19, 1993, p. A4.
[33] Edgar H. Schein, "Organizational Culture," American Psychologist, vol. 45, (1990), pp. 109–119.
[34] Terrence E. Deal and Alan A. Kennedy, Corp orate Cultures: The Rites and Rituals of Corporate Life, Reading, MA: Addison-Wesley, 1982, p. 22.
[35] Andrea Rothman, "Airlines: Still No Wind at Their Backs," Business Week, January 11, 1993, p. 96.
[36] Ibid.
[37] Gordon Bethune, From Worst to First, New York: Wiley, 1998, p. 4.
[38] Ibid., pp. 7–8.
[39] Ibid., frontispiece.
[40] Ibid., p. 268.
[41] Ibid., p. 14.
[42] Ibid., p. 32.
[43] Ibid., pp. 51–52.
[44] Douglas McGregor, The Human Side of Enterprise, New York: McGraw-Hill, 1960; John R. Schermerhorn, Jr., Management, 6th ed., New York: Wiley 1999, p. 79.
[45] Jane Engle, "Continental Could Be the Airline of the Future," Los Angeles Times, as reported in Cleveland Plain Dealer, October 22, 2006, p. G1.
[46] For example, Ivey and DeGeorge, p. 48.
[47] Bethune, p. 50.