United Blunder Prompts Airlines to Throw Cash at Their Problems

(Bloomberg) -- For U.S. airlines, doing right this week meant plunking down cold, hard cash.

United reached a settlement with a passenger who was dragged off a plane and bloodied. It also said it would pay as much as $10,000 to passengers who agree to give up their spots, following a similar move by Delta. Southwest said it would stop overbooking flights. And American added almost $1 billion in costs to “rebuild trust” with employees.

The moves underscored the wake-up call that airlines got from United’s social-media disaster. Carriers have posted the biggest profits in their history the last two years thanks to cost cuts, extra fees and low fuel prices. But all that belt-tightening and nickel-and-diming has made them as vulnerable as ever to complaints of poor customer service. Now they’re reaching for their checkbooks to try to burnish their reputations before things get worse.

“Airlines get a hugely disproportionate share of attention in the public eye,” said Samuel Engel, aviation vice president at consultant ICF International. “Everybody travels and everybody has an opinion about it.”

Or as Gary Leff, author of a frequent flier blog, puts it: “Nobody is happy with the airlines.”

Passenger Dragging

At United Continental Holdings Inc., the famous case of David Dao, 69, who was dragged off a plane April 9 after refusing to give up his seat for a crew member, culminated in an undisclosed legal settlement. The carrier also pledged to offer passengers as much as seven times what they used to get to change their plans when a flight is oversold.

The airline also will reduce flight overbooking -- a practice that’s been profitable because it ensures planes are traveling at maximum capacity even if some passengers cancel at the last minute. 

United declined to disclose the estimated revenue impact from the change. The benefits of overbooking probably run into the hundreds of millions of dollars for major airlines, said Itir Karaesmen Aydin, a professor at American University who has studied the practice. But the Dao case highlights the potential hidden costs.

“The United airlines story shows that in case of ‘rare events’ the unknown cost of overbooking can be extremely high,” Karaesmen Aydin said in an email.

Turnaround Effort

The fallout from the Dao debacle was a setback to United Chief Executive Officer Oscar Munoz as he tries to engineer a financial and operational turnaround after years as the industry laggard. The company’s earnings before interest, tax, depreciation and amortization last year were 19 percent of sales, nearly closing the gap with American Airlines Group Inc. but still behind Delta Air Lines Inc.

Munoz will be back on the hot seat next week when he appears Tuesday before the House transportation committee for a hearing on airline customer service.

“They’ve taken major strides, but only time will tell,” said Bruce Hicks, a public-relations executive who used to work for Continental Airlines, which merged with United. “They have a reputation for lousy customer service. It’s really going to be up to the front-line employees and supervisors to prove to the customers that they’re going to be different.”

United fell less than 1 percent on Thursday after the changes were announced. The shares recovered much of their losses since Dao’s experience turned into a social-media phenomenon, a sign investors don’t see it as a huge liability. Shares declined less than 1 percent to $70.07 at 1:13 p.m. in New York.

American Pay

Passengers also form their perceptions of airlines based on how they’re treated by employees, who have felt the strain of cost-cutting efforts for years. American tried to take a step to please its pilots and flight attendants this week, boosting pay in the middle of existing contracts -- a move Chief Executive Officer Doug Parker had previously rejected.

The measure will cost American an additional $930 million through 2019.

Wall Street didn’t like it. American fell the most in three months on Thursday and continued to slide another 3 percent to $42.68.

American said it decided on the action after realizing its workers would lag rivals for at least two more years -- potentially fueling ill will at a company with a history of caustic labor relations. Bridging the pay gap will help improve customer service, Parker said.

“Investments in our team are investments in our product,” Parker said.

The question for shareholders is whether American’s move was enough to placate its employees or whether further spending will be needed.

Wage Battles

“We do not expect the pilots to be happy with their current wages after the increase,” said Helane Becker, a Cowen & Co. analyst. “We expect the labor union to pivot to profit-sharing as their plan is below that of Delta and United.”

The need to spend more on image improvement adds to the many pressures facing the industry, including higher wages, fuel costs and fare competition. Those forces already were weighing on the airlines, which helps explain why the great profit expansion over the past few years may be coming to a close. U.S. airlines’ earnings per share are expected to drop slightly over the next four quarters compared with the prior period, according to data compiled by Bloomberg.

Carriers will also have to be on their guard for the next viral story that might force them to cough up more money.

“It is a bright, shiny object for the media and customers, especially customers armed with smartphones,” said Jay Sorensen, president of consultant IdeaWorks Co. and a former executive at a regional airline. “The airlines are newsworthy because they are endlessly entertaining. They’re the only business that has to move hundreds of thousands of people every day under complete control.”

To contact the reporters on this story: Mary Schlangenstein in Dallas at maryc.s@bloomberg.net, Michael Sasso in Atlanta at msasso9@bloomberg.net.

To contact the editors responsible for this story: Brendan Case at bcase4@bloomberg.net, Crayton Harrison