=20 ---------------------------------------------------------------------- This article was sent to you by someone who found it on SFGate. The original article can be found on SFGate.com here: http://www.sfgate.com/cgi-bin/article.cgi?file=3D/c/a/2006/03/19/BUG6VHOI6R= 1.DTL --------------------------------------------------------------------- Sunday, March 19, 2006 (SF Chronicle) VIRGIN AMERICA/On the Record: Fred Reid Fred Reid, a longtime executive at major airlines such as Delta and Lufthansa, made the jump last year to help startup low-fare carrier Virgin America get off the ground as its first chief executive officer. Based at San Francisco International Airport and backed by U.S. investors and British entrepreneur Richard Branson, Virgin America is awaiting certification by the Department of Transportation. Objections from other airlines and from organized labor have stalled approval of the application, which Reid hopes will be approved soon, so the new airline can begin flying late this year. In a question-and-answer session with Chronicle editors and writers, Reid talked about why low-cost carriers continue to win market share from traditional carriers, how Virgin America can differentiate itself from pioneering low-cost carriers like Southwest and JetBlue, why the fledgling airline chose San Francisco over competing cities and why airline food is so bad -- a situation he hopes to rectify on Virgin America. The interview has been edited for clarity and space. Q: Glenn Tilton (CEO of United Airlines) says there is going to be consolidation in the airline industry and there needs to be fewer airlines rather than more. We're now seeing discount airlines like JetBlue showing signs of wear and tear. Why on earth would you want to start a new airline? A: The traditional or so-called six legacy carriers have about three-quarters of the market measured in available seat miles flown -- and about 75 percent of their customer base is dissatisfied. You see this in the proprietary research that all the airlines purchase, which is not disclosed publicly. If you look at JetBlue and Southwest, it's the reverse -- 75 to 85 percent of their customers are happy. When you have an industry where the dissatisfaction is this great and you think that you can come out with something that's going to be better perceived and better accepted, then that is another opportunity. We will launch this airline with a cost position between 25 and 50 perce= nt more favorable than relevant competitors. Q: How do you arrive there? Do you just pay less? A: I think that our compensation will be reasonably attractive, but like other new-breed airlines, we will be looking for higher productivity. The other thing is new aircraft. They burn less fuel. They have far less maintenance requirements. Passengers like them better because they're brand new and they're clean and sparkling. There is a tremendous change in what you can buy in terms of technology, off-the-shelf, open-architecture technology that will enable you to buy tickets on the Web site much easier. The fourth one is high utilization -- not only people productivity, but asset productivity, in-air utilization. Airplanes make money when they're flying with passengers and they cost money when they are on the ground. The historical highs for short-haul or medium-haul domestic aircraft is eight to 10 hours, and the best in class is 12.5 to 13.5 hours, and we'll be the best in class. Q: Your background is with the legacy carriers. What makes an old-line g= uy like you think he can run a new discount carrier? Were you always a discount guy yearning to breathe free? A: Something like that. I think there are only two pure low-cost-carrier executives in the country today. One is Herb Kelleher, who founded Southwest Airlines, and the other is David Neeleman, who was involved in Canada with WestJet and then started JetBlue. Only Herb and David are untainted, if you will, but I would say that every other top-five executive comes from legacy carriers, because about 15 years ago, the low-cost carrier penetration in the U.S. market was only 8 to 10 percent. Today it is 30 percent. Q: Were you misguided? A: No, I wasn't misguided. I just didn't get the call. I finally got the call. It is not axiomatic that the executives at the old-line carriers are dumb people. They're not. A lot of the problems they have go back decades and decades. In the 1960s, you built your own information-technology system and you hired 300 IT people, and to throw all that out and start from scratch is punitively expensive. You had mergers. Delta bought Western. American bought a number of carriers. So you inherited different workforces, different IT systems, different fleet types. There is a lot of inherent complexity in the legacy carriers that started 30 or 40 years ago and the current management inherited. If you are coming from a legacy carrier to a new breed of airline, you know where some of the vulnerabilities are. You know what not to do. Q: Just to follow up on that. You have discussed your experience at Delta with Song, a carrier that failed. What happened there? A: Song performed financially better than the Delta mainline. I was the president of Delta and I was the chairman of Song. I was given full authority to take these planes out of the system and schedule them any way I wanted. So we had higher utilization. Also, the majority of the workforce involved with Song consensually trad= ed higher productivity for lifestyle changes. So you go to a flight attendant and say, "Look, if you fly 18 percent more hours this month, I'll give you three more nights at home because I'll schedule you differently." We were able to get consensual agreements with the employees, most of them. But ultimately what happened with Song was that the distress of the pare= nt (Delta) overcame the ability of the parent to really run two brands and a different business model. When I left, I presented the board with substantial expansion plans for Song. That was delayed for a year. Then the CEO said, "Let's do it." He then started to implement the growth plan that I had left when I departed in early 2004, and then it got really difficult for Delta. Once you're in bankruptcy proceedings and you're dealing with judges and creditors' committees, you don't have a lot of leeway. I'm guessing that, ultimately, the complexity of trying to grow a sub-brand while managing a bankruptcy proceeding became too much. Q: There are complaints regarding your business application both from airline competitors and the AFL-CIO. How are you going to manage that? As it stands right now, you're not cleared for takeoff. A: That is very true and that is a big issue with us right now. I spent more than 18 months crafting the application and raising the equity, all the time understanding that foreign investment, in any country, gets high scrutiny. There is just something xenophobic about the aviation industry. It's kind of outdated, but it is that way. It's changing slowly. From a structural and business model, it's the most global industry in the world, with the most antiquated capital laws. Try to explain this to a rational person and you would never get there. We filed the most thorough application in the history of aviation, more than 1,000 pages, knowing that it would get great scrutiny. Under U.S. law, a foreign investor may invest as long as he or she has less than 50 percent of the capital, and in our case it's 49 percent and only 25 percent of the voting rights on the board. So Virgin is a minority investor with only 25 percent voting rights. Lo and behold, the only detractors are the legacy airlines who are shrinking while the new breed of airlines are growing. Something like 85 to 95 percent of all new aircraft ordered are coming from the new-generation carriers. The others are shrinking or simply not ordering aircraft. We expected a spirited response from the airlines which simply don't want to see us in the marketplace. They have foreign money -- the hedge funds that have kept these guys out of bankruptcy. I'm not suggesting there is anything illegal. US Airways had a big investment from British Airways a long time ago. Continental had a big investment from SAS back in the '80s. They had the SAS chairman on their board of directors. KLM was known to have rescued Northwest from oblivion in the early '90s. These guys don't have any moral or legal objection to foreign investment. They know the score. Most of them have profited from foreign investment. They've made objections that I believe do not hold water and it will be for the (Department of Transportation) to decide. These are opportunistic and, in my view, meritless complaints. Q: You also have some union opposition. A: It's not just the AFL-CIO. It's the Air Line Pilots Association, as well. I am really puzzled by this one. There have been significant complaints to members of Congress and the (Department of Transportation) that we are somehow not conforming with U.S. law or that we're anti-union. That really puzzles me. I have been at four airlines in 30 years. I have worked congenially and honorably with unions in this country and 15 countries overseas. I personally did union negotiations in Greece, Israel, India and Italy. The unions that serve aviation have lost dramatic numbers, well over 100,000 jobs in the last five years. I am here to create a new airline that is going to have a very minimum of 3,000 direct jobs in the next couple of years. And every time you put an airline job in this country, you create 12 other jobs, like maintenance support, ramp agent and caterers. I am actually launching a company that is going to create 3,000 direct jobs and more than 36,000 indirect jobs in aviation. That's message No. 1. Message No. 2, the Railway Labor Act puts a lot of power in the hands of the employees to elect to be unionized or not. This is an employee decision, not what I think. Therefore, I'm really kind of disturbed and puzzled as to why labor wants to stop a company that is doing what they want and what the state of California wants, and that is job creation. This is truly a mixed-up message. I don't get it at all. Q: Well, JetBlue, of course, is successful, in part, because, according = to its own CEO, it's nonunion. Are you considering that model? A: I'm really open-minded. I worked at American, Pan Am, Delta and Lufthansa. Three out of the 4 airlines are almost totally unionized. One of them, Delta, is part unionized and part not unionized. In the history of aviation, there are a lot of toxic relationships betwe= en employees, leadership and unions. I would just say that it takes two to tango. Q: To what extent is Richard Branson involved with the airline? Do you call him? A: I see him mostly socially. He's always dreamt of seeing a Virgin-branded airline operating in the United States. But Richard is also very smart, and he understands that the only way to do that in the United States is through a trademark license, nothing more, nothing less than a trademark license that the U.S. investors contracted with the Virgin Group. So Richard is an idea guy. Richard is a creative guy. But he's not on the board. I saw him three times face to face last year, and spoke to him twice on the telephone. In total, five times. The conversation is usually like, "Well, how are things going?" I say, "Great." He says, "Are you ever going to get that airline started or not?" and I say, "One of these days," He says, "Do you need anything and are you comfortable?" I say, "I'm great." He does not get involved in the financials or the governance. Q: Do you work for him? A: No. I was hired by a management company called Virgin USA in April 2004. Virgin USA is a company that looks for new business opportunities for the Virgin Group. These opportunities may range from the wholly owned hotel to a minority position in the mobile space. So you could say ultimately I was hired by Richard. But when the company was capitalized on Nov. 22, 2005, we signed new employment agreements. I report to the board of directors, which has 75 percent voting rights. I report to a nonexecutive chairman that's a U.S. investor. Q: Do you need that brand? A: Yes, we do. We do need the brand. That is a big and important differentiating factor because Virgin stands for certain things in the eyes of consumers. It generally stands for low prices, great customer service, a company that tries to have a little fun, a company that is very professionally focused, but doesn't take itself seriously. The brand is crucial, but the brand will never work unless we do other things. Those other things are operating integrity, low sustainable cost structure, leveraging technology and providing good customer service. Q: I want to know a little bit about food. I want to know about the seat= s. I want to know about the type of plane you're going to use. I want to know about the routes, prices and what's the real timetable for getting started. A: I am very respectful of the rigors involved in airline certification. Whatever you want to say about the U.S. aviation industry, it's safe. The operating integrity and the oversight by (Department of Transportation) and FAA in this country is great. I was raised in Africa and I've lived in Asia twice, I lived in the Middle East. Aviation is much, much safer here than in many parts of the world. Having said that, the (Department of Transportation) did defer the answer period in which the deadline for objections was Dec. 29, and they have yet to reset the new deadline. My point is, "Guys, please get this thing back on track. Please do your due diligence. If there is anything wrong with our application, tell us what it is and we'll fix it, or challenge us and ask for additional documentation." If (it) was to approve this airline in the normal parameters, then there is no reason that we should not be operating by the back half of the third quarter of this year. Let's talk about food. We will have some free options, but we will also have food for sale, like Song did. Q: Are you going to try to be distinctive? A: I would like to be. I would like to have an upscale offering that's nutritional. I think we should also have the middle-of-the-road offering. Q: Why is airline food bad? A: It's not that they go out and purchase the sickest chickens around. What happens is the cost of getting it to the plane. You have to get it to a secure facility. You have to make sure that it gets on refrigerated trucks. The trucks have to be licensed and certified to drive around airports without banging into $65 million airplanes. We will have the latest generation of Recaro seats, Recaro being the famous German race car seat manufacturer who also makes airline seats. These are the latest economy seats available. They have very thin seat backs, 1.5 inches thick. Q: How much legroom? A: Thirty-two or more inches. Q: Are you going to have individual screens on the back of seats? A: We will. We'll have the largest screen of any U.S. domestic carrier. There will be screens at every single seat. We'll be two generations ahead in terms of what's available in both hardware and software: picture quality, the level of offering, the interactivity, games, music, live television, archived movies, a bunch of neat stuff. Q: Will passengers have to pay for that stuff? A: Some of it, yes. Just like JetBlue, you pay for the movies. The television will be free. Some of the games will be free and some won't. Q: What kind of aircraft will you be flying? A: A319s and A320s (Airbus). The latest models fresh off the factory lin= e. We have committed to 35 firm orders. We have options for 75 more. As to routes, we're still working on the final route plan. Any airline starts small with a handful of aircraft and then adds one or two a month as they grow. We will start with long-haul point-to-point service between major metropolitan cities on the Eastern and West Coast seaboards. The only specific one we have published is the inaugural flight between San Francisco and New York. Q: JFK? A: Yes. We haven't obtained slots yet, but we think it will be JFK. Q: What will your fare structure look like? A: We won't have 17 fares for any given city fare. We will have a simplified fare structure that is easy to understand. We will have a handful of price points, probably four or five. There's an advance purchase, then there's a sale fare, then there's an unrestricted which is a so-called walk-up fare. We will probably have a price cap in which you know that you will never pay more than blah blah blah. Some airlines don't give you your seat assignment until you pay for your seat. The dilemma with those airlines is you pay, and you don't know if you're going to get aisle, window or middle, then it spits out your seat assignment. If you don't like it, then you can change your booking -- and then you get a change fee. That is kind of unfriendly. We will avoid that kind of stuff. Q: I wanted to ask you about your choice of San Francisco as your headquarters. How do you square choosing one of the most expensive cities to do business in North America with your commitment to keeping costs low? A: We are here for a number of reasons. Taking a metric that's very popular in the airline business called local-originating revenue, depending upon what year you are talking about, the San Francisco Bay Area has either been No. 1, No. 2, No. 3 or No. 4 in the entire United States in volume of originating revenue. When you put a good product in New York, Los Angeles, Chicago or San Francisco, your chances are pretty good that you're going to get a decent amount of revenue. That's No. 1 Point No. 2 is I find it shocking that California, with its huge economy, and San Francisco, with its vibrancy and the originating revenue that I just talked about, doesn't have a hometown carrier. We want to change that. Thirdly, I also happen to admire the can-do attitude. I think it's a very progressive area. People are somewhat flexible and want to do good things and I would say that the workforce here and the passenger demographic will resonate with the Virgin brand more than Laredo or Milwaukee or Atlanta or Florida. Q: What kind of incentives did you receive? A: We didn't get anything that you didn't know about. Q: How much of a factor was that in selecting San Francisco as a spot? A: We did a very formal grid: Access to a hanger, access to workforce, access to passengers, room to grow in the airport, incentives yes or no, if so, how much. There was availability of talented people. There was availability of highly-trained flight crews and of licensed mechanics. We did a very, very rigorous contest and Boston, Washington, D.C., New York and San Francisco were the four finalists. San Francisco won. The incentives were probably 12 to 15 percent of the weight. Q: Speaking of low prices, in order to keep those fares down, you have to keep your cost structure down. Fuel costs are really high. How are going to deal with that? Are you going to be able to hedge some of your buying, a la Southwest? A: We'll probably have to get up to a certain critical mass of buying volume before we consider hedging. Fuel prices are an equal opportunity nuisance. It really messes up the profitability of all airlines. Those airlines that have good service, good customer ratings, young aircraft and low cost structure will be relatively better off. Even if prices increase three times a year for the next five years, air travel will be a bargain. Q: How long can you wait for the (Department of Transportation) to make a decision? A: There is no fixed timetable. The (Department of Transportation) has never shot down a sound application. They've shot down a handful of applications over the years. Minor things like the phones didn't work or the pilots weren't trained or there was no capital or no board. There is no good reason that I can think of (it) will not process our application in a fair and timely manner. Q: Do you have any reason to think that there are any political machinations behind the delay? A: I really don't know for sure. Q: Do you suspect there might be? A: It's theoretically possible. I would hope not because I don't think politics has a role to play in company formations, in any industry. Briefcase Name: Fred Reid Company: Virgin America Position: Chief executive officer Age: 55 Education: Bachelor's degree in South Asian Studies, UC Berkeley, 1973 Work experience: president and chief operating officer, Delta Air Lines; president and chief operating officer, Lufthansa ON U.S. ATTITUDES TOWARD FOREIGN INVESTMENT: =93There is just something xenophobic about the airline industry. It=92s outdated, but it=92s that way= .=92=92 ON THE VIRGIN BRAND: =93Virgin stands for low prices, great customer service, a company that tries to have a little fun.=92=92 ON CHOOSING SAN FRANCISCO FOR HEADQUARTERS: =93The workforce here and passenger demographics resonate more than in Laredo.=92=92 Beyond the boardroom What are your favorite hobbies? Reading and all-too-infrequent surfing/snowboarding, with a bit of yoga to keep me able to do the above. What are you reading? High-quality Anglo-Saxon literature, books short-listed for the Mann Prize and the Booker Prize. What's your idea of a perfect vacation? Eight hours of sleep. Briefcase Name: Fred Reid Company: Virgin America Position: Chief executive officer Age: 55 Education: Bachelor's degree in South Asian Studies, UC Berkeley, 1973 Work experience: president and chief operating officer, Delta Air Lines; president and chief operating officer, Lufthansa Participating in this interview were Business Editor Ken Howe; Deputy Business Editor Al Saracevic; assistant business editors Sam Zuckerman and David Tong; staff writers David Armstrong, George Raine and Thomas Frostberg; and editorial assistant Steve Corder. --------------------------= -------------------------------------------- Copyright 2006 SF Chronicle