2001: Why does Executive Jet do well while other airlines struggle?

AUDIENCE MEMBER: Good morning. I’m Martin Wiegand from Chevy Chase, Maryland.

WARREN BUFFETT: Good to have you here, Martin. (Laughs)

AUDIENCE MEMBER: Thank you. Thank you for the wonderful shareholder weekend, and thank you for the leadership and education you give your shareholders and the general public.

My question. Large airlines are in the news negotiating labor contracts. They claim they can’t pass along rising labor costs to their customers.

In the annual report, you say Executive Jet is growing fast and doing great. Executive Jet seems to be able to pass along its rising labor cost to its customers.

Is this because Executive Jet has a rational compensation plan that keeps employee salaries in line with billable services? If not, why does Executive Jet do well while the airlines experience troubles?

WARREN BUFFETT: Well, the big problem with the airlines is not so much what their aggregate payments will be. The real problem is when you’re in the airline business and your wage rates are out of line with your competitors.

When you get right down to it, the figure to look at with an airline — among a lot of other things — but you start with the cost per available seat mile. And then you work that through based on the capacity utilization to get to the revenue per — or the cost per — occupied seat mile.

And the — you could have labor costs or any other costs. You certainly have fuel costs up dramatically for the airlines from a couple of years ago.

As long as you’re more efficient than your competitor, and your costs are not higher than your competitor, people will continue to fly.

It’s when you get your costs out of line with your competitor, which was the situation that — where Charlie and I were directors of USAir a few years back — and our costs per seat mile were far higher than competitors.

And that was fine where we didn’t have competitors on some — many of the short routes in the East. But as the Southwest Airlines would move into our territory — and they had costs, we’ll say, of — and this is from memory — but they might have had costs below eight cents a seat mile. And our cost might have been 12 cents a seat mile.

You know, that is a — you’re going to get killed, eventually. They may not get to this route this year, but they’ll get there next year or the year after.

So if you’re running a big airline at Delta or United or whatever, if your costs are on parity or less — labor costs — than your other major competitors, that is much more important to you than the absolute level.

And the NetJets service is not really designed to be competitive with United Airlines or an American or something of that sort. It has a different group of competitors.

And I think we have a absolutely terrific pilot force there. And we want them to be happy. But there’s a lot of other ways. I mean, you want to pay them fairly. But with our pilots for example, it’s extremely important to them, in many cases, to be able to live where they want to and to work the kind of shifts that we can offer. So we attract them in many other ways than bidding against United Airlines or American Airlines.

Big thing in — you just can’t take labor costs that are materially higher than your competitor in a business that has commodity-like characteristics such as airline seats. You just can’t do it over time.

And you can get away with it for a while. But sooner or later, the nature of a capitalist society is that the guy with the lower cost comes in and kills you.

Charlie?

CHARLIE MUNGER: The airline unions are really tough. And it’s interesting to see a group of people that are paid as well as airline pilots with such a brutally tough union structure. That really makes it hard in a commodity-style business.

And no individual airline can take a long shutdown without having considerable effects on habit patterns and future prospects. It’s just a very tough business by its nature.

Passenger rail travel, even in a previous era, was a pretty tough way to make a buck. And nothing is all that different with the airline travel.

We hope that our services are preferred by customers more than one airline seat is preferred compared to another.

WARREN BUFFETT: Yes, fractional ownership is not a commodity business. I mean, the people care enormously about service and the assurance of safety. And I don’t think that, you know, I don’t think if you were buying a parachute you’d want to take the — necessarily take the low bid, and —

CHARLIE MUNGER: Yeah. (Laughter)

WARREN BUFFETT: Now with the big commercial airlines with millions and millions of passengers, people, I think probably correctly assume, that there’s quite a similarity in both service and safety.

But if you’re in a business that cannot take a long strike, you’re basically playing a game of chicken, you know, with your labor unions. Because they’re going to lose their jobs, too, if you close down. So you’re playing a game of chicken periodically.

And it has a lot — there’s a lot of game theory that gets involved.

To some extent, you know, the weaker you are, the better your bargaining position is. Because if you’re extremely weak, even a very short strike will put you out of business. And the people who are on the other side of the negotiating table understand that. Whereas, if you have a fair amount of strength, they can push you harder.

But it is of — it is no fun being in a business where you cannot take a strike. We faced that one time back in the early ’80s when there were — we were in kind of a death struggle in Buffalo with The Courier-Express.

And when I bought The Buffalo News — actually Charlie did. He was stranded there during a snowstorm, and he got bored. So, he called me and said, “What should I do?” I said, “Well, you might as well buy the paper.” (Laughter)

And so we were in this struggle. And — but when we bought the Buffalo News, we had two questions of the management, and one of them I can’t tell you.

But the second one was, we wanted to meet with the key union leaders, and we wanted to tell them, “Lookit, if you ever strike us for any length of — significant length of time — we’re out of business.

“You know, you can make our investment valueless. So we really want to look you in the eye and see what kind of people you are before we write this check.” And we felt quite good about the people, and they were good people.

And we had one situation in 1981, or thereabouts, where a very, very small union, I think, less than 2 percent of our employees, struck over an issue that the other 10 or 11 unions really didn’t agree with them that much on.

But they struck, and the other unions observed the picket line, which you would expect them to do in a strongly pro-union town, such as Buffalo.

And I think, as I remember, they struck on a Monday. And I remember leaders of some of the other unions actually with tears in their eyes over this, because they could see it was going to put us out of business.

And frankly, I just took the position then, I said, “Lookit, if you come back in a day, I know we’re competitive. If you come back in a year, I know we will not be competitive.

“And if you’re smart enough to figure out where exactly the point is that you can push us to and still come back and we have a business and you have jobs, I said, you’re smarter than I am. So, you know, go home and figure it out.”

And they came back in on Thursday, and we became very competitive again. But they could’ve — I mean, it was out of my hands. I couldn’t make them work, and if they decided they were going to stay out long enough, we were not going to have a newspaper.

And that’s the kind of situation, occasionally, you find yourself in. And I would say the airline industry is a good example of people — where people find themselves in that position periodically.

Charlie, anything you want —

CHARLIE MUNGER: Well. The shareholders may be interested to know, vis-à-vis competitive advantages in our NetJets program, that the day that other charter plane crashed in Aspen, NetJets refused to fly into Aspen at all. People remember that kind of thing.

WARREN BUFFETT: Yeah.