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Richard Anderson’s Flight Plan for Delta

In his nine years as CEO of Delta Air Lines, Richard Anderson has turned the traditional airline business model on its head by focusing on scale, scope and service.

Richard Anderson never intended to be a CEO. A self-described nonconformist, Anderson began his career as a prosecutor in Harris County, Texas, before a chance conversation with a neighbor in 1987 turned into a new job as a lawyer at Houston-based Continental Airlines. In 1990, he moved to Northwest Airlines in Minnesota, where he began an ascent that culminated in three years as CEO. In 2004, he decamped for UnitedHealth Group, spending three years as an executive at the insurer until Delta Air Lines offered him the top job in 2007.

“I think a lot of how you get formed is serendipitous, in the sense that you don’t always know what you’re going to be doing next in this life,” says Anderson, 59, who has a JD from the South Texas College of Law. “I don’t have a business degree, and I never took an accounting course or a business course in college. I thought I was going to be a criminal trial lawyer.”

At the moment he moved into the corner office, Delta was in dire need of a new flight plan. The company had just emerged from Chapter 11 bankruptcy, and along with its peers was facing seemingly insurmountable headwinds: Fuel prices were rising, but the industry was fiercely competitive in its pricing; labor strikes loomed; and debt was mounting. In the face of all of it, Anderson decided the best course would be to dispense with the sector’s well-worn routes out of its problems.

His top goals included building out Delta’s network. In 2008 the company merged with Northwest Airlines, creating what was at the time the largest commercial airline in the world — and setting an example that the remaining U.S. airlines would soon follow.

As part of his efforts to create scale, Anderson has sought international partnerships and equity stakes, which have allowed for a profitable global expansion in spite of prohibitions to foreign ownership of airlines. In June 2013, the company completed a $360 million purchase of a 49 percent stake in U.K.-based Virgin Atlantic Airways. A joint venture with Société Air France and the Netherlands’ KLM Royal Dutch Airlines has given Atlanta-based Delta hubs in Paris and Amsterdam. The company is also developing relationships with Brazil’s Gol Linhas Aéreas Inteligentes, Mexico’s Aeromexico and several carriers in Asia, including China Eastern Airlines Corp. and Korean Air Lines Co.

Anderson raised eyebrows in 2012 when he announced Delta would be entering the oil business with the purchase of a Phillips 66 refinery in Trainer, Pennsylvania. He argued that the acquisition would help the airline to control volatile jet fuel costs — the carrier’s biggest expense — and he’s now roundly cheered for the move. Over the past four quarters, Delta has made $220 million in profits on the refinery, $70 million more than the company paid for it.

“In the past you had managers at Delta and elsewhere that allowed their passion for flying to influence their capital stewardship; Richard is cut from a different mold,” says J.P. Morgan senior analyst Jamie Baker, the No. 1 Airlines analyst on the All-America Research Team for seven straight years. “He isn’t emotionally attached to airlining. This isn’t just about running the best airline for Richard and his team; it’s about running the best possible transport company that just so happens to be an airline.”

Under Anderson, Delta has shrunk its net debt by $10 billion, to $7.4 billion in March 2015 — with plans to push it down to $4 billion by 2017. Delta received three credit upgrades from Standard & Poor’s from May 2013 to October 2014 and now sits two notches away from investment grade. Delta, whose share price is up nearly 400 percent since August 2012, rejoined the S&P 500 in September 2013 after being removed from the index in 2005 just ahead of its bankruptcy filing.

J.P. Morgan’s Baker says he’s starting to get calls about Delta from new types of investors: those who have long steered clear of the notoriously cyclical and high-risk airline industry. And he’s telling them that now’s the time to buy, given that he believes Delta’s valuation doesn’t yet reflect how far it’s come. “If you believe that markets are ultimately efficient,” he says, “then the market will come to realize that the new Delta can’t merely be valued the way the old Delta for decades was.”

Institutional Investor Contributor Katie Gilbert recently spoke with Anderson about why a broken airline model hung on for so long, how he plans to keep growing Delta and what goes into the making of a nonconformist CEO.

Institutional Investor: You’ve said that your goal upon becoming CEO of Delta was nothing less than a rethinking of the entire airline business model. What had to change, and why had a dysfunctional model held on for so long?

Anderson: Many of the business practices at the airline were rooted in a regulated era. We needed to move our decision-making, our culture and even our management team to act and think and perform like a high-quality S&P industrial company.

We knew we needed to consolidate. We needed to have inorganic growth and build out a network much the same way you’d build out a railroad network or a cell-phone network or a trucking network. Airlines are network businesses with high capital costs, and they very much need economies of scope and scale. We had to move the business model from being a commodity-focused model to a high-quality product model. That would require both an investment and a very different way of thinking about providing the services we provide to our customers.

We had to move away from a debt-financed model to an equity-financed model. The industry historically had piled on far too much debt, and high-quality S&P industrial companies typically are investment grade. By the end of this year we’ll be operating on investment-grade credit metrics.

I believe the other big mistake that airlines historically had made was to treat their employees as commodities. This is a very complicated business that requires dedicated, professional, highly trained workforces throughout the enterprise. And we really wanted to put our employees first and be certain that we had all of the what I’ll call hard benefits, like wages, benefits and profit-sharing, but also the soft benefits of being a top employer.

Why have you pursued as many joint ventures as you have while steering Delta?

First of all, there are prohibitions and other legal hurdles to foreign ownership of airlines around the world. That’s one.

Second, think about a partnership like the Aeromexico partnership, which is the most recent Open Skies Agreement that Delta has played an important role in obtaining for the U.S. government: Aeromexico has the No. 1 franchise in the largest trading partner of the U.S. in North America. No other carrier can replicate what Aeromexico has in terms of the broad and deep network and the brand and the high-quality network that it provides. That cannot be replicated, and it cannot be replicated by a non-Mexican carrier for a whole lot of political and regulatory reasons, to say nothing of the fact that you’d have a late mover disadvantage. With the joint venture and equity investment in Aeromexico, we can participate in the domestic Mexican network business of Aeromexico, and Aeromexico can participate in our domestic network business through joint ventures, code share, joint distribution, joint sale agreements and joint operating agreements.

Where do you see opportunities for expansion today?

We’ve made Latin America a focus. It has close geography to the U.S., and the economies down there are burgeoning, generally speaking. We believe that developing joint ventures in Latin America will be an important source of growth.

Second, we’re continuing to build our hub in London with Virgin Atlantic. We purchased 49 percent of Virgin Atlantic, which is the top-rated brand across the transatlantic, in conjunction with its strong network in London Heathrow. This is an important development, because Delta did not even serve London Heathrow Airport until 2009; because of a bilateral treaty with the U.S., we were legally prohibited from flying our airplanes to London Heathrow. Now we have the No. 2 position and we operate a hub there in the most important transatlantic market for U.S. and British carriers.

Next is China. We have a deep partnership with China Eastern, the Chinese hubbing airline in Shanghai. We have a long-term vision with them to develop a hub in Shanghai. China Eastern will, of course, do all of the domestic flying from the Shanghai hub, and we will jointly share the long haul transpacific flying to the U.S. We are also developing Seattle. It’s our newest hub. We’re continuing to very profitably build it into a major U.S. gateway to Asia.

Why is increased customer segmentation so important for Delta?

The challenge we’ve had in the airline business is that unlike, for instance, the hotel business, where a hotel operator can have a low-end leisure product and a high-end midtown hotel and the half-a-dozen different brands at different price points in their hotel portfolio, we have to do all of that on the same airplane. So what we’re doing is segmenting on our airplanes.

We have four products that we’re developing on our network: one is basic economy, which is going to be priced competitively with the deep discount carriers and give a very basic product on the airplane. The second would be our main cabin with traditional economy service. Third is our Delta Comfort Plus, which is a bigger cabin with more space. And then we have first class on domestic routes and Delta One on transcontinental and international routes for premium travelers.

We’re really in the early stages of this. Much of it is enabled by technology, and our ability to drive information to the customer. There may be an initial purchase point, but along the way, we want to give the consumer control in managing their travel. That includes being able to purchase different products and different attributes, whether it’s a movie on the airplane or deciding to buy a seat assignment at the last minute.

In the old era of regulation, the government determined all rates, routes and services, and there were only two ticket prices on every flight: coach and first class. Now consumers want a lot more choice.

You’ve recently exchanged heated words with the heads of competing airlines in the Middle East about the sizable government subsidies they receive. Is this still a major concern for you?

Yes. It is a concern for American, United and Delta. We have a strong coalition. At the outset, let me note that all three of these airlines are huge supporters of Open Skies agreements. We’ve been the beneficiaries of 114 such agreements. But our Open Skies agreements have very clear provisions about requiring carriers that sign them to let the marketplace work without subsidies. That’s the very clearly expressed stated policy of the U.S. government.

We have three carriers that are outliers in the United Arab Emirates and Qatar; they have received over $42 billion in subsidies. What we’re asking is just that the government takes steps to engage in consultations and figure out reasonable steps to level that playing field. We certainly respect the right of Qatar, Etihad and Emirates airlines to operate to the U.S., but at the same time, they need to comply with the Open Skies agreements that their country signed with the U.S. government. Airlines are unique in the following sense: Unlike most other industrial companies in the U.S. — though there are certainly exceptions in other industries — many of our competitors are not airlines; they’re governments. In this case, that’s what’s going on. If you look at the last statements from Emirates about their earnings and their future strategies, it was an interview by one of the members of the ruling party of the country who’s chairman of the airline. It would be similar to having President Obama making a statement about one of the U.S. airlines’ earnings and what their future network growth would be. That’s one of the differences that we face in our industry. And we compete against these state-owned enterprises quite successfully; we just have these two outlier treaties. 

In the last couple of years, Delta has adopted a number of sustainability measures, from more fuel-efficient jets to a recycling program to using biodiesel in trucks at your Detroit hub. How did these environmental considerations so recently make it onto the radar?

I just think every corporate organization has a responsibility toward sustainability. It makes good business sense and good social sense. Our employees want to be part of an organization that is socially responsible. So we’re very involved in helping establish the International Air Transport Association goal. We’re really the only industry in the world that has a global framework for the whole industry to improve fuel efficiency by an average of 1.5 percent per year from 2009 through 2020. We want to be a carbon neutral industry by 2020.

The reason it makes such great sense from a business standpoint is, remember about 30 percent of our costs are carbon costs. The more efficient we become, the better we are for the environment and the better we are for our shareholders.

You describe yourself as an unconventional CEO. How does this translate into the way you lead Delta?

I don’t really approach business in a conventional way. I don’t read a lot of the Wall Street sell side analyst reports, don’t play golf, don’t participate in the Business Council or those sorts of things. I kind of want to have a tabula rasa in the sense that I don’t want to be influenced unnecessarily by what is going on in a more conventional business approach.

A lot of CEOs are chairman, CEO and president; they get three titles. I really only have time for one. I believe in a split chairman and CEO. We also have a chief operating officer. When you think about people who are chairman, CEO, president and COO, that’s too much work. We have a very distributed model where we really want to delegate down through the organization and have this company run from the bottom up. •

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