British Airways: Cabin Pressure

No one could accuse Willie Walsh of being downbeat in the face of adversity. "Being the CEO is great," says the boss of British Airways with a chuckle. "You get all the credit. And you get to blame other people when things go wrong." He's joking. He has to be, for if he lived by this credo, he'd have been pointing his finger nonstop in recent months.

A squabble with cabin crew employees in January over pay and working conditions triggered flight cancellations that set BA back $150 million. Last month, a report by the Association of European Airlines placed the firm near the bottom of the region's carriers for punctuality. In a ranking of lost luggage, BA performed worse than any other airline that provided data, losing 75% more bags than Air France or Lufthansa (archrival Virgin Atlantic did not participate). Even worse, Britain's Office of Fair Trading (OFT) and the U.S. Department of Justice fined BA more than $500 million in August after determining that it had colluded with rivals to fix prices. Two former BA execs, commercial director Martin George and communications chief Iain Burns, resigned last year in connection with the affair; and criminal investigations into the collusion are continuing on both sides of the Atlantic. All this just as access to the transatlantic market out of Heathrow airport — currently restricted to BA and a few other carriers — is about to be blown wide open.

But don't confuse this with a crisis. Really. These ignominies, significant though they may be, risk overshadowing the real progress that the 45-year-old Dubliner has made at BA since taking over in 2005 as its youngest-ever boss. Adjusting to the scale of the challenge of running Europe's third-largest airline after four years as boss of Irish carrier Aer Lingus "was easy," says Walsh. "I just multiplied everything by 10." Not all of BA's bigger numbers meant better. When he arrived, the company's pension fund was short of almost $3 billion, more than the shortfall at any other major British firm. And payroll for BA's 46,000 staff sucked up a bloated 30% of its costs.

Fired up by the math, Walsh (a former Aer Lingus pilot who landed the top job there in 2001) quickly got to work cutting the figures down to size. On his first Monday in the BA job, he set about reaching a deal with trade unions to rub out the pension deficit over the next decade through one-off cash injections and changes to employee benefits. Two months later, "Slasher" — as Walsh was known at the Irish carrier for culling a third of its staff while rescuing it from the brink — went to work on BA's head count. Hundreds of senior managers got the boot. Soon afterward, he unveiled a blueprint for shrinking BA's costs by close to $1 billion, partly through further job cuts. With fewer bills to pay, BA looks set to hit its target operating margin of 10% next year, its highest ever. With its debts reduced, credit agencies have raised the company's rating to investment grade after it tumbled in the wake of 9/11.

The price-fixing penalties wiped at least some of the gloss off all that. According to the OFT, scheming with rival Virgin over the level of fuel surcharges started months before Walsh took control of BA. As soon as the OFT informed BA in mid-2006 that it was investigating the company, the airline cooperated with the authority's investigations. (Virgin, whose legal team first contacted the OFT about the scheming once it got wind of it, should escape any fine as a result.) Still, it's hardly reassuring that staff at BA thought it a smart idea to collude with its fiercest rival. Is there a problem with values at the carrier? "That wasn't anything that was in the dna" of the company, says Walsh. "I've stressed this significantly at every opportunity internally: we're not going to tolerate that sort of behavior."

Dealings with the trade unions are less clear-cut. Settling the dust-up with the Transport and General Workers' Union (T&G) early in the year at least averted the even bigger losses that a cabin crew walkout would have triggered. But the ugly dispute left both parties admitting that "a fresh start is needed to the relationship," BA said in a statement issued at the time. That will take a while. The roots of January's squabble over pay levels were buried in agreements drawn up in the '90s, years before Walsh arrived. He acknowledges: "You don't change the way you do business with long-established trade-union relationships overnight."

There are signs, though, that change is under way. While his predecessors kept union negotiations at arm's length, union leaders say, Walsh's direct involvement helped speed up a resolution. With Walsh and his union counterpart sequestered in a London hotel, says Brendan Gold, T&G's national secretary for civil air transport, "serious negotiations were done." Ahead of BA's move next year into the new $8.5 billion Heathrow Terminal 5, the airline persuaded thousands of ground staff to agree to change their practices. So, while an aircraft tug driver used to leave work before the end of his shift if he had completed his list of tasks, staff at the new terminal will return to their base after each individual job before being assigned another. Such deals, Walsh says, are "evidence of securing agreement without hassle, without friction."

The opening of T5, as the new terminal is known, should also help tackle another of BA's weaknesses: its much-criticized hub. "BA has a fundamental challenge none of its European peers suffer from," says Chris Avery, an airline analyst at JPMorgan in London. "Heathrow is stretched to its limits." Conceived for 45 million passengers a year, it now sees almost 70 million annually endure its crowded terminals and snaking lines. Airlines wait longer for gates to clear, and creaking baggage-handling equipment is prone to breakdowns. Though it can't ease runway congestion — Heathrow's "Achilles heel," says Avery — T5 can make BA look better. Currently split between two of Heathrow's outdated terminals, BA will house virtually all its operations under one roof as soon as March.

Things won't stay quiet for long, though. For all the challenges of the past couple of years, BA is perhaps yet to face its biggest test of the Walsh era. The airline's shares have plunged by almost a third since February, owing partly to worries that liberalization of the transatlantic market next year will cut into its profits. Under current rules, only BA, Virgin and the U.S. carriers American Airlines and United Airlines can fly to and from the U.S. via Heathrow. For BA, that restricted access has been a gold mine. With the industry in meltdown in the wake of 9/11, BA "rightly used the cartel of Heathrow to the U.S. to generate a large proportion of recovery in profits," says Nick van den Brul, an airline analyst at BNP Paribas in London.

But under the Open Skies agreement drawn up by Washington and Brussels, from early next year any E.U. airline will finally have the right to fly to any city in the U.S., and vice versa. With U.S. rivals Delta and Continental expected to start operating flights out of Heathrow next year, "BA's business-class fare is going to be under considerable pressure," says JPMorgan's Avery.

Walsh will have to push hard for growth in other markets to compensate for this hit. From next summer, BA plans to launch a new service between the U.S. and major business centers in Continental Europe, flying reconfigured 757s from its existing fleet. While he is guarded about the fine details, "getting a new airline up and running in a little over 12 months," as Walsh sees it, "is a great test of how quickly we can respond." And if things take off, he's even promising to share the acclaim.