On Thursday, Southwest Airlines (NYSE:LUV) announced that it had reached an agreement in principle with union negotiators for a new pilot contract. If the agreement is approved, it would mark a big step forward toward labor peace at a company renowned for strong management-labor relations.
That's a big "if," though. Even when airlines have struck tentative agreements with union negotiators, the terms have often been rejected by the rank-and-file membership recently. However, a successful ratification would have big implications for pilot pay across the industry, as a growing pilot shortage means that airlines need to offer competitive pay to attract talent.
Big profits driving labor unrest
2014 was a great year for airlines in the U.S., as consolidation began to have a meaningful positive impact on industry profitability. So far, 2015 has been even better, as oil prices have tumbled, creating a windfall worth billions of dollars annually for the biggest airlines.
This rapid increase in airline profitability has coincided with rising labor tensions. This probably isn't a coincidence. Across the industry, many labor unions are looking for airlines to share the wealth through big raises and work rule improvements.
For example, Delta Air Lines (NYSE:DAL) offered its pilots a seemingly generous 8% immediate raise and 6% raise in 2016 (followed by 3% raises in 2017 and 2018) earlier this summer. However, while Delta and the union agreed on the contract terms, a large majority of Delta Air Lines' pilots voted against ratifying the agreement. They were mainly opposed to concessions on profit sharing that were included in the contract.
While pilots have the most bargaining leverage of any employee group, they haven't been the only ones holding out for bigger raises. In July, a stunning 87% of Southwest Airlines flight attendants who voted on a tentative agreement that would have raised their pay rejected it. Southwest's flight attendants already had industry-leading pay, but they apparently think they can do even better.
The new deal could be a tough sell
While Southwest's pilots have a history of cooperative relations with management, this labor peace has deteriorated recently. The company has been in negotiations with the pilot union for three years at this point. While airline union contracts never expire, the current contract began in September 2006 and became amendable after August 31, 2012.
The pilots even activated a "strike preparedness committee" in May in order to plan for a potential strike if talks with management broke down. (However, under the Railway Labor Act, the union would need to be officially released from negotiations by the National Mediation Board for a strike to be legal.)
Given this evident frustration among the pilots, the tentative agreement will need to deliver big increases in pay and improved work rules to have a realistic shot at ratification.
Pilots at legacy carriers like Delta Air Lines have opportunities for advancement to high-paying widebody captain positions that don't exist at Southwest. As a result, Southwest likely needs to offer much higher pay than what 737 pilots at other airlines receive in order to convince its pilots to ratify the agreement.
Setting a new bar
It's hard to handicap the odds of Southwest's pilots voting in favor of the tentative agreement. Both the airline and the union have been keeping the terms confidential. And recent history shows that just because an airline union negotiating committee approves a contract offer does not mean that the rank-and-file members will ratify it.
On the flip side, this means that if the deal goes through, it will set a new bar for airline pilot contracts. Most immediately, the Delta pilot contract becomes amendable at the end of this year. It already looks like Delta will have to spend more than it hoped for after pilots rejected the first tentative agreement. A lucrative pilot contract at Southwest would add to the pressure on Delta.
For now, we just have to wait to see the key terms of the new proposal and whether this is the long awaited breakthrough that secures the approval of rank-and-file pilots.
Adam Levine-Weinberg is long January 2017 $40 calls on Delta Air Lines, The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.