AO: United Paper Shuffle

From the cutting room floor, as it were, AO’s got an excerpt so exclusive that it didn’t even make it into Andy Kessler’s latest book, Running Money, about the paper shuffle that transformed the airline business and Wall Street itself.

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    “You can’t wear jeans,” the woman at the United Airlines counter told me.
    “What was that?” I asked.
    “I’m sorry, we have rules and codes of conduct to adhere to. I can’t let you sit in First Class wearing jeans.”
    “Really?” I had a cheap suit in my bag, but the last thing I wanted to do was dash into some phone booth and change into super executive so I could fly to Chicago.
    “We can’t have some sort of riff-raff in our premium sections.”
    “Well, I’m headed to a…”
    “This is United Airlines, global leaders in air travel and destinations.”
    “I’m interv…”
    “Just a second. Your record is flashing red. This is very odd. Are you some sort of VIP?”

“I like to think so, but I don’t think too many beyond my mother would agree.”

“Well someone at United Airlines thinks so. Your record has been flagged and the ticket comped. I don’t think I’ve ever seen one like this. Family members get comped, but something is going on here with your record. Here you go, seat 2B. Or is that not to be, teehee. Enjoy your flight.” She then whispered, “Next time, please don’t wear jeans, we have standards here.”

“OK, got it,” I whispered back.

“And welcome to the Friendly Skies,” she shot back.

Actually, I was headed to a job interview at United Airlines outside of Chicago. I was a 26 year old techie and could not have cared less about United. But they were nice enough to provide a round trip first class ticket to Chicago, where my girl friend Nancy happened to live, and I was tired of paying up for the 771 mile trip.

On board, I sat next to a pilot who told me he was jealous that I got to wear jeans in First Class. I saved the “I’m interviewing” line just in case he started harassing me, but he couldn’t have been a nicer guy.

Chicago, Illinois – Spring 1985

“Hello, welcome to United Airlines. Thanks for coming out all this way. I’m sure you have a very busy schedule, I appreciate your time.”
“Not a problem, I have been looking forward to this visit to Chicago.”

“Great. Oh, I should introduce myself. I’m Norm Poole. I haven’t been here that long, six months or so. I was hired with the task of updating United’s computer systems. It’s pretty antiquated stuff around here. You’re from Bell Labs, right?”

“Yes, Holmdel.”

“Great. I saw that on your resume, that’s why you’re here. Actually, my son is also with the Labs, out here at Indian Hill.”

“I doubt I know him, it’s a big place.”

“OK then, let’s head back to my office. It’s a bit of a hike. They don’t care too much for us tech types.”

Norm and I proceeded to walk what seemed like a quarter mile through United’s building.

“You know that United is building a new terminal at O’Hare?”

“I think I read something about that.”

“Yeah, it is loosely based on the Great Crystal Palace of Victorian England fame, 1850 something.”

“In what way?” I asked.

“As far as I can tell, lots of glass.”

“I like watching the planes take off and land.”

“Most people do, calms the nerves. Actually, the Crystal Palace was part of the Great Exhibition that showed off all the accomplishments of England and its colonies. So the powers that be around here want the new terminal to be as high tech as possible, to show off their constant path towards progress, a ‘Now is the Time’ sort of thing.”

“Isn’t that the tag line of the GE Carousel of Progress at Disneyland?”

“Probably. Wasn’t it the World’s Fair? No matter. We’ll show off our advanced thinking.”

“How is that?” I asked.

“Lots of computer monitors, maybe even in color. Plus, we have to figure out some scheme to move data around without wires. The architect has already placed all the glass and forgot we might need wires. Wires are pretty ugly, so my group has to fix the design flaws with some wireless technology.”

We wound our way through the building talking about computers and networking. I realize later that the interview had already started, but I was too busy talking in the sights.

“So, you know a lot about the UNIX operating system?” Norm asked.

“Sure, I use it, and I can program in C.” I answered.

“Great. That’s what we use around here.”

We kept cutting through these large rooms with giant tables in the middle of them.

“Personally, I prefer VAXes. UNIX machines are always crashing.”

“OK, Andy. This is an airline. There is an unwritten rule to not use that word.”

“Which word.”

“The C-word.”

“Oh, I get it, sorry. I find that UNIX machines are, …, are prone to unscheduled service disruptions.”

“There you go. You’ll fit in here well.”

As we walked through more of these rooms, I kept noticing what looked like airline tickets stacked in foot high piles all over these massive tables. Workers, almost exclusively women but of all ages, were gabbing away while flipping through these piles of tickets. It seemed like United Airlines Global Headquarters had dozens of these rooms, with stacks and stacks and stacks of these tickets.
“Can I ask you something?” I asked.

“Sure, fire away?” Norm answered.

“What’s with those giant tables and all those women?”

Norm started to chuckle. “Oh that? Ticket sorting. It’s sort of the dirty little secret of the airline business. We can get people on and off planes, and fly them to where they need to go, but then we have to sort all their damn tickets.”

“Don’t you just throw them out after the flight takes off?” There were no depths to my personal naiveté.

“We wish. Every single ticket is flown back to headquarters to be processed. First we have to strip out our competitors tickets, which we accept for payment, and then settle with them.”

“Aren’t they a different color or something.”

“That would make it too easy, but not a bad idea. Once their tickets are gone, we have to sort our own tickets and match them against the flight manifests to make sure everyone actually paid, measure yield and load and all those other things that schedulers like to know about.”

“Wow, sounds like a really boring job.”

“I’m sure it is. Most of these people are high school grads, and maybe a few dropouts. You don’t have to be a rocket scientist to sort tickets, but you’ve got to be literate.”

“But this is 1985. Shouldn’t this stuff be automated somehow?”

“You’re kidding right? There is a room full of PhDs who sit around and figure out just how to code those stupid tickets, so when we get them back, we know where they came from. Each ticket is touched something like fifteen times from the time we collect it at the airport until we are done with our sorting and accounting.”

“But isn’t it expensive?”

“Probably $20 bucks per ticket. I’ve only been here for six months, but as far as I can tell, the airline industry is not that concerned about costs. First, they, er, we can just raise prices, you pay the $20, not us. Second, if we took one olive out of each salad we serve on every flight, we could save a half a million bucks a year. Sorting tickets is a necessary evil.”

“Still…”

“I know, I know. I agree. If I were in charge, that is the first thing I would attack. Get rid of the stupid tickets. But my priority, my mandate is to make the Crystal Palace at O’Hare seem high tech.”

We walked through four or five more of these rooms, and I started thinking hitting rocks with a sledgehammer all day was more interesting than running an airline.

“OK, we’re finally here.”

Not me.

It wasn’t hard to solve United’s paper shuffle. In fact, the technology had been around for over a decade – the same stuff that saved Wall Street.

It was the modern computer that helped create the modern stock market. In fact, they grew up together. Wall Street provided the capital for the computer industry to create faster machines to handle Wall Street’s growing computing needs. Wall Street used to be a collection of people, but as computers permeated their way into every crack and crevice, it changed the business of raising and managing risk capital.

In 1949, punch cards, that Herman Hollerith invented to speed up the 1890 census, were finally used to record trades. Can you hear IBM salivating? In 1950, electronic computers started doing the sorting of trades, in 1961 magnetic tape stored data, in 1964 computers were used to clear certain trades by matching records. IBM computers were indispensable to Wall Street, and Wall Street bid their stock up to provide IBM as much capital as it needed to grow.
As volume and profits grew, more Wall Street partnerships were created to get in on the game. By the 1960’s, electronic message switchboards replaced those pneumatic tubes of 1918 so order entry and execution confirmation could happen in almost real time. Of course, this was to the advantage of the traders to be able to get the most current feel for the market; customers were still out of that loop. But the back office was neglected, stock certificates still had to be collected and distributed. Wall Street hit a wall in 1968 and for many it was fatal. Electronics facilitated trading but did nothing to help clearing and making sure buyers got certificates from the sellers.

As volume increased, by some 30% a year in both 1967 and 1968, the people intensive clearing process took forever. Certificates piled up to the ceiling tiles at brokerage firms, either awaiting payment or as errors and bad trades yet to be reconciled. Hiring more people barely helped. Firms would work 24 hours a day, 7 days a week and still fall behind. Customers simply stopped paying since they stopped getting their certificates. The NYSE began closing one day a week to catch up. They mandated a Central Certificate Service that created electronic certificates for a few stocks so settlement and clearing could happen without handling physical certificates. It was too little, too late. 160 NYSE member firms went belly up in 1969 and 1970, their credit squeezed as it took so long to process the volume of trades, victims of their own success. It was a big problem for those not tech savvy.

Small companies, who couldn’t afford the NYSE or didn’t have the size or pristine balance sheets needed to be listed, could have their stocks traded off-exchange, or OTC, over-the-counter. Until 1961, it was a pretty sleazy business, trading was thin, quotes were by appointment, spreads were at the whim of one or two traders. In 1961, the SEC empowered the National Association of Security Dealers or NASD to automate the trading of these OTC stocks. Pretty impressive for 1961. Of course, it took until 1971 for the first NASDAQ stock to trade as lots of new technology clearly needed to be invented.

But capital raising on Wall Street was typically for blue chips only. It merely required a handful of phone calls. “We are raising $200 million for a new line of yellow cheese for Kraft, how many shares can I write you down for?” Tech deals were almost impossible to sell that way. It’s not so much that investors wanted equal access, it’s that the only way they could be sold was to explain it face to face.

One neat one was waltzed around that made these strange devices named I2102’s, which were one kilobit of static memory made with a planar process, that were rapidly replacing core memory in IBM computers. This company also had a new “micro” processor used in some Japanese calculators. Yup, in 1971, Intel had a lot of explaining to do, the phone didn’t cut it, and so they had to visit institutional investors in their offices across the country to sell their Initial Public Offering. The IPO road show was thus invented by C.E. Unterberg Towbin to raise money for futuristic and hard to explain technology companies. Now all companies have to go through this grueling ritual. But Wall Street was all too happy to take these new companies out - IPO’s paid 7% fees, and still do.

In May 1973, a new entity took over the clearing process. The Depository Trust Company or DTC, with the help of IBM using cheaper Intel memory, quickly created a system of electronic record transfer of ownership, replacing the sorting tables. 16 million shares were trading every day, 4,729 different companies had their shares registered with the DTC, and the back office paper crunch soon ended. With an automated back office, liquidity went up and the risk of investing on Wall Street went down. This is a subtle and critical point, but lower risk on Wall Street meant more risk capital could be deployed in the economy and Silicon Valley started heading down the runway for takeoff.

For 25 more years, most traditional investors missed the big move in technology stocks, until they all rushed in the same day in January 1999. Hedge funds were too busy playing with currencies, especially a lucrative yen-carry trade that blew up in October 1998. Julian Robertson’s Tiger Fund had only one saving grace in 1999 - a huge position in US Air. It was a value stock, and Julian Robertson had bought it right. By May of 2000, United Airlines had made a $60 cash bid for US Scare-lines. Tiger was sitting pretty, and despite a tough year of withdrawals - $20 billion in assets dropped to about $6 billion. But with the airline merger, Tiger showed a gain for 1999.

But, Julian Robertson joined a long line of old dogs chasing fire hydrants. Once deregulated, airlines were protected by the complexity of their back office. Anyone could refuel and fly a plane, but it took a special organization to sort the paper tickets. In fact, like United, you could buy other airlines and sort their tickets too, saving zillions.

But when technology ended the paper trail and e-tickets came of age, it wasn’t the existing airlines that benefited. New players like Southwest and JetBlue could enter the business cheaply. A couple of million bucks in servers and broadband was all the back office they needed – the sorting tables were a thing of the past. It was like taking candy from a baby for these new guys to take market share from unionized United or US Air with their Vietnam era pilots and aging battle-ax flight attendants.

Withdrawals were relentless, so Julian Robertson closed Tiger in March of 2000, holding onto a few shares he thought would do well, like US Air. Oopsy - US Airline filed for bankruptcy in August of 2002, it’s stock a children’s shoe size of 2 or 3 compared to the mature $60 United offered and withdrew. He should have paid attention to those folks in Silicon Valley.

JFK – Winter 2003

The Van Wyck was backed up, as usual. I hated the trip out of Manhattan to JFK, except I was headed back to SFO. I was running late, it was raining, I was lucky to even get a cab at all, and now I’m crawling down what should never have been named an Expressway. Most cabbies know how to cut through the borough by taking Woodhaven Boulevard. My grandmother used to live somewhere along it, near Cross Bay Boulevard, but I would lose at Queens Monopoly.
We finally hit JFK, and I threw $50 to the driver and ran out to check in. I think I had just enough time to get frisked by airport security, buy a NY Post, and get on the plane. I just hope there was no line at check in. I always got stuck behind some family headed to Moomba via Dallas and Frankfurt.

But just inside the door, instead of a line, there were five kiosks. Nice touch screen displays lined up in a row with United’s logo blinking away. This I had never seen before. It prompted for my United Mileage Plus card, which I kept handy for upgrades to First Class. I swiped away and my reservation instantly popped up.

“Do you need any help?”

“Excuse me?”

A nice middle-aged woman with a Queens accent smiled. “I just wanted to know if you needed any help with these machines.”

“No, I’ve got it figured out.” I had read somewhere that with these kiosks, United dropped the cost of ticket handling from $20 to under $1.

“Well, don’t figure it out too well. Some of us need the work.” She smiled again, but I could tell she would just have soon picked up a nearby fire extinguisher and smashed all five kiosks in a heartbeat.

“I understand.” I nodded. It had been not quite twenty years since I was a stowaway in United First Class under the pretext of an interview, and saw the groaning tables in Chicago.

“Well, welcome to the Friendly Skies.”

She smiled again and didn’t give me any grief about wearing jeans.