VARIG S.A. (Viação Aérea Rio-Grandense) History

Address:

Rua 18 de Novembro #800
90240-040 Porto Alegre/R S
Brazil

Telephone: (051) 358-7063
Fax: (051) 358-7001

Website: www.varig.com.br

Public Company
Incorporated: 1927
Employees: 17,741
Sales: R $3.62 billion (1998)
Stock Exchanges: Sao Paulo Rio de Janeiro
Ticker Symbol: RG; VRG
NAIC: 481111 Scheduled Passenger Air Transportation

Company History:

An estimated 11 million passengers a year fly VARIG S.A. to 36 cities within Brazil and 32 cities abroad. Domestic and European routes each accounted for slightly less than 30 percent of passenger traffic; North American destinations accounted for about 17 percent. Asian and Latin American routes each accounted for about a sixth share. North American routes accounted for nearly 40 percent of cargo traffic, versus 32 percent for Europe.

Origins

VARIG was founded by a German immigrant, Otto Meyer, when he obtained a license to operate Brazil's first registered commercial aircraft, a nine-passenger Atlantico, in 1927. That same year, Meyer saw the need for administrative assistance. He hired a secretary, Ruben Berta, and later described his new employee as "an energetic young man of 19 who attached little importance to the salary I could afford ... I invited him to hang up his hat and coat and get the typewriter going."

Meyer and Berta worked together to develop the fledgling airline, headquartered at the time in Porto Alegre, a coastal town in southern Brazil. It was Berta who ultimately would exert the most influence on VARIG's future, with his vision of a company owned by its employees.

When Brazil joined the Allies of World War II in 1941, Meyer withdrew from the company and Berta assumed the presidency of VARIG. After the war, Berta restructured VARIG's ownership based on the message in a papal letter by progressive Roman Catholic Pope Louis XIII. (Brazil is the largest Catholic nation in the world, with more than 90 percent of its population belonging to the church.) Pope Louis XIII's Rerum Novarum (Of New Things) of May 15, 1891 called for a commitment to collective bargaining and fair pay on the part of employers while suggesting that workers would exert greater efforts for their employers if they held ownership interests. This dictum inspired Berta to develop a plan for mutual ownership of VARIG by its employees.

Postwar Employee Ownership

Berta established an employee foundation in 1945, with the approval of VARIG shareholders, to oversee conversion to shared ownership. The foundation (which was named for Berta after his death in 1966) reported in 1992 that approximately 80 percent of VARIG's stock was held by employees and less than 20 percent of its shares were traded on the open market.

In addition to acting as an umbrella foundation for VARIG and its subsidiaries, the Berta Foundation was the financial base for employee perquisites not generally available through government programs. Those include, but are not limited to, free medical and dental treatment, low interest loans, subsidized meals, and vacation retreats, primarily for the benefit of employees living in Brazil. Those working at overseas offices (there are 25 offices in North America alone) received medical, dental, and life insurance coverage from the Berta Foundation, along with a matched savings plan and a pension plan that began paying benefits to employees as early as age 55. Oversees workers also had the opportunity to use the foundation's services and facilities while in Brazil.

Erik de Carvalho, who succeeded Berta in 1966, was at VARIG's helm to oversee several of the company's acquisitions, beginning with an air charter company, Rotatur, in 1969. But it was not until the 1970s, with the acquisition of VARIG Agropecuaria, an agricultural enterprise that started in the State of Maranhao in 1973, that VARIG took its first step away from air transport. VARIG Agropecuaria consisted of a 45,000-acre complex devoted to raising poultry and livestock and to farming. The company also acquired the Tropical Hotel chain consisting of six properties, each located in or near Brazil resort areas. The five-star Manaus Tropical Hotel, for example, is located in Manaus, a city not only steeped in history, but natural beauty as well--the Rio Negro meets the Amazon River in Manaus.

Although VARIG has diversified through various nonairline acquisitions, it continues to dominate the Latin American airline industry. VARIG strengthened its South American operations with the addition of Cruzeiro do Sul Airlines in 1975 and Rio Sul Airlines, which operates only in southern Brazil. But VARIG's air ventures outside of South America have given it a stability not available to companies limited by government regulation to national air service. VARIG's most significant international connection was the establishment of services to the United States, which started with twice-a-week flights on VARIG's Super G Constellation planes from New York to Rio on August 2, 1955. Routes to Miami and Los Angeles were added in 1961, followed by routes to Chicago in 1990. The U.S. connection proved to be VARIG's ace-in-the-hole during Brazil's economic upheaval of the 1980s.

VARIG continued to expand operations in the early 1990s, adding Toronto to its list of destinations and establishing three Los Angeles/Japan flights. The company also flew to 12 European destinations, four African cities, two cities in Japan, and all of the principal cities of Latin America. In addition, no doubt responding to the strong Asian economy, VARIG planned to begin a Rio/Johannesburg/Bangkok/Hong Kong cargo route in January of 1993, giving VARIG coverage extending eastward from Tokyo to Hong Kong.

VARIG's growth included continuous upgrading of its equipment. The 1992 VARIG/Cruzeiro fleet included ten Boeing B-747s, ten DC-10--30s, ten B-767s, two McDonnell Douglas MD-11s, 41 Boeing B-737s, and 14 B-727s. Because the company was consistently able to meet or exceed the stringent safety guidelines of both the Deparmento Aeronatical Civil of Brazil and its U.S. counterpart, the Federal Aviation Administration, its fleet maintenance earned a reputation that was literally worth money. VARIG was awarded contracts to service Brazil's military aircraft at the company's industrial maintenance complex in the Rio de Janeiro International Airport.

In 1991 VARIG carried 6,519,255 passengers on its domestic and international routes and logged 16,402,000 passenger-kilometers. The figures, however, were lower than in previous years due to the effects of the Persian Gulf War, deregulation, and fluctuating economic conditions.

Those changes did not prevent VARIG from maintaining its status as the leading Latin American airline in kilometers flown, hours flown, cargo transportation, passenger-kilometers, route systems, and number of employees, but it did lead to a reorganization after the death of President Helio Smidt. When Rubel Thomas succeeded Smidt, he restructured the company's upper management with an eye toward more direct decision-making. He sought to increase competitiveness by streamlining costs while updating the air fleet--not a small feat, with a devalued currency and the need to buy aircraft from U.S. and European suppliers.

Deregulation in the 1980s

The impact of the Gulf War on VARIG was minimal compared with the combined effect of deregulation and economic factors. Inflation, which in Brazil has been as high as 1,500 percent a year, had a significant influence on the air carrier's strength in the late 1980s and early 1990s. World prices for major Brazilian exports such as sugar cane, rubber, coffee, and oranges fluctuated during this time period. These price changes, along with droughts and floods within the country during the 1980s, wreaked havoc on the Brazilian economy. The country attained the unenviable position of being one of the world's largest debtor nations. In addition, Rio de Janeiro was losing stature as a tourist destination because of high crime rates and the conspicuous problem of homeless children.

In 1986 the government mounted a stabilization campaign that hinged on changing its status from that of a mostly agricultural nation to a more industrialized economy. Among the recovery strategies instituted by President Fernando Collor de Mello was a plan to deregulate Brazil's airline industry, much the way President Ronald Reagan did in the United States in the 1980s.

In October of 1990, Brazilian trucking magnate Wagner Canhedo used US $43 million of his own money along with other financing to purchase Brazil's second largest airline, VASP, from the State of Sao Paulo. The transaction took place at the end of a three-year period in which Brazil's three major airlines--VARIG, VASP, and Transbrasil--posted a combined loss of US $1.5 billion. Canhedo planned to use VASP to challenge VARIG's domestic leadership. He quickly increased VASP's fleet by 50 percent.

VARIG President Thomas noted the benefits of the privatization of VASP, telling a reporter in 1991 that while VASP was a state-owned entity, the company was "not much concerned about competing in the market, because the state would cover it." That, he said, hurt private companies like VARIG and Transbrasil that did not have such resources.

VASP stepped up competition within the first 18 months of its privatization, snagging a larger share of Brazil's cargo market, mostly from Transbrasil. VARIG, which had 51 percent of the market in 1990, lost two percent of its business during that period. VASP and Transbrasil also announced intentions to challenge VARIG in the international market with a possible joint venture. The cargo market itself was expanding, as Brazil became more industrialized and began shipping a more equitable amount of products to North America.

Transbrasil received approval for routes to Orlando, Miami, Washington, D.C., and New York. VASP announced intentions to begin passenger service to Tokyo with connections in Los Angeles and San Francisco, a move that would open the door for the company to begin cargo operations, as well as tap into demand for passenger service by Brazil's substantial Japanese population. Up until 1991, VARIG--then the nation's flag carrier--had held a state-chartered monopoly on such activity. The Brazil market also became more open to U.S. airlines such as Pan Am. VARIG responded to international competition by increasing the number of flights flown on its routes to the United States, Canada, and Europe.

Deregulation allowed both new and established airlines to expand existing fleets, thereby increasing capacity not as a result of demand, but in anticipation of it. That led to speculation on the part of some airline officials that the resultant fare wars would, rather than create a more dynamic market, force some airlines out of business.

But those concerns did not stop others from entering the field. In late 1991 the president of Lider Taxi Aereo of South America, Capt. Jose Afonso Assumpcao, convinced international investors to back his plan to create Air Brasil, a domestic service linking three of Brazil's major cities: Rio de Janeiro, Sao Paulo, and Belo Horizonte. He planned to use the British Aerospace jet, 146-200. It was the first new airline the country had seen in many years. Until then, strict government regulation prevented such new growth.

Air Brasil's limited service was strategic: to parallel but not directly compete with the Ponte Aerea (Air Bridge), a Rio/Sao Paulo shuttle operation shared by VARIG, Transbrasil, and VASP. Around the same time, VARIG's President Thomas announced that the 30-year-old Lockheed Electra turboprops used for the Air Bridge would be replaced with the larger Boeing 737s, sparking questions about safety in traveling to and from airports that are hemmed in by mountains and other obstacles. VARIG responded by increasing minimum experience requirements for pilots and suggesting that the runways be inspected more often.

Officials of the nation's pilots union remained skeptical on safety issues, despite successful trial runs by VARIG from the Santos Dumont airport (where pilots must negotiate a runway with a mountain at one end and a bridge at the other) to the Congonhas airport, located in Sao Paulo's downtown area.

New routes, new competition, and new aircraft increased the effect of ongoing air fare wars. Some airline executives voiced concerns about stringent federal controls that prevented them from matching fare increases to the rate of inflation. Continued government regulation of air fares--allowing for rate decreases but not necessarily increases--made it more difficult for airlines to remain competitive while still turning a profit.

More Challenges in the 1990s

By 1991, the VARIG Group consisted of 23 companies, which boasted combined sales figures of US $2.5 billion. It lost $614 million from 1991 to 1993, however. The company took advantage of a weak aircraft market to renegotiate terms with its creditors; in 1993 its annual leases amounted to $500 million for 50 planes.

In a major restructuring, VARIG also cut more than 2,500 jobs and closed ticket offices. The carrier was losing money on international passenger operations, but earning a profit domestically. To spur business, VARIG entered a marketing agreement with Delta Air Lines.

The carrier's share of international traffic to and from Brazil fell to less than 40 percent in the mid-1990s. Other sectors slipped as well. A new ad campaign was launched to update VARIG's image. The planes began sporting a new paint scheme and logo, which added the word "Brasil" to make VARIG aircraft more identifiable overseas. It also launched its "Smiles" frequent flyer program that encouraged passengers to recommend particular flight personnel for special bonuses of their own.

After a short stint by Willy Engels, the VARIG board appointed Fernando Pinto president of the airline in January 1996. At the time, the carrier was $2.5 billion in debt, about half of it aircraft debt. Pinto, son of a VARIG pilot, had led the company's regional subsidiary, Rio Sul, through a period of fantastic growth.

VARIG aimed to recapture the international business traveler. It increased the number of business class seats and made them roomier. Sony personal inflight entertainment systems were part of the prescription to win back customers.

Pinto went right to work improving the company's bottom line. It conducted well-timed sale/leaseback agreements on aircraft that saved the company millions. Pinto dismissed 5,000 employees, mostly administrative ones. At the same time, he was challenged to raise motivation levels. He bemoaned the carrier's once great reputation for service. Pinto also preached cost control throughout the organization and sought to instill a European-styled accountability in individual employees. VARIG succeeded in raising on-time performance to 95 percent.

By October 1997 VARIG had dropped its brief alliance with Delta and instead teamed with United Airlines before becoming a member of the global Star Alliance, which also included SAS, Lufthansa, Thai International, and Air Canada. In 1998 VARIG entered into a joint venture with General Electric to make GE VARIG Engines.

The carrier continued to be burdened by enormous interest charges. In January 1999 the Brazilian currency was sharply devalued; fortunately, VARIG earned a significant portion of its revenues in U.S. dollars.

Principal Subsidiaries: Companhia Tropical de Hotéis; Companhia Tropical de Hotéis da Amazonia; Serviços Auxiliares de Transporte Aereo S.A. (SATA); Serviços Aereos Gerionais S.A. (RIO-SUL); Nordeste Linhas Aereas S.A.

VARIG S.A. (Viação Aérea Rio-Grandense) History

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