American Airlines
Strategic Report for
American Airlines
Jed Cullen
Kevin Yamazaki
Deirdre Chew
April 7, 2010
April 7, 2010
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American Airlines
Table of Contents
Executive Summary ............................................................................................ 3 Company History................................................................................................. 4 Financial Analysis ............................................................................................... 8 Current Financial Position.................................................................................. 8 Industry Comparable Analysis ......................................................................... 12 Stock Performance .......................................................................................... 14 Management and Analyst Outlook................................................................... 15 Competitive Analysis ........................................................................................ 16 Internal Rivalry ................................................................................................. 17 Supplier Power ................................................................................................ 18 Buyer Power .................................................................................................... 19 Entry and Exit .................................................................................................. 19 Substitutes and Complements ......................................................................... 20 SWOT Analysis .................................................................................................. 23 Strengths.......................................................................................................... 23 Weaknesses .................................................................................................... 23 Opportunities ................................................................................................... 24 Threats............................................................................................................. 24 Strategic Recommendations ............................................................................ 25 Address Labor Costs ....................................................................................... 25 Explore Maintenance Outsourcing................................................................... 26 Continue Fuel Efficiency Initiatives .................................................................. 27 Pursue Strategic Alliances ............................................................................... 27 Enhance International Offerings ...................................................................... 27 Exercise Political Power of Legacy Carriers .................................................... 28 Appendix ............................................................................................................ 30 References ......................................................................................................... 34 April 7, 2010
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American Airlines
Executive Summary
American Airlines, a brand that has weathered world wars, deregulation, fuel
price volatility and growing threats of terrorism, is continuing to face challenges
in the struggling airline industry. American Airlines is burdened by high labor
costs, a weak balance sheet, and perpetual union issues. While nearly all of
American’s legacy carrier peers are facing a difficult market environment, most
were able to achieve cost reductions through bankruptcy or bankruptcy
protection, a step that American Airlines has stated strongly that they will not
take. Furthermore, AA, like other legacy carriers, faces increasing competitive
pressure from low-cost carriers. The enhanced ability for consumers to compare
prices further exacerbates this pressure. Despite its excellent management team,
the company has recorded an annual loss in seven out of the past nine years.
American Airlines must address its high costs, improve its international
offerings, and find a solution to the competitive threat posed by low-cost carriers.
We recommend that AA avoid excessive concessions to the flight attendants
union, citing that AA flight attendants are among the best paid in the industry. To
further reduce costs, American should explore maintenance outsourcing, and
continue taking initiatives toward greater fuel efficiency.
With regards to American’s inability to compete with foreign carriers on
international routes, we believe that the company needs to invest in flat bed
seating in business class on long haul flights. We also believe that American
stands to gain by opening routes to Seoul and Hong Kong, which will link them to
new markets and are accessible without expanding the current fleet. To address
the domestic threat posed by low-cost carriers, we recommend that American
and other legacy airlines lobby for a tax credit system, distributed in an auction
method, to ease the burden on carriers who provide access to underserved areas.
These strategies, combined with planned fleet replacement and a recent interline
agreement with JetBlue, will position AA to thrive as the economy recovers.
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American Airlines
Company Overview and History
American Airlines, American Eagle, and AmericanConnection currently provide
scheduled service to 250 cities in 40 countries, with an average of over 3,400
daily flights. Together, these carriers operate a fleet of over 700 aircraft, and are
subsidiaries of the AMR Corporation. Though AMR was founded in 1982, the
American Airlines brand has been a major player in air travel for over three
quarters of a century.
In 1929, the Aviation Corporation acquired scores of independent airlines as the
airline industry experienced sweeping consolidation. The following year, the
Aviation Corporation changed its name to American Airways, to reflect the brand
under which many of the regional carriers flew. The company was headquartered
in New York, and ran routes from New York, Boston, and Los Angeles to Dallas.1
The company was renamed American Airlines in 1934, and Cyrus Rowlett Smith
became the president. Smith went on to run the company as CEO until 1968,
when he resigned to serve as United States Secretary of Commerce.2
Within its first decade of operation, American Airlines flew its one-millionth
passenger, became the number one domestic carrier in the United States (by
revenue), and began trading on the New York Stock Exchange. The airline had
also collaborated with New York City Mayor Fiorello LaGuardia to develop
LaGuardia Airport. As a first-mover among airlines, and a critical player in the
development of the project, American was also granted extra hangar space and
real estate. AA opened the world’s first airline lounge, the Admirals Club, in
1939.2
The 1940’s offered American myriad opportunities to expand into other areas of
the airline industry. In 1942, American launched the catering subsidiary
SkyChefs, which provides in-flight meals to American and other carriers. In 1944,
American, which had become the first commercial airline to fly the DC-3 eight
years earlier introduced a freight route making use of this line of aircraft. Though
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American Airlines
half of their fleet was turned over to the military during World War II, the
company launched American Overseas Airlines, (AOA), its first European service,
in 1945.2 AOA was acquired by Pan American World Airways in 1950.3
After the war, American Airlines quickly renewed its fleet to match growing
demand for air travel in the United States. By 1949, AA was the “fleet of the
future,” and the only airline with a ubiquitous use of pressurized, post-war
planes.2 As the company expanded, American Airlines introduced programs to
make flying more affordable for families, and introduced coach service as an
economic alternative to first class.
The fifties brought further advances for the company in reservation and flight
tracking technology, as well as the implementation of transcontinental nonstop
flights with the Douglas DC-7. By the end of the decade, American Airlines was
moving into the jet age, becoming the first airline to offer coast-to-coast jet
service on the Boeing 707. In the following two years, American Airlines also
pioneered turbofan and turboprop service on the Corvair 990 and Lockheed
Electra, respectively.
American Airlines spent the first half of the 1960’s working with IBM to create
SABRE, which at the time of its introduction in 1964 was the second largest and
most powerful electronic data processing system after the US government’s
mainframe. American Airlines’ iconic AA logo was designed in 1967. The sixties
also saw the introduction of the Boeing 727 and 747, with the freighter edition of
the latter debuting in 1974. As American added new planes to its fleet, it
expanded its route offerings through a 1970 merger with Trans Caribbean
Airways, and with the acquisition of routes in 1975 from Pan-America.
The Airline Deregulation Act of 1978, which removed government control over
routes in exchange for market allocation, prompted a massive campaign of route
expansion for American Airlines. At the same time, AA moved its corporate
headquarters to Dallas/Fort Worth, where it had already established training
facilities and reservations offices. By 1981, the Dallas/Forth Worth airport
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became the major hub of American’s worldwide hub-and-spoke system. The same
year, American Airlines launched its revolutionary AAdvantage Frequent Flyer
program, which remains a hallmark of the company and boasts an enrollment of
over 50 million members today.4
In 1980, faced with rising fuel costs, AA retired the Boeing 707. These planes
were phased out as the newer more efficient 767 joined the fleet in 1982. The
same year, stockholders approved a plan to reorganize American Airlines. The
passenger and cargo businesses would operate as separate subsidiaries under the
holding company AMR Corporation. In 1984, AMR grew to incorporate the
American Eagle system, a regional carrier connecting passengers to American
Airlines. As AA expanded its hub-and-spoke system through the 1980’s, the
company added Chicago, Nashville and Miami as hubs, and made the SABRE
system accessible through a personal computer.
In 1990, American Airlines purchased TWA’s London-Heathrow assets,
establishing a hub in the United Kingdom. In the following years, American
Airlines tried to introduce their “Value Pricing” program with the hopes of
making flight fares more simple, understandable and cheap. Stiff price
competition, however, prevented the success of the modified fare structure,
leading AA to abandon the model shortly thereafter. The years 1993 and 1994
were marked by a comprehensive service agreement with Canadian Air, and the
formation of the SABRE technology group as a separate entity under the AMR
umbrella. In 1995, AMR announced the SABRE group would file for an IPO,
commencing a spinoff that would be completed by 2000.
In September of 1998, American Airlines announced the formation of a new
global alliance, oneworld, which would generate codesharing agreements among
multiple international airlines. Founding members included Cathay Pacific,
Canadian Airlines, Quantas, and British Airways.5 Today, oneworld members
serve nearly 700 destinations in over 130 countries and territories, and the
alliance has grown to include eleven major carriers.6
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American Airlines
In early 2001, American Airlines completed the acquisition of the near bankrupt
Transworld Airlines, adding a hub in St. Louis. Unfortunately, American Airlines
flights were the target of the September 11, 2001 attacks. This event left the entire
airline industry struggling, but hit American Airlines especially hard because the
company was in the wake of a major acquisition.
Since 2001, AMR has posted annual losses in seven out of the past nine years,
accumulating to a net loss of almost $11 billion over the period. While it has
expanded non-stop service to include routes to Russia and China, the company is,
like other legacy carriers in the airline industry, struggling significantly. Rising
fuel costs over the past decade and recent economic downturn have raised
questions about the economic sustainability of American Airlines. 7
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American Airlines
Financial Analysis
American Airlines, like other hub-and-spoke airlines, has been struggling
financially since 2001. The first half of the decade presented rapidly rising fuel
costs as a major challenge, and the recent economic downturn has further
reduced demand. In the past five years, many of its hub-and-spoke competitors
turned to bankruptcy filings or protection and aircraft order deferrals to
reorganize and address costs. American, however, insists that fiscal discipline will
keep them attractive to investors as they weather the storm, and are going
forward with plans to renew nearly their entire fleet in the coming five years. The
company is proud of its status as the only U.S. airline which has weathered World
War II, deregulation, the Gulf War, the attacks of September 11th, periods of
incredible fuel price volatility and the recent major recession without being
acquired or going bankrupt.
American Airlines has cut costs significantly in the past nine years, but recorded
heavy losses in every year with the exceptions of 2006 and 2007. 8 While AMR is
betting heavily on resurgence in demand for commercial air travel as the
economy recovers, analysts expect annual losses through the end of 2011. The
current strategy of AMR emphasizes long-term success. It is questionable
whether investors are patient enough to wait for these returns, and whether they
are as confident as management that AMR will thrive after the economic
recovery. Of equal importance is the consideration of whether AMR will have the
financial strength to continue through these difficult times, should resurgence in
demand take longer than expected.
Current Financial Position
In 2009, AMR recorded a net loss of $1.47 billion, compared with a 2008 net loss
of $2.1 billion.9 This past year’s loss was driven by a decrease in air travel as a
result of the economic downturn, leading to significant reduction in passenger
revenue. Industry-wide fare discounting exacerbated such declines, further
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diminishing American’s passenger revenue per seat mile. Overall revenue fell
from $23.77 billion in 2008 to $19.92 in 2009. 10
In response to decreased demand, American Airlines continues to enact capacity
reductions, reducing mainline seating capacity by an additional 7.2% since 2008.
This reduction in capacity, along with a year-over-year 33% decrease in fuel
prices, helped to soften the blow to the company’s finances. Jet fuel, the largest
single cost that the company faces, fell from a 2008 average of $3.03 to a 2009
average of $2.01, and constituted 35.1% and 26.5% of 2008 and 2009 operating
expenses, respectively. 11 AMR’s credit rating, due to the weakness of its balance
sheet and the state of the aviation industry, limits its ability to hedge fuel prices.
As such, volatility and/or disruptions in the supply of fuel, as well as escalating
costs may adversely impact AMR’s financial position. 12
The company’s guidance suggests it is in a stronger financial position than at the
beginning of 2009, although American increased its lease-adjusted total debt by
$831 million. The company will need to raise substantial additional funds to
maintain liquidity, and will face challenges doing so on acceptable terms. These
liquidity issues may be further worsened if American Airlines is required (by
potential new financial regulation) to maintain reserves to cover the credit card
processing agreements it has with multiple financial services companies. 13
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American Airlines
Industry Comparable Analysis
American Airlines recorded the second highest revenues in the airline industry
(after Delta) in 2009, but recorded the largest loss of its peers. As the recession
hit, American’s revenue fell sharply, dropping 16% in 2009 compared to 2008.
While net margins improved, the company still maintains the lowest net margins
in the industry.
The reduction in demand for air travel put additional strain on American’s debt
load, and ability to raise funding in capital markets. American, along with United
and USAir, have liabilities that exceed their assets, as is indicated in their
negative debt/equity ratios, and debt ratios in excess of one.14 The corporate debt
for each of these firms is rated B-, limiting the ability of the companies to enter
into fuel hedging agreements, as well as to sell debt at favorable rates.15
Southwest is unique among airlines in that it has a significantly higher corporate
debt rating (BBB) which is considered investment grade. American and its peers
issue debt rated as B or lower, which is considered to be speculative grade.
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16
In addition to unfavorable indicators in terms of traditional financial measures of
debt, operations and leverage, American struggles on a number of industry
specific metrics as well (see appendix). In the third quarter of 2009, American
was in the top half of its peers in terms of operating expense and fuel cost per
available seat mile and was in the bottom half of the industry in terms of margins,
and revenue per average seat mile.17
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American Airlines
Stock Performance
Last 12 Months: AMR, S&P 500 and XAL Airline Index18
Last 12 Months: AMR, S&P 500 and XAL Airline Index19
Last 5 Years: AMR, S&P 500 and XAL Airline Index20
Despite forecasting losses through 2011, analysts are bullish on AMR stock. Postearnings analyst reports in January 2010 indicated an “Overweight” or “Buy”
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rating from Morgan Stanley, Bank of America-Merrill Lynch, JPMorgan,
Barclays, and UBS, as well as a “Hold” rating from Citigroup. 21
Management and Analyst Outlook
As stated in management guidance from the 4Q 2009 press release, AMR plans
to increase its international capacity by 3.2%, while reducing domestic capacity
by 0.5%. This will produce a net increase in mainline capacity of 0.9% compared
with 2009. AMR is planning for an average system price of $2.36 per gallon
during the first quarter of 2010, with an average of $2.42 throughout the entire
year. 22
Management expects a 1.1% increase in average cost per seat mile, excluding fuel,
due to costs of bringing a new fleet of aircraft online. These new aircraft,
however, are 35% more efficient, and are expected to deliver a 2% increase in
mainline fuel efficiency in 2010.23
Credit analysts expect 2010 revenues to improve by 9% but for fuel costs to rise
23%, well above management’s guidance. Although AMR will undergo extensive
capital expenditure as it renews its fleet, analysts expect attractive sale-leaseback
agreements to offset these costs. While AMR remains at the top of network
carriers in terms of liquidity and balance sheet health, the overall view on the
airline industry from credit analysts is “Cautious,” as rising fuel prices and worsethan expected revenue recovery present significant risks to the financial health of
the industry. 24
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American Airlines
Competitive Analysis
The airline industry continues to face a challenging market environment. While
loss margins shrunk in comparison to 2008, IATA estimates that the global
airline industry lost $9.4B in 2009, slightly stronger returns than the $15.9B
estimated loss in 2008.25
American Airlines provides scheduled transportation of passengers and high
priority cargo via aircraft between two airports, one of which is located in the
United States. With this definition of business, the North American Industrial
Classification System (NAICS) identification is “Scheduled Air Transportation”
(48111). American Airlines is significantly involved in two subcategories of this
classification: “Scheduled Air Passenger Transportation” (481111) and “Scheduled
Air Freight Transportation” (481112).26
While the markets and customers for passenger and freight transport may vary,
there is significant cross-elasticity of supply in providing both these services.
Many of American’s competitors also benefit from this economy of scope; like
American, they derive most of their revenue from passenger transportation.
American Airlines business faces competition from both legacy hub-and-spoke
carriers like Alaska, Continential, Delta, Northwest, United and U.S. Air, as well
as point-to-point low cost carriers including JetBlue, Southwest and Airtran.
American Airlines also faces competition on international routes, especially from
AirFrance, Lufthansa, and British Airways.
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Five Forces Industry Analysis and Strategy
Force
Strategic Significance
Internal Rivalry
High
Supplier Power
High
Buyer Power
Medium
Entry and Exit
Low
Substitutes & Complements
Low
Internal Rivalry
American Airlines faces its most significant competition domestically, where
multiple carriers compete for the same customer base, commonly on identical
routes. In 1978, the Airline Deregulation Act established consumer market power
over air travel. This action greatly benefitted passengers by driving fares down,
but put immense competitive pressure on airlines. Because air travel is a largely
undifferentiated product between airlines, this competition principally takes
place in the price arena.
Two distinct carrier models dominate the market in which American Airlines
competes. The legacy carriers, including AA, use a hub-and-spoke model. This
model allows carriers to serve a vast network of airports with a smaller fleet size
compared to direct point-to-point service, and is necessary for the present
comprehensive domestic air transport system.
American Airlines and other
network carriers employing this model, however, face stiff competition from
point-to-point low-cost carriers (LCCs).
The LCC model piggybacks on the existing network, typically flying only the “cash
cow” routes. In addition to cherry-picking profitable routes, LCCs often also
reduce their operating costs by flying to secondary airports in major regions,
offering no-frills service with “sardine-packed” seating. They also commonly only
use a single airplane type to simplify pilot training and maintenance inventory.27
While such a model does not provide a comprehensive and sustainable air travel
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system, their ability to undercut the hub-and-spoke airline companies presents a
significant competitive threat to legacy carriers like American Airlines.
The competitive threat posed by LCCs has grown significantly in the past decade
with the proliferation of online ticketing, which has been growing steadily over
the last decade. This phenomenon has intensified cost competition as passengers
can compare prices across the industry before choosing a carrier. While
passengers have always been price sensitive, increased availability of pricing
information has greatly aided LCCs in stealing marketshare from the network
carriers.
Supplier Power
There are three key inputs to operations involved in the transportation of freight
and passengers by air: fuel, aircraft and labor. Supplier power in each of these
areas is significant.
Aviation fuel is the largest single expense in AMR’s budget.28 American has
among the highest fuel costs per seat mile, and highest fuel costs as a percentage
of operating costs of any of its competitors. Despite the immense amount of fuel
consumed by the company, there is very little bargaining power in the purchase
of this commodity, which has a market rate determined externally by long-term
contracts, futures markets, and spot prices. As mentioned earlier, AMR is limited
in its ability to hedge fuel prices. The firm, like each of its competitors, is
enormously sensitive to fluctuations in the price of oil.8
American Airlines faces supplier power when purchasing aircraft, as two giants,
Boeing and Airbus, dominate the supply for commercial airliners. At the end of
2009, AA’s fleet (not including American Eagle) consisted of 610 aircraft, 349 of
which were owned. American Airlines’ fleet is split 60/40 between Boeing and
McDonnell Douglass, and Boeing planes represent 75% of their owned
equipment. AA is in the process of phasing out their McDonnell Douglass fleet for
additional Boeing planes.29 The small number of firms in the aircraft
manufacturing industry gives a fair amount of bargaining power to the supplier.
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Labor is the third major input to operations in the airline industry. Labor in the
airline industry is highly unionized, and wages, salaries and benefits constitute
about a third of AA’s total operating expenses. While some of American Airlines’
competitors
have
achieved
labor
cost
reductions
through
bankruptcy
proceedings, American continues to pay some of the highest labor costs in the
industry.30 It is unclear whether this gap can be closed, as the bargaining power
lies with the unions. The labor costs of AA’s competitors are predicted to rise, and
possibly narrow this gap. Union pressure, however, along with the seniority of its
workforce, will likely continue to keep American Airlines’ labor costs higher than
those of its peers.
Buyer Power
Due to the proliferation of online ticketing, consumers have nearly perfect
knowledge of pricing in the industry. This factor, combined with the price
sensitivity arising from the undifferentiated nature of airline service, grants a
significant amount of buying power to the consumer. Furthermore, because
passengers have low switching costs, even within the same travel schedule (i.e.
multiple carriers for the same trip), buyer power is further amplified in the airline
industry. In general, this enhanced ability of consumers to act on price has
benefitted low-cost carriers, which can offer more attractive pricing on many of
the high-trafficked routes.
Entry and Exit
Significant barriers to entry favor the existing firms in the airline industry. In
terms of financial barriers, operating an airline is a capital intensive, high fixedcost endeavor. There are significant economics of scale that arise from marketing,
the capacity to spread fixed costs over many routes, and the ability to enter into
codesharing agreements.
In addition to economic difficulties, there are regulatory and logistical barriers as
well. The airline industry is still highly regulated, both in terms of route
scheduling and homeland security. In addition, “slots” at major airports are
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valuable commodities that are often locked into long-term contracts. For
example, it is impossible to add flights at New York’s three major airports
without acquiring the operating rights from another carrier. These three airports
are involved in 6 out of the 10 most trafficked routes in the US, and the
restriction on the supply side has made these operating rights quite expensive.31
Exit from the airline industry is also a difficult process. In addition to the
liquidation of fleet, equipment, plant, property and operating rights, airlines are
obligated to honor the existing passenger reservations. In 2005, rather than
exiting the industry, five of the seven largest network carriers opted to enter
bankruptcy or bankruptcy protection agreements and reorganize.32
Substitutes and Complements
Substitutions for commercial air travel include other forms of transportation and
other methods of accomplishing the tasks that motivate the need to travel. The
former encompasses both business and leisure travelers, while the latter is more
relevant to business customers.
In the United States, there are few viable substitutes for long distance air travel.
The US lacks a strong high-speed rail network, and even on shorter legs, trains
are slower, and often not significantly cheaper, than traveling by air. There is an
extensive interstate system and available low-fare bus transportation, but airlines
still seem to offer a better value proposition for long distance travel.
Over short distances, the advantages to trains and road travel are amplified,
especially in light of heightened security measures that extend the length of time
it takes to travel by plane. For distances under 250 miles, the door-to-door time
is often shorter when traveling by land. In many cases, land travel is less
expensive as well.
For business and high net-worth customers, a viable substitute is private,
chartered or corporate jets. The growing popularity of fractional-ownership
programs and lessened pre-boarding hassle have made this substitute more
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attractive. This segment of the industry, however, is even more sensitive to
business cycles, and charter jet customers tend to downgrade to first or business
class on carriers like American during economic downturn.
The second substitute, most relevant to business customers, is the growth of
telecommunications, which has been greatly enhanced in the past decade by the
proliferation of fiber optic networks and high speed internet. With continued
improvement in video-conferencing technology, businesses may be able to
consider less travel to be essential to their own operations, reducing corporate
spending on commercial airliners. This is particularly problematic because on
many flights, business class financially supports coach class by paying higher
fares for a service that does not cost the airline significantly more to deliver. This
substitution will be more significant in economic downturns, as corporations cut
travel budgets further.
Travel by air is usually purpose motivated and non-experiential. Passengers see
the use of this service as a means to an end, namely to travel between two
destinations. As such, we posit two categories of complements when considering
air travel. The first category, unilateral complements, see an increase in demand
with increases in air travel, but their prices do not significantly increase air travel
itself. The second category, bilateral complements, can influence air travel with
changes in prices or desirability, as they motivate the demand for travel.
Unilateral complements to air travel include on-board wireless internet access, a
la carte items, in-flight shopping, and other amenities offered during the flight
experience. These serve primarily to enhance the traveling experience, and in
some cases to add revenue to the carrier, or edge out a competitor in terms of
offerings. American Airlines specifically has implemented wireless internet on all
767-200 flights, select MD-80’s, and is working on installing the service on their
fleet of 737’s.33 While these amenities can affect preference of one airline over
another, and subsequently patterns of demand between carriers, they are unlikely
to draw new customers to the industry.
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Bilateral complements include hotel stays, car rentals, and general goods and
services associated with business or leisure travel. A reduction in the cost, or
increase in the desirability, of reaching a destination will stimulate air travel and
increase demand on all carriers in the industry. Similarly, if air travel is very
inexpensive, there will be increased demand for these travel-related goods and
services. Undeniably, the airline industry is very pro-cyclical, and economic
activity tends to generate more demand for both business and leisure travel.
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SWOT Analysis
Strengths
•
AAdvantage
o Enrollment of over 50 million
o Perennially recognized as one of the best customer loyalty programs
o Highest proportion of redeemable seating capacity among legacy
carriers
•
Reputation and Brand Strength
o One of the oldest, most established, carriers in the industry
o Only legacy carrier which hasn’t filed for bankruptcy
•
Strategic Airport Locations
o Hub positions in Dallas, Miami, Chicago
o Strong presence in major business hubs
•
Investor Confidence
o AA generates strong operating cashflow
o Highly-rated
Weaknesses
•
Inability to compete on international flights
o Foreign carriers dominate market and offer higher quality service
o West coast weakness inhibits ability to reach Asian markets
•
Financial position
o Analysts forecasts losses through 2011
o Credit rating inhibits ability to enter fuel hedging contracts
•
Dependence on resurgence in demand
•
Labor and Union Issues
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Opportunities
•
Flightplan 202034
o Management has laid out a plan of action for the next ten years
o Emphasis
on
investing
wisely
in
fleet,
earning
loyalty,
strengthening the global network, building workplace community
and flying profitably
•
Address labor costs
o Flight attendant union negotiations
o Maintenance outsourcing
•
Enhance international offerings
o Potential for growth in Asian markets
o Upgrade business class on long-haul flights
Threats
•
LCC model edging out legacy carriers
•
Competitors have reduced costs through bankruptcy and consolidation
•
Fuel market volatility
•
Escalating militancy of labor unions
•
Growth in videoconferencing and travel substitutes
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Strategic Recommendations
Address Labor Costs
American Airlines has some of the highest labor costs in the industry, as a result
of having a highly unionized workforce, but also in part due to the tenure and
seniority of their workforce. Competitors were able to slash union commitments
through bankruptcy and bankruptcy protection, but AA is constantly fighting
pressure from unions and driving labor costs upward.
At present, AA is fighting its flight attendants union, the Association of
Professional Flight Attendants (AFPA). In mid-March, the APFA appealed to the
National Mediation Board to declare that negotiations are at an impasse. In
addition, the APFA board of directors has indicated that it will distribute strike
ballots to its members in early April.35 If the National Mediation Board declares
that talks have deadlocked, it can initiate a 30-day “cooling-off period” after
which union members can begin a strike.36
AA should maintain its managerial discipline throughout flight attendant
contract negotiations. Though flight attendants unions are known to be militant,
it seems likely that many will cross the picket line if it comes to a strike. British
Airways flight attendants have received very little public support for their current
strike, despite the comparatively favorable public opinion of unions in the United
Kingdom versus the United States.37
38
AA’s flight attendants are among the
highest paid in the industry, and the current national unemployment rate is over
10%, putting a lot of pressure on flight attendants to cave in.39 Furthermore,
American Airlines’ management has lower levels of executive compensation than
its peers, giving the APFA little to point at in terms of demanding concessions.40
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American Airlines
Flight Attendant Compensation by Carrier (2008)41
Airline
Salary
Hours/Month Hours/Year
Salary/Hour
Pay
rate
versus AA
American
$49,776
43.0
516
$96.47
100%
Continental
$49,061
46.7
560.4
$87.55
90.8%
United
$40.129
41.7
500.4
$80.21
83.2%
Southwest
$53,027
63.1
757.2
$70.03
72.6%
US Air
$39,716
47.5
570
$69.68
72.2%
Delta
$36,409
48.6
582.7
$62.49
64.8%
Airtran
$29,706
58.8
705.6
$42.10
43.6%
Jetblue
$33,014
73.4
880.8
$37.48
38.9%
Frontier
$31,217
96.4
1156.8
$26.99
28.0%
Explore Maintenance Outsourcing
Another driver of AA’s escalated labor costs is their approach to maintenance.
American Airlines performs all of their heavy maintenance in-house at facilities
in Tulsa, Oklahoma and Kansas City, Missouri.42 Though AA management
rationalizes this decision by emphasizing the control over their product, many of
their competitors have been able to achieve significant cost savings by
outsourcing aspects of mechanical labor. Continental sends its 777s to HAECO in
Hong Kong for heavy maintenance; United Airlines sends 777’s and 747-400’s to
Ameco in Beijing for annual and heavy maintenance checks; US Air and JetBlue
have their A320 fleet serviced at AVEOS in El Salvador.43
44 45
American
announced in October 2009 that they were phasing out their Kansas City
overhaul and maintenance base to adjust for capacity cuts.46 Rather than
investing capital to expand the remaining Tulsa facility, American should explore
options abroad to see if their scheduled maintenance could be performed at a
lower price.
April 7, 2010
Page 26
American Airlines
Continue Fuel Efficiency Initiatives
As fuel prices escalated in the second half of the last decade, American Airlines
moved quickly in the implementation of fuel-efficient practices. In addition to
taking measures to lighten the load each plane is flying, other practices such as
the installation of blended winglets are estimated to have saved American
Airlines 111 millions gallons of fuel in 2008 alone.47 They have been installed on
the owned 737-800s (77 in total) and should be extended to the remaining 31 that
are currently under operating lease agreements. This will not only improve fuel
efficiency, but mitigate the environmental impact of AA’s operations and reduce
its sensitivity to fuel price fluctuations.48
Pursue Strategic Alliances
In early stages of analysis Vector Strategy Group favored recommendations for
American Airlines to partner with a low-cost carrier, and, as a separate endeavor,
to work to feed more international travel through John F. Kennedy Airport in
New York. We are pleased with the recent announcement of AA’s alliance with
JetBlue, and commend management for finding a way to simultaneously
implement these two strategies.
American will gain eight takeoff and landing slot pairs at JFK, and offer seamless
service to customers who fly JetBlue domestically to connect to American Airlines
international destinations.49 Aviation analyst Robert Herbst estimates that the
agreement will add at least $14 million and $55 million to JetBlue and
American’s operating income, respectively.50
Enhance International Offerings
American Airlines lags its international competitors in terms of in-flight
amenities and domestic carriers with regards to connections to Asian markets.
AA can address these issues by upgrading its hardware, and opening new routes
to hubs in East Asia.
April 7, 2010
Page 27
American Airlines
AA is the only domestic carrier to guarantee a lie-flat seat in business class on
long-haul flights, but non-U.S. carriers are far ahead with flat bed seat
implementation. Furthermore, Delta, Continental and United are also moving
ahead with United guaranteeing flat bed seats through business class by the end
of 2010.51
52
As American Airlines renews its fleet, it should pay attention to the
configuration that its competitors are offering and work to stay competitive.
American should begin building out its Asian presence with its existing fleet and
lay the groundwork for more routes to the region upon future delivery of the
787’s it has on order from Boeing. American should enter this region by initiating
service from Chicago-O’Hare to Hong Kong and from Dallas-Fort Worth to Seoul.
The former of these routes would connect two major oneworld hubs and build out
American’s connectivity to codesharing partner Cathay Pacific. Initiating service
to Seoul introduces American to a large local market, where AA is well-positioned
to steal U.S.-based Korean Air customers with its AAdvantage program.
American has 47 Boeing 777’s in its fleet, though its current route schedule only
requires 42 planes. While AA is obligated to keep a portion of its fleet reserved for
military contracts it is possible to add new Asian routes on a limited basis with
these extra 777’s. If this expansion is successful, they could add frequencies and
routes with the coming integration of the Boeing 787 into their fleet.53
Exercise Political Power of Legacy Carriers
With American Airlines leading the pack, the legacy carriers in the United States
have a fair amount of political clout.54 There is a political case that the hub-andspoke carriers can make regarding the market environment they function in and
the boon that a comprehensive airline network generates for the national
economy. While government regulation of the extent seen before 1978 seems
undesirable, the legacy carriers can make a case for an incentives-based program
that will preserve the viability of the network service they provide. A successful
lobby for tax credits could position the legacy carriers to compete with low-cost
carriers and return to sustainable profitability.
April 7, 2010
Page 28
American Airlines
The establishment of a tax credit that airlines could achieve by flying scheduled
routes through underserved areas would create a support system for the valuable
network that legacy carriers provide. The market would price the credit, with
each stipend going to the lowest bidding carrier that is willing to fly the route.
The advantages to such an incentive system are numerous. First, it would create a
subsidy for providing a public good (airline service to underserved markets)
without disrupting competition among carriers to fly that route most efficiently.
Second, it would put the legislative focus on serving an airport rather than
subsidizing a specific airline, mitigating the opportunity for favoritism. Third, it
would allow legacy carriers to more effectively compete with low-cost-carriers on
profitable routes, as they would no longer need to subsidize the lagging demand
on the less popular routes. This occurs on a very small scale at some regional and
local airports, and a national clearinghouse for tax credits would strongly
enhance the financial sustainability of a comprehensive air transport network.
April 7, 2010
Page 29
American Airlines
Appendix
Quarterly Operating Profit/Loss Margin55
rd
4th
Quarter
2008 (%)
1st
Quarter
2009 (%)
2nd
Quarter
2009 (%)
3rd
Quarter
2009 (%)
3 Quarter
Operating
Profit/Loss
$(Millions)
145
198
130
67
43
1
-246
338
3Q 2009
Rank
Network
Airlines
3rd
Quarter
2008 (%)
1
2
3
4
5
6
7
Alaska
Northwest
United
Delta
Continental
US Air
American
7-Carrier
7.2
-5.7
-8.4
2.2
-4.2
-20.5
-4.2
-5.4
4.1
-13.8
-13.5
-1.2
-1.0
-12.5
-3.9
-6.7
1.0
0.9
-3.7
-10.0
-3.1
-1.0
-4.7
-4.0
4.2
5.4
4.3
-3.5
-5.2
4.4
-5.3
-0.5
16.8
6.9
2.9
1.4
1.3
0.1
-4.8
1.4
3Q 2009
Rank
Low-Cost
Airlines
3rd
Quarter
2008 (%)
4th
Quarter
2008 (%)
1st
Quarter
2009 (%)
2nd
Quarter
2009 (%)
3rd
Quarter
2009 (%)
1
2
3
4
5
Spirit
Allegiant
Frontier
JetBlue
AirTran
Virgin
America
Southwest
7-Carrier
-19.4
5.0
-2.6
1.6
-6.9
12.0
21.6
0.0
5.3
9.3
17.1
30.1
8.4
9.1
8.8
17.3
23.8
9.5
7.9
11.0
14.6
14.4
10.3
7.7
6.2
3 Quarter
Operating
Profit/Loss
$(Millions)
26
18
31
67
37
-47.5
-24.0
-36.7
-8.4
3.2
5
3.0
-0.8
2.6
3.9
-2.1
2.9
4.7
7.0
0.8
4.2
23
206
3rd
Quarter
2008 (%)
4th
Quarter
2008 (%)
1st
Quarter
2009 (%)
2nd
Quarter
2009 (%)
3rd
Quarter
2009 (%)
4.2
5.1
1.4
7.0
13.7
3rd Quarter
Operating
Profit/Loss
$(Millions)
24
5.3
2.7
6.6
7.1
11.8
55
6.0
7.6
4.0
7.7
10.7
22
6.5
9.0
-11.2
0.2
6.5
7.1
-5.0
7.1
6.8
7.9
-7.0
0.9
8.7
16.2
-6.1
4.3
9.2
3.8
-4.7
N/A
41
9
-8
N/A
3.5
4.9
4.3
7.2
8.3
14
rd
6
7
3Q 2009
Rank
Regional
Airlines
1
Horizon
American
Eagle
Atlantic
Southeast
SkyWest
Comair
ExpressJet
Mesa**
7-Carrier
Total
2
3
4
5
6
7
April 7, 2010
Page 30
American Airlines
Fuel Cost per Available Seat Mile (in cents) 56
3Q 2009
Rank
1
2
3
4
5
Delta
American
United
Northwest
Continental
US
Airways
Alaska
6
7
3Q 2009
Rank
1
2
3
4
5
6
3Q 2009
Rank
2
3
4
5
6
7
Low-Cost
Airlines
Allegiant
Southwest
JetBlue
AirTran
Spirit
Frontier
Virgin
America
7
1
Network
Airlines
Regional
Airlines
Comair
American
Eagle
Horizon
SkyWest
ExpressJet
Atlantic
Southeast
Mesa**
April 7, 2010
2.04
2.18
2.11
2.50
1.89
5.33
5.87
7.02
8.08
5.58
3.85
3.13
2.11
3.00
2.98
3.61
3.41
3.31
3.27
2.84
77.0
56.4
56.9
30.8
50.3
Percent
Of
Operating
Costs for
Fuel
2004
15.8
20.0
18.4
20.0
15.4
1.86
5.70
2.39
2.83
52.2
13.3
2.12
5.26
2.26
2.62
23.6
21.4
3rd
Quarter
2004
3rd
Quarter
2008
2nd
Quarter
2009
3rd
Quarter
2009
Pct.
Change
3Q 20043Q 2009
2.06
1.41
1.37
2.08
2.45
1.93
6.25
3.99
5.00
5.78
5.46
5.52
2.92
2.84
2.86
2.60
2.24
2.31
3.34
3.33
3.04
3.00
2.75
2.74
62.1
136.2
121.9
44.2
12.2
42.0
Percent
Of
Operating
Costs for
Fuel
2004
24.8
18.5
22.8
24.1
28.4
20.9
N/A
5.12
2.19
2.62
N/A
N/A
3rd
Quarter
2004
3rd
Quarter
2008
2nd
Quarter
2009
3rd
Quarter
2009
Pct.
Change
3Q 20043Q 2009
3.52
9.35
2.58
6.47
83.8
Percent
Of
Operating
Costs for
Fuel
2004
28.8
3.55
8.98
4.87
5.21
46.8
25.0
2.19
3.51
1.79
7.07
4.99
6.75
3.15
2.05
2.88
3.68
1.47
0.16
68.0
-58.1
-91.1
14.8
26.5
14.5
3.16
9.45
2.81
0.13
-95.9
25.8
2.86
4.99
2.05
N/A
N/A
26.5
3rd
Quarter
2004
3rd
Quarter
2008
2nd
Quarter
2009
3rd
Quarter
2009
Pct.
Change
3Q 20043Q 2009
Page 31
American Airlines
Operating Cost per Seat Mile (in cents) 57
3Q 2009
Rank
US
Airways
Delta
American
United
Northwest
Continental
Alaska
7-Carrier
Total
1
2
3
4
5
6
7
3Q 2009
Rank
1
2
3
4
6
7
3Q 2009
Rank
3
4
5
6
7
Low-Cost
Airlines
Southwest
Frontier
JetBlue
AirTran
Virgin
America
Allegiant
Spirit
7-Carrier
Total
5
1
2
Network
Airlines
Regional
Airlines
Comair
Horizon
American
Eagle
SkyWest
Atlantic
Southeast
ExpressJet
Mesa**
7-Carrier
Total
April 7, 2010
3rd
Quarter
2008
4th
Quarter
2008
1st
Quarter
2009
2nd
Quarter
2009
3rd
Quarter
2009
3rd
Quarter
Operating
Expenses
$(Millions)
20.8
18.8
15.1
14.4
15.0
2,801
16.2
15.9
17.3
18.9
16.3
13.9
15.9
14.6
16.7
18.9
15.2
12.5
15.8
13.4
12.8
14.4
13.2
11.7
15.3
13.3
12.2
12.6
13.4
12.3
14.2
13.9
13.4
13.1
12.8
11.7
4,729
5,368
4,305
2,676
3,213
714
17.1
16.2
13.9
13.5
13.7
23,80
10.9
12.1
10.9
11.6
10.2
11.2
10.2
10.0
9.9
9.2
9.0
9.2
9.7
9.1
9.0
9.0
10.7
9.9
9.4
9.1
3rd
Quarter
Operating
Expenses
$(Millions)
2,643
270
789
560
13.0
11.1
9.2
8.7
8.6
153
11.8
11.6
9.1
8.7
7.4
7.8
7.6
7.8
8.3
7.9
109
152
11.0
10.3
9.5
9.3
9.9
4,678
3rd
Quarter
2008
4th
Quarter
2008
1st
Quarter
2009
2nd
Quarter
2009
3rd
Quarter
2009
22.0
20.7
20.4
19.8
19.9
18.4
16.8
17.7
21.0
18.0
3rd
Quarter
Operating
Expenses
$(Millions)
230
154
20.0
18.6
17.2
16.5
16.2
412
13.7
12.3
11.4
10.9
9.9
399
19.4
16.1
14.1
12.7
9.1
176
9.8
16.2
6.9
13.5
7.4
12.8
6.9
12.2
6.7
N/A
186
N/A
16.3
14.2
13.3
12.4
11.8
1,558
3rd
Quarter
2008
4th
Quarter
2008
1st
Quarter
2009
2nd
Quarter
2009
3rd
Quarter
2009
Page 32
American Airlines
Revenue per Seat Mile (cents per available seat mile) 58
3Q 2009
Rank
US
Airways
Delta
Alaska
Northwest
United
American
Continental
7-Carrier
Total
1
2
3
4
5
6
7
3Q 2009
Rank
1
2
3
4
5
6
3Q 2009
Rank
3
4
5
6
7
Low-Cost
Airlines
Frontier
Southwest
JetBlue
Allegiant
AirTran
Spirit
Virgin
America
7-Carrier
Total
7
1
2
Network
Airlines
Regional
Airlines
Comair
Horizon
American
Eagle
SkyWest
Atlantic
Southeast
ExpressJet
Mesa**
7-Carrier
Total
April 7, 2010
3rd
Quarter
2008
4th
Quarter
2008
1st
Quarter
2009
2nd
Quarter
2009
3rd
Quarter
2009
3rd
Quarter
Operating
Revenue
$(Millions)
17.3
16.7
14.9
15.0
15.0
2,802
16.5
14.9
17.8
16.0
15.3
15.6
15.7
13.0
16.6
14.7
14.1
15.1
14.4
11.8
14.5
12.3
12.8
12.8
14.8
12.8
13.3
12.7
12.7
12.7
14.4
14.1
14.0
13.8
13.3
13.0
4,796
859
2,874
4,435
5,122
3,256
16.2
15.2
13.4
13.4
13.9
24,144
11.8
11.0
11.1
12.4
10.8
9.7
11.2
10.7
10.8
11.6
11.0
9.8
10.1
9.7
9.9
10.6
10.1
9.4
10.1
10.2
9.8
9.9
10.1
9.4
11.0
10.7
10.2
9.7
9.7
9.2
3rd
Quarter
Operating
Revenue
$(Millions)
301
2,666
856
127
597
178
8.8
9.0
6.7
8.0
8.9
158
10.9
10.7
9.8
10.0
10.4
4,88
3rd
Quarter
2008
4th
Quarter
2008
1st
Quarter
2009
2nd
Quarter
2009
3rd
Quarter
2009
24.2
21.6
22.0
20.8
21.6
18.6
20.1
19.1
21.8
20.8
3rd
Quarter
Operating
Revenue
$(Millions)
239
178
21.1
19.1
18.5
17.8
18.4
467
14.6
13.2
12.3
11.9
10.9
440
20.7
17.5
14.7
13.7
10.2
198
8.9
16.2
6.6
14.5
6.9
12.9
6.5
12.7
6.4
N/A
178
N/A
16.9
14.9
13.9
13.4
12.9
1,699
3rd
Quarter
2008
4th
Quarter
2008
1st
Quarter
2009
2nd
Quarter
2009
3rd
Quarter
2009
Page 33
American Airlines
References
http://www.aa.com/i18n/aboutUs/main.jsp&anchorEvent=false
2 http://www.aa.com/i18n/amrcorp/corporateInformation/facts/history.jsp
3 http://bulk.resource.org/courts.gov/c/F2/184/184.F2d.66.21727.21728_1.html
4http://www.aa.com/AAdvantage/aadvantageHomeAccess.do?anchorLocation=
DirectURL&title=aadvantage
5 http://www.oneworld.com/ow/news/details?objectID=1271
6 http://www.oneworld.com/
7 AMR 2009 Annual Report
8 AMR 2009 Annual Report
1
AMR 2009 Annual Report
10 http://seekingalpha.com/article/183529-amr-corp-q4-2009-earnings-calltranscript
11 AMR 2009 Annual Report
12 AMR 2009 Annual Report
13 AMR 2009 Annual Report
14 2009 Annual Report & 10-K for DAL/UAUA/LUV/AMR/JBLU/CAL/LCC/ALK
15 http://www.standardandpoors.com
16 2009 Annual Report & 10-K for DAL/UAUA/LUV/AMR/JBLU/CAL/LCC/ALK
17 http://www.bts.gov/press_releases/
18 Google Finance
19 Google Finance
20 Google Finance
21 January 21st Brokerage Reports
22 http://seekingalpha.com/article/183529-amr-corp-q4-2009-earnings-calltranscript
23 http://seekingalpha.com/article/183529-amr-corp-q4-2009-earnings-calltranscript
24 January 21st Brokerage Reports
25 http://www.iata.org/ps/intelligence_statistics/Pages/index.aspx
26 http://www.naics.com/censusfiles/ND481111.HTM
27 http://www.southwest.com/about_swa/press/factsheet.html#funFacts
28 AMR 2009 Annual Report
29 http://www.aa.com/i18n/amrcorp/corporateInformation/facts/fleet.jsp
9
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American Airlines
30http://web.mit.edu/airlinedata/www/2008%209%20Month%20Documents/E
mployees%20and%20Productivity/Total/Total%20ASMs%20Produced%20per%
20Dollar%20of%20Employee%20Compensation.htm
31http://www.brookings.edu/~/media/Files/rc/reports/2009/1008_air_travel_t
omer_puentes/1008_air_travel_appendix_3.pdf
32 http://recession.org/library/list-of-bankrupt-airlines
33http://www.aa.com/i18n/urls/gogo.jsp&anchorLocation=DirectURL&title=gog
o?anchorLocation=DirectURL&title=wifi
34 http://www.centreforaviation.com/news/2010/01/22/american-airlinesflightplan-2020/page1
35 http://www.apfa.org/content/category/9/17/46/
36 http://www.star-telegram.com/2010/03/03/2012954/american-airlinesflight-attendants.html
37 http://news.bbc.co.uk/2/hi/business/8597519.stm
38 http://www.glgroup.com/News/After-Pointless-Strike-British-Airways-IsBack-In-Business-47515.html
39 http://aviationblog.dallasnews.com/archives/2010/03/the-flight-attendantsunion-at.html
40 http://seekingalpha.com/article/174816-trying-to-understand-airlineexecutive-compensation
41 http://web.mit.edu/airlinedata/www/default.html
42 http://www.aa-mro.com/
43 http://www.haeco.com/
44 http://www.ameco.com.cn/index-e.htm
45 http://www.aeroman.com.sv/
46http://www.tulsaworld.com/business/article.aspx?subjectid=45&articleid=200
91028_45_0_hrimgs266815
47 http://www.aa.com/content/images/jp/ta/pdf/UPDAATE_09Mar_en.pdf
48 http://aviationblog.dallasnews.com/archives/2009/03/american-flies-boeing767-300.html
49 http://www.prnewswire.com/news-releases/american-airlines-and-jetblueairways-sign-agreement-to-collaborate-at-key-east-coast-gateways89588957.html
50 http://www.centreforaviation.com/news/2010/04/06/new-american-airlinesjetblue-deal-expected-to-generate-usd69-million/page1
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American Airlines
http://www.flightglobal.com/articles/2010/01/25/337592/continental-citescompetitive-gains-with-lie-flat-seats.html
52 http://asia.businesstraveller.com/asia-pacific/news/delta-airlines-joins-thefull-flat-seat-club
53 http://www.aa.com/i18n/amrcorp/corporateInformation/facts/fleet.jsp
54 http://www.wsws.org/articles/2001/oct2001/air-o18.shtml
55 http://www.bts.gov/press_releases/
56 http://www.bts.gov/press_releases/
57 http://www.bts.gov/press_releases/
58 http://www.bts.gov/press_releases/
51
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