American Airlines sharply reduced costs as part of its turnaround strategy. But the company still faces challenges as it tries to return to profitability.
By Trebor Banstetter
Star-Telegram Staff Writer
ABOARD AMERICAN AIRLINES FLIGHT 1086 -- Things are different these days on this McDonnell Douglas MD
-80 aircraft as it cruises from North Texas to New York.
In the cockpit, Capt. Byron Smith keeps a closer eye on fuel conservation by carefully monitoring the airplane's altitude and airspeed.
In the cabin, flight attendant Stephen Jacob serves only drinks. He is pleasant with passengers but acknowledges that tempers can be shorter these days as the crew works longer for less pay.
Passenger Julius Ringquist has a prepacked "bistro bag" rather than a hot meal. He used an automated check-in machine rather than speaking with a gate agent.
In many ways, this 1,391-mile daily flight epitomizes the new American Airlines, which has changed dramatically in the year since the Fort Worth-based carrier narrowly avoided bankruptcy.
More than 500 cost-cutting measures have reduced expenses. There are fewer employees, and they are paid less and operate the airline more efficiently.
Yet, when Flight 1086 lands at John F. Kennedy Airport after a three-hour-and-17-minute trip, it's still a money-loser.
It's a problem that continues to vex American's top executives. Despite great progress in slimming down, the airline continues to lose money, and no one can predict when it might return to significant long-term profitability.
"American has accomplished a lot, and they're really quite far ahead of most of the other major carriers," said airline analyst Ray Neidl of Blaylock & Partners in New York. "But they're not there yet. Clearly, more has to be done."
Although it doesn't usually break out data for individual flights, American agreed to provide the Star-Telegram with financial and operating details for Flight 1086. American executives say it is a typical flight in the airline's network.
The figures include the flight's current results as well as its performance a year ago, before the world's largest airline began slashing costs.
The differences are startling.
Flight 1086's margin -- the difference between the cost of flying the route and the money it makes -- has improved by about 80 percent. Passenger revenue has climbed nearly 13 percent, thanks in part to a 5 percent average increase in airfares.
On a purely operating basis, Flight 1086 is profitable. Its earnings leaped more than 130 percent, well into the black.
Excluding fuel, whose price has risen dramatically, costs dropped by 12 percent. That kind of cost-cutting is crucial in an industry where a single traveler can determine whether a flight makes or loses money.
Still, the flight loses money after taxes and nonoperating expenses are factored in. Those expenses include American's high interest payments, which are part of the fallout from its poor financial performance and the billions of dollars in debt built up since 2001.
"The amount of money we're losing on that flight has dramatically shrunk," said Scott Nason, American's vice president of revenue management. "It used to be a lot of money, and now it's a small amount."
Some of the cost cuts are apparent to passengers such as Ringquist, a business traveler who says he flies every week. In addition to the ticket machines and cold meals, passengers endure longer waits between connections at hub airports because of American's new route schedule.
But the employees have been affected the most. To avert a bankruptcy filing last April, union-represented employees approved $1.6 billion in concessions. The givebacks meant salary and benefit cuts, thousands of layoffs and stricter work rules that required more productivity.
On the ground at Dallas/Fort Worth Airport and at Kennedy, fewer employees work more hours to load, fuel and maintain Flight 1086. Every American worker involved with the flight -- from the pilot to the flight attendants, gate agents, baggage handlers and others -- is coping with smaller paychecks and reduced benefits.
Smith, the pilot, plans to pull his 10-year-old daughter and 8-year-old son out of private school next year as his family adjusts to a 32 percent drop in his base salary.
"We can't drop ten grand on elementary school anymore," said Smith, 44, a 14-year American Airlines employee who lives in Colleyville. "There's a lot of belt-tightening going on."
Jacob, 34, an American flight attendant for five years, has seen his hours increase by about 25 percent because of extra shifts and overtime. Yet he makes slightly less than he did a year ago.
"I was about to get my big five-year raise when the concessions hit," said Jacob, who lives in New York. "It can be very frustrating."
A year ago, American was losing more than $5 million a day, thanks to a complex, inefficient operating structure and costly labor contracts. Many industry analysts believed that a painful tour through bankruptcy court was inevitable.
Today, thanks to a turnaround plan announced in August 2002 and implemented last year, overall costs have dropped about 12 percent.
American even posted slightly lower costs for the fourth quarter of 2003 than rival Continental Airlines, which has been lauded as the most efficient major carrier since a 1992 bankruptcy restructuring.
"That's huge," said Brian McMenamy, American's managing director of airline profitability and financial analysis. "Just huge."
American "is now the new low-cost leader among network carriers," said airline analyst Jamie Baker of J.P. Morgan Securities.
Like most executives, McMenamy has experienced the turnaround plan personally, having taken two pay cuts in the past year.
On Flight 1086, the management cuts translate into a drop of almost 11 percent. But as they tout the improvements, executives acknowledge that the flight probably won't become profitable anytime soon.
"We're still losing money every single month," Nason said. "And there's nothing I can see that says we're on a trend to become profitable."
American cannot count on its lower costs to lead to substantial, consistent across-the-board profits, largely because intense competition from discounters has pushed airfares to the lowest levels in decades.
"By historical standards, we're still in a very depressed revenue environment," Gerard Arpey, American's chief executive, told analysts last month. "I don't know that we'll ever get out of this state of depression."
That doesn't mean profits are impossible. The airline posted a $1 million profit for the third quarter of 2003, largely because of its cheaper operations. Some analysts predict that American will turn a profit this year.
But most say that more changes -- at the airline, among competitors and within the economy -- will probably be needed before American can soar to a long-term recovery.
"The problem is, while American has cut costs, they're still not as low as guys like Southwest and JetBlue," said Alan Sbarra, vice president of Unisys R2A Transportation Management Consultants. "At the same time, they've got to match those low fares."
Sbarra believes that the only salvation for major airlines such as American, Delta and United lies in making even deeper cuts and in harnessing the strengths the low-fare carriers lack, such as international flights, greater frequency of flights and large frequent-flier programs.
But he fears that American and other large carriers may coast through the economic recovery earning small profits, then feel pressure to enrich labor contracts when they expire in 2008.
"Then, they're going to get slammed in the next downturn," he said. "And the next one, whenever it happens, will be even worse."
Others are more optimistic. Airline consultant Mike Boyd of the Boyd Group in Evergreen, Colo., said American is doing a good job against its discount rivals, using ticket giveaways and other promotions to defend its market share.
"They're leveraging their core strengths, which is their size, their hub network and their ability to deliver a product," he said. "JetBlue is never going to have that."
The coming year "will be tough, but I think it will be a healthy one for American," he said.
The changes in the industry are obvious at Kennedy, where American was the top carrier a year ago. Today, the dominant airline is JetBlue Airways, which gobbled market share with cheap tickets and in-flight amenities such as satellite television and leather seats.
JetBlue, which debuted in 2000, can operate more cheaply because it pays its employees less than American, is smaller and flies only in markets with high demand.
But no low-fare carrier competes with American on its three daily nonstop flights between D/FW and Kennedy, allowing the airline to sell some higher-priced tickets. It was charging as much as $2,200 round-trip recently for a full-fare coach seat bought at the last minute.
The lack of competition is one reason revenues have gone up for Flight 1086 as travel demand has risen.
Nonetheless, most of the passengers aboard the Jan. 26 flight flew on cut-rate fares because they bought their tickets far in advance. With AirTran Airways offering discount tickets to New York's La Guardia Airport -- albeit through its Atlanta hub -- American still has to offer low-priced advance fares for price-conscious passengers.
And most of the 106 travelers on the flight -- which was about 80 percent full -- were leisure passengers or business travelers who booked early enough to get a deal, Nason said.
The lowest round-trip fare available was $207, he said.
"Predominantly, bookings are deeply discounted," he said. "This is not a [route] in which we sell a lot of full fares."
For example, the flight's first-class cabin was full, but only one passenger had paid the full fare. Everyone else had upgraded to first class using frequent-flier miles.
Savings on the ground
Many of the factors driving the savings on Flight 1086 began long before the airplane took off.
On average, maintenance and ramp operations are down nearly 12 percent, among the flight's biggest savings. The drop stemmed largely from the new labor contracts as well as American's decision to restructure its schedules at D/FW.
The airline no longer operates large banks of flights that take off and land at the same time, with an hour wait in between. Instead, planes take off every few minutes, requiring fewer ground workers to prepare for departure.
The new flight structure also helped cut the cost of passenger services, which include gate agents and skycaps, by almost 15 percent.
The average cost of airport agents at the ticket counters for Flight 1086 is down almost 10 percent because of several factors, including more automated check-in machines as well as salary cuts and layoffs.
Increased use of American's Internet booking site helped push travel agent commissions and credit card fees down by almost 17 percent. The airline works hard to steer customers to the site, offering extra frequent-flier miles and other inducements.
"It's a very efficient channel for distributing our product," said Bella Goren, American's vice president of reservations.
Countless other initiatives have helped. American has saved nearly $700,000 by using coffee maker parts from old DC-10s to repair machines. It's a plan submitted by employee K. Vance Lawin, who researched its viability before discussing it with his supervisor.
Even the airplane is working harder. On average, the MD
-80 will spend more hours in the air each day than a year ago.
Savings in the air
The single biggest reduction takes place after Flight 1086 takes off. The cost of the flight crew dropped by nearly 17 percent.
That's due primarily to two factors -- longer hours and less money. Other savings come from items such as cheaper hotel and transportation costs for crew members because of the renegotiated contracts.
The airline has also reduced training fees by parking hundreds of airplanes. American has gone from 15 types of aircraft to seven -- meaning flight crew members don't have to be trained as often to work on different planes.
For pilot Smith, all the cutbacks have meant keeping a sharp eye on the family budget and eliminating many luxuries.
"We don't go out to dinner, and I don't play golf much anymore," he said. "You cut out as many little things here and there as you can."
Smith and his wife were considering taking their children out of private school last year; the cutbacks sealed the deal, he said. "That's probably one of the biggest changes for us," he said.
Smith said he joined American in 1989, largely because of the carrier's reputation for innovation. "At the time, American was very forward-looking, and it seemed to have strong leadership in Bob Crandall."
He chuckled wryly. "Who knew that when I hit my 40s, I'd be talking about cutbacks?"
Smith is often paired with younger co-pilots who worry about being laid off. "You try to be as supportive as you can," he said. "Everyone in this business knows what it feels like to be on the edge like that."
Jacob said the cutbacks have hurt morale. That's particularly difficult for flight attendants because they're expected to be friendly to passengers, which can be difficult when fatigue follows a shorter layover.
"When there's a problem, with a delay or weather or something, and the passengers start getting upset, that's when you feel it the most," Jacob said.
"It's my hope that most of us are professional enough that the passengers never notice," he said. Then he added, laughing, "but when we're in the galley and no one can hear us, you can bet there's a lot of talk about the day we're having."
His overtime means more days in the air. Jacob estimates that he has as many as four fewer days off a month.
Jacob said the extra hours have dramatically altered his social life. "You don't have time to go out and see friends. You just want to sleep and rest up," he said.
Fewer attendants are needed on Flight 1086. When meals were part of the flight, as many as six flight attendants were on board; today, the airline uses the federal minimum of three. Food and beverage costs dropped a little more than 10 percent.
American also no longer gives away headsets for in-flight entertainment.
Passengers can use their own or buy a pair from the airline. That not only saves the price of the headphones but also eliminates the cost of cleaning the equipment after every use.
What steps can American take to close the gap between costs and revenues?
Clearly, additional expenses can be eliminated. For example, American plans to restructure flight schedules this year at its Miami hub. Those changes are part of $600 million in expenses that executives say they must slash before reaching their goal of $4 billion in annual savings.
Arpey has said recently that the campaign won't end there. The CEO has told employees that reducing expenses must become part of the airline's culture.
"We have to change the whole paradigm in this company, which has historically been revenue-focused, to cost-focused," he told analysts.
He has also acknowledged that American isn't likely to reduce costs enough to match the low-cost carriers. But he doesn't believe it has to.
He told the Society of Airline Analysts in a speech last year that he hopes the airline can push costs low enough to make money as long as it charges somewhat higher fares than the discounters.
Although Arpey won't specify how much of a premium American can charge, his predecessor, Don Carty, said he believed the airline could charge up to 30 percent more than Southwest or JetBlue.
Some analysts, however, doubt that American can charge much more than the low-fare carriers on routes where they compete directly. And pricing information shows that, in most cases, American and other major airlines match the lowest fares on competitive routes.
"This idea that American can get a pricing premium over the JetBlues of the world is a huge assumption," said analyst Sbarra. "And we haven't seen any indication yet that it's happening."
Regardless, nearly everyone -- from the analysts to the executives to the employees -- agrees that even more changes are in store if the new American Airlines is to thrive.
"We have managed to pull ourselves out of the nose dive we were in," Arpey told analysts recently. "But the work we need to do, to transform AMR into a consistently profitable company, is just beginning."
Despite the difficulties of working for American today, both Smith and Jacob say they plan to stay with the airline.
"American is still the best airline to work for and to fly for, and when we get over this, I think we'll all get a very good return on the investment we're making with our time and money," Jacob said.
Said Smith: "For me, joining American Airlines was like a marriage. And I'm not about to break that commitment now."