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American Airlines' Leader
Tries to Cut Costs While
Battling Rivals, Fuel Hikes
By MELANIE TROTTMAN
Staff Reporter of THE WALL STREET JOURNAL
December 30, 2004; Page B1
It's hard to imagine a worse time to be running a major airline.
Weighed down by mammoth costs, big hub-and-spoke airlines are struggling to compete with smaller, sleeker discounters. Those fast-growing upstarts have contributed to a glut of airline seats that have deflated passenger fares. Lower fares are great for passengers, but they've pinched airline revenues just as fuel expenses have soared to record highs. Industry analysts spend their time debating not about profits, but about who's going to survive.
AMR Corp.'s American Airlines had just posted a $1.04 billion first-quarter loss when Gerard J. Arpey took over as chief executive in April 2003, rising from a one-year stint as president (a title he's kept) and chief operating officer of the airline he's been with since 1982. The cash-crunched, debt-ridden airline had just avoided a trip through bankruptcy court through bitter negotiations with employee unions that won the company $1.8 billion in wage and benefit givebacks. But that wasn't enough. The world's largest airline was in need of extreme repair.
Within a month of taking office, Mr. Arpey, who is also chairman, unleashed an aggressive turnaround plan to further slash costs and streamline operations. He whittled the fleet to six types of planes from 14, and largely abandoned an expensive "more legroom in coach" strategy after finding passengers didn't want to pay more for the extra space. To compete with budget airlines such as AirTran and JetBlue, he capped fares and eased restrictions on certain routes. And he hired consultants he compares to marriage counselors to help mend labor relations.
Mr. Arpey's swift action lowered American's operating costs from among the highest of the major hub-and-spoke carriers, to among the lowest, narrowing losses. But since then, market conditions have only worsened with weaker fares and higher fuel costs. Meanwhile, other airlines are catching up to American with their own turnaround plans, and it's become apparent that Mr. Arpey didn't do enough to return to profitability. The airline, based in Fort Worth, Texas, is expected to post net losses this year totaling $958 million, compared with last year's losses of $1.2 billion, according to estimates provided by Thomson First Call.
So Mr. Arpey has shouldered his ax again. Earlier this month the airline announced it would pull meals off all domestic flights' coach cabins, and it's even taking away passenger pillows on some flights to pare costs.
In a recent interview, the 46-year-old airline veteran talked about the challenges facing the industry and how he hopes to avoid sinking further into a sea of red ink. He also explained why someone would be crazy enough to want to be an airline executive these days. Excerpts:
WSJ: This has been a particularly bad week, in a particularly bad year, for airlines. Is there something systemically wrong with the industry? Are you in danger of losing the confidence of the flying public?
Mr. Arpey: Well, with close to a third of the industry's capacity operating in bankruptcy, there are clearly severe problems in the industry. Any carrier, in bankruptcy or not, that loses the confidence of the flying public won't be around very long.
WSJ: Is the labor unrest at US Airways a harbinger of more trouble? Are there likely to be more disruptions in terms of lost baggage, computer glitches, cancellations and delays?
Mr. Arpey: Although there are a lot of commodity-like aspects to the airline business, it is in the end a service business. Good service can only be provided by motivated people who understand that their own welfare is dependent on doing a good job for the customer. Labor unrest is truly suicidal behavior from the company's and employees' perspectives. That's why, beginning early in 2003, we've worked hard to make our unions and employees our business partners. We've made good progress, but still have a lot of work to do. Those management teams, unions, and employees that figure this out will be successful in the long run; those that don't, won't.
WSJ: With so many airlines now in bankruptcy protection, and announcing ever deeper cuts, how can they ensure the same level of safety they've always been so proud of? Has American cut back on maintenance at all?
Mr. Arpey: Absolutely not! Safety is the cornerstone of everything we do -- compromising on maintenance would simply be foolish. Beyond that, the FAA regulates and actively scrutinizes the maintenance program of every U.S. carrier. I'd also never operate an aircraft at American that I wouldn't put my kids on.
WSJ: When do you expect the industry to be profitable again?
Mr. Arpey: Next year is shaping up to be another difficult year, so it could be very hard to predict. One of the problems the industry has today is too much capacity, which is not allowing any of us to cover our costs. You know it's a very difficult time in the airline industry when in the third quarter, which is traditionally the best quarter for airlines, only one or two carriers actually earned a profit.
WSJ: What's your outlook on fuel prices?
Mr. Arpey: When we move into the first quarter of 2005, We're anticipating a much higher fuel bill than we had a year ago. And unlike a lot of industries, we have not been able to take that cost and pass it on to our customers.
WSJ: Is the industry's pricing power is improving?
Mr. Arpey: We had some modest success in the fall and winter at raising some fares, so in that sense I think, yes, it has improved, but nowhere near the point where we are passing on what we're incurring in higher fuel prices.
WSJ: How much does a $10 domestic increase in fares save you on fuel costs?
Mr. Arpey: If we were able to sustain a $10 increase that would amount to several million dollars a day in added revenue.
WSJ: How are you responding to competition from discounters?
Mr. Arpey: In the past, American was very good at finding ways to bring in more revenue than our competitors from every departure we flew. We did it by having many different types of airplanes, each for a specific mission, and we created a very complex operation. We were successful at increasing revenue but it was very expensive.
Our turnaround plan is all about moving toward simplicity to drive the cost of producing our product down. We are striving to provide a high-quality product that our customers value while adopting some of the practices that have made the low-cost carriers successful.
We're not going to get down to one fleet type like Southwest, but we can emulate some of their operating paradigms by not operating all six types of airplanes to every airport that we fly. So in our 2005 plans, we're pulling 737s out of Chicago and pulling MD
-80s out of Miami.
WSJ: Giving your customers what they value is part of your turnaround plan. How does pulling pillows off of certain planes help?
Mr. Arpey: In the domestic operation, managing the pillows, cleaning the pillows, and keeping them in inventory drives a lot more expense than you might otherwise recognize. By taking them off the airplane, we drive simplicity and lower expense. And in most of the domestic short-haul markets people were using those pillows less and less. So it's an example of emulating our low-cost competitors. Those are some of the tough decisions that we need to make to get our costs down.
WSJ: How much are you saving from this?
Mr. Arpey: Hundreds of thousands of dollars a year.
WSJ: But how would you feel if you wanted to sleep on the plane and didn't have a pillow?
Mr. Arpey: I'd bring my own pillow.
WSJ: With all the biggest airlines piling on to the more profitable international routes now, is overcapacity and price-cutting a risk in that arena as well?
Mr. Arpey: One of the things that we can capitalize on is the depth and breadth of our network. It's one of the ways that we can compete more effectively with low-cost carriers that operate primarily in the domestic market. So next year we have very aggressive plans internationally, and American will be expanding our Asia network by close to 50%. We'll also be building our European service. We can draw traffic from all over the world to our domestic network. Having said that, certainly as more and more carriers pour capacity into international markets that will put downward pressure on pricing.
WSJ: What does American offer that the low-cost competitors don't?
Mr. Arpey: Our strengths include a very broad network that spans the U.S. and the globe. We have the largest frequent-flier program, Admirals airport clubs and a great first-class product. Our challenge is we can't abandon those strengths as we strive to drive our costs down to more competitive levels.
WSJ: Can American and other carriers extract a revenue premium for those services -- can you really charge more for them?
Mr. Arpey: Even in this difficult revenue environment, we get more revenue per passenger than the low-cost carrier. How big that revenue premium is and how much of it you can sustain over the long term, I think, is the more difficult question. Undoubtedly we can sustain a revenue premium. It's just smaller than it once was, and I think there's going to continue to be pressure on it.
WSJ: Revenue premium can mean fares are higher, but can it also mean that you're selling more of the higher fare?
Mr. Arpey: More of the higher fare and a different mix of traffic. In an Austin-to-Dallas market, for example, we will have customers that are going to New York, Tokyo and London. You could have one guy on that flight at $49, and then you turn that $49 fare off because you said 'I'm going to wait and see how many passengers I've got going to London and all these other places.' Then as you move nearer to your departure date, you may turn back on a $99 local fare instead of the $49 fare.
And that's what our yield-management and pricing group does every day. They look at every flight in every market. They decide how much connecting traffic to take, how much local traffic to take, and at what price.
WSJ: What effect would a US Airways liquidation have on American Airlines?
Mr. Arpey: Any capacity that comes out of the industry I think would be a net benefit and potentially give us pricing power that we haven't had for the past couple of years. Our network does not overlap as much with US Airways as some others, so I don't think we would be as much of a beneficiary as some of the other network carriers.
WSJ: American has gone through some really rough periods with its unions. How are you patching things up?
Mr. Arpey: We have tried to make the heads of our unions, and other employees, our business partners, recognizing that their future is inexorably linked to the success of American Airlines. This isn't about sitting around singing Kumbaya and trying to be friends. It's about us educating them about our business and our challenges, and seeking their help in meeting those challenges. Likewise, it's about them educating us about their business as union leaders.
WSJ: Do you worry about the possibility of having to ask for more concession from employees?
Mr. Arpey: Well again, our focus today is to work collaboratively to achieve all that we can within the current confines of our contract and we have many initiatives in place for 2005 and we'll see what happens with these other carriers.
WSJ: What do you do to stay in touch with ground-level employees?
Mr. Arpey: I try to spend as much time as I can when I travel going to break rooms, talking to agents at the gate, talking to flight attendants on board the airplane, riding in jump seats, and I answer all the e-mail that gets sent to me, so I feel pretty well connected to our employees.
WSJ: What, if anything, are you encouraged by in the industry right now?
Mr. Arpey: I'm encouraged by the insatiable appetite for travel in this country and around the world. With the globalization of the world's economy, I think you're going to see more and more robust travel, so I'm very encouraged by the product that we offer. There's never been a better value.
WSJ: Why would anyone want to be an airline executive these days?
Mr. Arpey: I've been around it my whole life. [Mr. Arpey's father worked for several airlines including TWA and Continental.] I started loading bags when I was in college with one of our competitors and was fortunate to get an internship in graduate school with one of the European carriers, and then I joined American right out of business school, and I've been here ever since. I'm very passionate about the industry and about my company, and it's hard for me to imagine doing anything else.
WSJ: And you also fly as a hobby?
Mr. Arpey: I do fly. Ironically, flying takes me away from the airline business. It's hard to think about anything else when you're flying an airplane.
Write to Melanie Trottman at email@example.com