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The Airline Mess


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THE AIRLINE MESS

June 10 was shaping up to be Bob Crandall's kind of day. The CEO of American Airlines had learned that Continental and shareholders of America West had sued his company for predatory pricing. And he was about to face a Senate committee looking into accusations that American was out to drive weaker competitors into the ground. While other chief executives might have adopted a conciliatory stance, Crandall faced down the lawmakers and his accusers with guns blazing.

"America West's management has failed," he snapped. And Northwest's owners are "wheeler-dealers who loaded the balance sheet with debt." Crandall told them the market must be allowed to "finish the painful process of eliminating surplus capacity." Then he offered his own stark vision of the airline industry: "This business is intensely, vigorously, bitterly, savagely competitive."

It's the kind of business where Robert Lloyd Crandall feels right at home. After serving seven years as chairman and CEO of AMR Corp., parent of the world's largest airline, the man some call "Fang" or "Darth Vader" is still the industry's fiercest competitor. His dogfighter tactics--such as more frequent flights on selected routes than other airlines can muster and bursts of lower prices--have driven some weaker rivals to despair.

WREAKING HAVOC. But Crandall is also indisputably an airline visionary. Frequent-flier programs, Super Saver fares, a two-tier wage structure, and creative use of computer reservation systems were all Crandall innovations that redefined the way airlines do business.

Crandall, 56, is still out to remake the industry, and this time his competitors are more fearful than ever. American's recent simplified fare structure and a dramatic half-price promotion in May have suddenly thrown almost all airlines into a tailspin.

Other carriers that had hoped for a relatively decent second quarter are all but certain to sustain losses because of the price war. Fort Worth-based American Airlines Inc. itself expects to post a second-quarter loss--at a time when some analysts say it should be making money. And foreign rivals, even as they push to deregulate their own markets, are worried that Crandall's aggressive expansion overseas will wreak havoc on them (page 54).

The world according to Bob Crandall, many of his U.S. and overseas competitors believe, is a world in which they no longer exist. "Crandall's strategy is cannibalistic," says Air France Chairman Bernard Attali. "His goal is to kill the weak. He plans to do that in the U.S. first. Later, he'll try the same thing overseas."

To hear Crandall tell it, he is the most misunderstood man in Corporate America. "We are more victims than villains," he says. Victims of carriers in Chapter 11, such as Continental Airlines Inc. and Trans World Airlines Inc., that have used their bankruptcy status to lower costs unfairly. Victims of increasing labor and other operating costs. Victims of protectionist governments and their flag carriers abroad. Victims, says Crandall, of "our dumbest competitors"--those that charge low fares, which American and others are forced to match but that often make it impossible for any carrier to make money.

TO THE DEATH. All those factors, says Crandall, rob American of its ability to control its destiny. "The business is driven entirely by the behavior of our competitors," he says. "Each airline decides what's best for it without regard for what is best for the industry."

Dumb or not, weaker airlines' behavior is certainly understandable: With fewer planes and flights, often poorer service, and some with reputations tarnished from bankruptcy, they believe they must undercut the majors to win passengers. Yet Crandall is emphatic: "We cannot give them a price advantage." And so the endless price wars go on--until one or more carriers destroy themselves.

That leads many to fear the creation of a cozy oligopoly. Critics point to the recent settlement of a price-fixing case in which American, United, Delta, and USAir recently agreed to pay more than $400 million to former passengers. The four all deny the charges, however.

The latest fare battles have diminished the prospects of survival for such weakened airlines as America West Airlines Inc. and TWA. American itself may be at risk, Crandall warns--and not only because of low fares. Soaring costs may force the major carriers to take drastic steps. "Let's suppose the next two or three years go by--and American goes bankrupt, Delta goes bankrupt, and United goes bankrupt," he says. "Now, we're all bankrupt."

`PREDATORY.' That scenario may sound farfetched. But in the past two years, the industry has bled an astounding $6 billion in red ink. AMR itself--with revenues of $13 billion in 1991--has lost $280 million in the past two years. And the short-term prospects are little better. Thanks in part to the recent fare war, for which some hold American responsible, Crandall's airline will likely suffer a loss in 1992. Except for Southwest Airlines Co., none of the major carriers is expected to turn a profit.

Critics say Crandall is partly to blame. On Apr. 9, American portrayed its new fare structure as one that would benefit the entire industry. "Value Pricing" offered just four fares for any route--instead of the plethora of convoluted fares that had become so frustrating to travelers. Corporate discounts were dropped. And American lowered coach fares 38%--to roughly the level that those on corporate discounts had enjoyed. Simpler, cheaper, more equitable fares, said Crandall, would eventually stimulate demand and increase trafficon all carriers that adopted the newapproach.

But many saw it as an attack. American was trying to destroy TWA's niche targeting fliers who could not get discounts, said TWA Chairman Carl Icahn--who promptly undercut American. "The whole program is largely predatory," says America West's CEO Michael J. Conway. Others cite as evidence Ameri-can's admission that it would take a short-term hit from the new fares.

The 50% fare cut in May blew the controversy sky-high. The debacle began when Northwest Airlines Inc. announced a 2-for-1 promotion. American saw that as a challenge to its new pricing scheme. So it shot back with a move that matched the promotion while preserving its fare structure: It halved its summer advance fares. The result: Carriers counting on strong summer sales to sustain them through slower months saw their revenues going up in smoke. Says Edward R. Beauvais, founder and Chairman of America West: "What we have here is de facto regulation--with American as the regulator. They set the price and punish anyone who deviates." In the latest twist, American is seeking to raise prices, but not as much as some weaker carriers would like.

`CRAZY WAY.' To others, the shock waves are merely the natural consequence of deregulation. "What's happening now is a 10-year sweep," says Elizabeth Bailey, a former member of the Civil Aeronautics Board and now professor of public policy and management at the Wharton School. "Those in trouble are in trouble by and large because they leveraged themselves in the '80s. American didn't leverage itself in that crazy way."

Even so, the view from Crandall's cockpit is bleak. Costs are rising faster than revenues, and he's hard-pressed to do much about it. Demand is soft. Bankrupt carriers often make it impossible to raise prices. And American and such major rivals as United Airlines Inc. and Delta Air Lines Inc. face an increasing threat from their no-frills competitor Southwest.

While a dearth of venture capital or accommodating bankers lessens the prospects of a new rash of low-cost carriers taking to the skies, the traveling public is imposing its own marketplace discipline. Leisure travelers and a growing number of business travelers won't pay high ticket prices. They're opting instead to drive--or stay home.

Crandall has no choice but to preach a message of urgent reform. He says American and the industry must completely rethink the way they do business to survive in the next century. "We will do whatever is needed--however dramatic the changes may be." American's Value Pricing is just the first of many things to put what Crandall calls value back into air travel.

Yet other than a simplified fare structure and a stubborn refusal to allow anyone to underprice him, Crandall is uncharacteristically vague on the details. That raises the question: Has Crandall's strategy all along been aimed at eliminating rivals and then boosting prices once they are gone? Crandall argues that the bloodbath never would have happened if other airlines hadn't challenged his pricing structure. But given the pressures his rivals faced, how could he have expected them to stay in line? "He sees himself as the enforcer," complains Northwest CEO John H. Dasburg. Northwest, like Continental, has sued American over its pricing moves.

Bob Crandall doesn't cave in to critics just because they make a lot of noise. Take the recent case of Cayman Airways Inc. The tiny flag carrier of the Cayman Islands recently took out an advertisement in The Wall Street Journal pleading with Crandall to discontinue a second flight American had added to the island. "How are we to explain to our children that an airline bearing the name of the only country which the average Caymanian admires even more than our own Great Britain has taken bread out of their mouths?" read the ad. Robert W. Baker, American's executive vice-president for operations, says the flights were authorized by the island's government. But the airline has no intention of reducing its service, at least for now.

`CRANDO.' That may be standard operating procedure in an admittedly cutthroat industry. Yet CEOs of other airlines don't get open letters pleading for mercy. It's just that Crandall's legendary tough-guy image invites such tactics, which are intended to sway public opinion against him. That image is reinforced by tales of a company video in which Crandall, wearing camouflage and face paint, appeared as "Crando." And it is that relentlessness that helped turn American from an also-ran about a decade ago--when he was first tapped to run the company--into the most powerful player today.

A graduate of Wharton and a financial man before climbing to the top ranks, Crandall remains a voracious consumer of statistical data. He grills lieutenants every Monday on details--from on-time records and baggage deliveries to load factors and payroll labor hours--"asking every time: 'Are we doing better than our competitors?" ' says one former executive. "If you haven't done your homework, you do not want to meet with Bob Crandall," says E. Arnold Menn, a longtime acquaintance of Crandall's who runs an executive outplacement firm in Austin, Tex.

The chain-smoking Crandall's intense, driven style meshed well with his strategy for American throughout the '80s: vigorous expansion. From 1983 to 1988 alone, Crandall plowed nearly $7 billion into new planes, doubling the size of American's fleet, to 468 aircraft, and beefing up the work force by 81%, to 78,000 employees. What made that possible was a novel two-tier wage scale that Crandall engineered in 1983. New hires were paid significantly less than old employees, making growth not only desirable but also necessary: The larger American grew, the cheaper it became to operate.

American was still growing at full throttle when the economy began slowing in 1990. And as troubled carriers such as TWA and Eastern Air Lines Inc. were forced to sell key assets in their efforts to stay aloft, American jumped in to grab rich foreign routes. Defenders say American had no way to see the gulf war and recession coming and that it had no choice but to snatch growth opportunities. The same was true for United and Delta, which were buying aircraft and foreign routes as fast as American was. "It's fairly remarkable that it took several years of huge losses" before American and the other megacarriers slowed down, says analyst Philip Baggaley at Standard & Poor's.

LEAN AND HUNGRY? Now, Crandall is in the unfamiliar position of slamming on the brakes. Last November, he announced an $8 billion, or 50%, cut in American's capital-spending plan over four years. United and Delta later followed suit. But Crandall is talking louder than anyone else about slowing down and cutting costs. "What the public wants is affordable transportation," he says, "and that's very difficult to do for a traditional airline."

Crandall's role model for an untraditional airline: Southwest. The spunky carrier, with $1.3 billion in revenues last year, has been the most consistently profitable over the past decade. Its operations are unlike any other in the industry. Instead of a hub-and-spoke system, it flies point-to-point short trips--at rock-bottom fares. If you fly Southwest, you get a cheap ticket, but no advance boarding passes, no meals, and you can't transfer your baggage automatically to another carrier's flight. The absence of those services, plus an extremely productive work force, give Southwest a fearsome 43% cost advantage over giant American.

Southwest's slow but steady expansion from its home base in Dallas to Phoenix, California cities, and now Chicago's Midway Airport worries Crandall. Southwest doesn't target the long-distance traveler and generally uses secondary airports. But it now operates many flights as long as two hours, and plenty of passengers are riding successive trips on Southwest to travel great distances. If the airline continues to turn profits while megacarriers lose money, Crandall worries that "Southwest will be as big as we are."

Crandall says he wants to imitate Southwest in many parts of the country, possibly with a whole new operation. But even he admits that that's easier said than done. Eliminating advance boarding passes, for example, doesn't erase such overhead as the computer systems and the programmers needed to support the rest of American's operations.

American's managers fear that a no-frills product, even under a separate brand name, could tarnish the image of its regular service. So concerned is Baker, the operations head, that he spent a recent Saturday afternoon at the Richardson (Tex.) library studying Coca-Cola Co.'s disastrous launch of New Coke in 1985. "They disenfranchised their most loyal customers," says Baker, who worries that American, which built a reputation for excellent full-line service, could do the same if it's not careful.

So far, Crandall's moves in that direction have been experimental. American has eliminated meals on many short flights, as has rival TWA, to try to dent its $700 million-a-year food budget. On longer flights that aren't at mealtimes, American discovered passengers merely want a diversion, and not necessarily a meal. The solution: food as a toy, or "FAAT," which means handing out such goodies as granola bars or crackers. And American is replacing beef with chicken entrees on many flights, for a saving of $470,000 annually.

JURY IS OUT. Yet even if Crandall makes headway in emulating Southwest, it won't be enough. Crandall warns he may surrender in some markets and close some of American's seven hubs. High on the hit list: Nashville, Raleigh-Durham, N.C., and San Jose, Calif. Travel patterns on the East Coast have changed, American executives say, since the airline first planned the operations in Nashville and Raleigh.

They're also experimenting with new ways of organizing flights at those hubs, but the jury is still out. San Jose, which mostly handles intra-California traffic, has been particularly hard-hit by Southwest's successful expansion. "Pricing in California is now being set by Southwest," says Donald J. Carty, American's executive vice-presidentfor finance and planning. "The question is, can we ever make money in thatbusiness?"

The question is, can American make money anywhere if it doesn't get its fares more in line with its growing costs? Chief among Crandall's problems: labor. Payroll and benefits now account for one-third of American's expenses--and are likely to go higher. Restive union leaders, who note that American still enjoys a labor cost advantage over major competitors, will undoubtedly demand a bigger share of the pie.

After especially bitter negotiations in 1990, American agreed to a labor contract that will give the average pilot a pay increase of 14% in each of the coming two years. And benefits are rising even faster than wages. American argues that it is being held hostage: No airline can afford a strike. Analysts warn that as the industry consolidates, the balance of power will continue to shift in labor's favor.

EXTINCTION? Meanwhile, weaker carriers aren't going anywhere very fast. America West may not survive, some observers say. But TWA could hang on a few more years. Continental, with solid routes and strong hubs, may well emerge from bankruptcy with lower costs and leaner operations. If it does, it can use its advantage to challenge American with lower fares. "The Big Three American, United, and Delta may turn out to be dinosaurs," says TWA's Icahn.

Extinction may not be imminent, but pressures are mounting. American's cost of renting airport space rose 20% last year. With 85% of all tickets booked by travel agents, up from 50% a decade ago, commissions have mushroomed. Fuel prices, always unpredictable, have been ticking up. Add to that the cost of new government regulations--covering everything from noise control to maintenance to drug testing--and there seems to be no relief in sight. "United, American, and Delta are going to have to figure out ways of lowering their seat-mile costs or get out of town," says Michael J. Boyd of Aviation Systems Research Corp. in Golden, Colo.

Crandall had banked on growth overseas, but that arena holds decidedly mixed prospects. Latin America does show great promise. Two years ago, American nearly tripled the size of its operations there with the $470 million purchase of Eastern's Latin routes. It has since plowed nearly $100 million into developing the market, with good results. American has become the No.1 carrier in the region, with a 50% share, and is aggressively gaining share from local carriers. United, which bought Pan American World Airways' Latin routes last year, has not made nearly as significant inroads.

CHINA-SHOP BULL. But strong protectionist sentiments in Europe have clouded prospects in that important market. And Crandall has been virtually locked out of the Pacific, too. It's partly his own fault--for failing to go after Pan Am's Pacific routes when they were on the block in 1985. While Crandall called them too expensive, United snatched the routes for $750 million. But Crandall, who has since conceded that the decision was a mistake, blames the Japanese in part for keeping their markets so tightly controlled.

Crandall saves most of his ire for the State Dept. and Transportation Dept., which he claims are too timid to defend U.S. carriers. He is angered by Washington's failure to insist that foreign governments uphold their treaties. "Now, if I was running the State Dept., I'd say: 'Have at 'em, boys. Fly!"' says Crandall. Such bluster does not always help his case in Washington. "I think it diminishes his effectiveness," says a Washington representative for a competing airline. "A bull in the china shop doesn't sell well here."

Global alliances might smooth the way overseas. American is now in talks with Canadian Airlines International, Canada's second-largest carrier, about an alliance in which American would pay roughly $170 million for a 25% stake in it. The deal would include a potentially lucrative arrangement for American to provide computer services, and a marketing plan that would further enhance American's role as North America's largest carrier. Another lure: Crandall would get access to Canadian's Pacific routes. If the deal goes through, it would be the largest alliance American has ever reached with a foreign airline.

Yet strength abroad won't mean much unless Crandall can find a way to fix his problems at home. He must boost revenues and lower costs to earn respectable returns for shareholders. The last time American delivered what Crandall calls adequate return on equity was 1988--with 16%. He is trying mightily to achieve it again, but he is taking American and the rest of the industry into uncharted territory to get there. Yet whether Crandall is to blame for the havoc in the skies--or whether what has happened is the result of deregulation--may no longer matter. The competitive forces unleashed by deregulation and Crandall's own tactics are reshaping the industry. Now, he and his rivals must deal with a whole new set of problems, the solutions for which they have not yet found.TWENTY YEARS AT AMERICAN

1973

Bob Crandall joins American as senior vice-president for finance

MID-1970s

Crandall develops SABRE reservations system into a travel-agency booking tool,

after attempts at developing an industrywide system fail

1976

American pioneers sophisticated yield-management techniques by using data from

SABRE system to predict booking trends on specific flights

1977

Super Saver fare program introduced, offering deep discounts to leisure

travelers and revolutionizing fare structures. TWA and United file complaints,

blasting fares as money-losing propositions, but Civil Aeronautics Board

permits them. Competitors later follow

1980

Crandall becomes president; promptly shuts down some routes and grounds 18% of

carrier's fleet as he begins overhaul of airline

1981

American unveils AAdvantage, industry's first frequent-flier program, a

powerful tool in developing brand loyalty. Other carriers follow

1983

Crandall introduces novel two-tier wage structure that lowers costs, and allows

American to grow rapidly

1984

American places then-single biggest aircraft order in U.S. aviation

history--$1.3 billion--for 67 MD-80s

1985

Crandall becomes chairman and CEO. Crandall and American sign a consent decree

with the Justice Dept. to settle charges of price-fixing in 1982. United snaps

up Pan Am's Asian routes. Crandall later regrets failure to buy those routes,

as American is virtually shut out of Pacific

1989

Crandall buys Eastern's Latin American routes for $470 million

1991

Having lost out on Pan Am's London routes, American buys three London routes

from TWA for $445 million

APRIL, 1992

American's Value Pricing plan simplifies fares and lowers coach fares as much

as 38%. Rival carriers follow, but TWA and others grumble the plan is designed

to kill weaker carriers

MAY, 1992

Responding to Northwest's 2-for-1 summer promotion, Crandall slashes summer

advance-purchase fares 50%, creating a bloodbath among U.S. carriers. Crandall

says he is defending his price structure

JUNE, 1992

Continental, America West shareholders, and Northwest file suits, accusing

American of predatory pricing

DATA: BW

Wendy Zellner in Dallas and Andrea Rothman in New York, with Eric Schine in Los Angeles and bureau reports


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