Carnegie Consulting Strategic Solutions for Business
Ensuring Corporate Vitality in a Changed Industry
Prepared for: AMR Corporation - Table of Contents -
Executive Summary...... 2
Company Overview ...... 2
Internal Rivalry...... 5
Substitutes and Complements...... 7
Conditions of Entry and Exit ...... 8
Buyer and Supplier Power...... 9
Financial Overview ...... 11
Strengths, Opportunities, Weaknesses, Threats...... 12
Strategic Analysis: Ensuring Corporate Vitality in a Changed Industry
...... 14
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -1- Executive Summary
As the United State's largest airline, the AMR Corporation, parent of American Airlines and American Eagle, has for over seventy years been synonymous with air travel in the US. Today, the air industry is as competitive as it has ever been, and the AMR Corporation faces threats from a number of dimensions. This report analyses the air industry through a five forces methodology with specific focus on AMR's business. A summary of the threat of each of these forces to profits is below. Following the five forces analysis, the report explores the strengths, weaknesses, opportunities, and threats (SWOT) that face AMR before providing a strategic plan for continued corporate vitality.
The strategic plan, presents a three-tiered approach that focuses on increased political lobbying, the continuation and expansion of cost cutting mechanisms, and, most importantly, the recommitment to customer service and satisfaction.
Summary of Five-Forces Analysis of the Airline Industry in the U.S.
Force Threat to Profits Internal Rivalry Medium to High Entry Low to Medium Substitutes and Complements Low to Medium Supplier Power High Buyer Power Medium
Company Overview
Company History The AMR Corporation traces its roots to Charles Lindberg, who was the chief pilot for Robertson Aircraft Company, one of many aviation companies that consolidated in 1929, eventually forming first American Airways in 1930 and then American Airlines in 1934. American Airlines enjoyed early successes-- by 1937 American had carried its millionth passenger, and by the end of that decade American was the nation's top domestic air ______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -2- carrier in terms of revenue passenger miles. American's freight service was initiated in 1944 and grew over the late 1940s and 1950s.
During World War II American Airlines turned over half of its fleet and crew to the military airline, Air Transport Command. At the same time, the remaining fleet experienced a vast increase in demand for air travel.
Between 1945 and 1950, American operated American Overseas Airline (AOA), which would eventually merge with Pan American World Airways. AOA marked American's first European service, and it wouldn't be until 1982 that American would resume service to Europe. At the same time, American had expanded its fleet and was able to offer the only complete fleet of pressurized passenger airplanes.
Also during this period, American introduced the Magnetronic Reservisor, which kept track of available seats. 1953 saw the first transcontinental nonstop service in both directions and in 1957 American built the world's first facility specifically for flight attendant training.
In the early 1960s, the Magnetronic Reservisor, through a partnership with IBM, evolved into SABRE (Semi-Automated Business Research Environment), which would extend from coast to coast and become the largest data processing system for business use, and second only to the U.S. government's SAGE system.
The 1960s and 70s saw a modernizing of American's fleet, and also the addition of Caribbean routes through a merger with Trans Caribbean Airways and acquisitions from Pan American World Airways. In the late 70s American introduced its most popular fare, the Super Saver, which expanded in less than a year from discounts on flights from New York and California to fares across the entire country.
The deregulation of the Airline Industry in 1978 and 1979 was met by American with increased service and new routes across the U.S and Caribbean. It was at this time that American also moved its headquarters from New York City to Dallas/Fort Worth.
The AADVANTAGE travel program, revolutionary at the time, was introduced in 1981. Also in that year, American established its Dallas/Fort Worth hub. The following year American established a hub in Chicago. It was also in 1982 that American Airlines carried its 500 millionth passenger.
The AMR Corporation was created on May 19, 1982 through a stockholder approved reorganization plan. American Eagle was added as a subsidiary in 1984. Also in that year, AMR stopped flying its fleet of 747 cargo planes, instead focusing on smaller cargo shipped on passenger flights. In 1988 AMR launched its same-day freight service.
1986 saw the establishment of hubs in San Juan and Nashville, and for the first time, AMR employed over 50,000 people. The Miami hub opened in 1989.
SABRE, which continued to grow, was used by over 10,000 travel agents by the end of 1985. The system moved to a secured underground facility, protected against all major
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -3- disasters in 1987, and at the same time was opened to the public for access via personal computer. SABRE was taken public in 1996.
The early 90s were witness to several new services, including the International Flagship Service, American Flagship Service, and Value Pricing. Also during this time, AMR was expanding their facilities, the highlight of which was the first maintenance facility built in the U.S. in more than 20 years. It was during this activity that American Airlines’ billionth passenger flew.
In 1998, AMR acquired Reno Air and Business Express. It was also at this time that AMR, partnered with four other airlines to launch the ONEworld alliance, allowing passengers access to frequent flyer miles, lounges, and other benefits of partner airlines in a code sharing agreement that covers over 130 countries.
American's "More Room Throughout Coach" program was launched in 2000, and in 2001 American boasted larger overhead bins. It was also in 2001 that American announced plans to acquire Trans World Airlines. At this same time American sped the construction of a new $1.3 billion terminal at New York's JFK airport.
American Airlines lost two planes in the terrorist attacks on September 11th, and a third plane in a crash on November 12, 2001.
Regulation Prior to deregulation in the late 1970s, the Civil Aeronautics Board (CAB) controlled entry, routes and ticket prices. Deregulation ended the CAB's management of this domestic cartel, and granted the Department of Transportation (DOT), the recently formed Transportation Security Administration (TSA), and the Federal Aviation Administration (FAA), with scaled back regulatory control of the air industry. For the first time, these three agencies allowed any "fit, willing, and able" airline to fly on any route and charge any rate. The shift marked, in general, a focus from promoting and ensuring that the airlines served the public's economic interests to primarily ensuring that they operated safely.
Even after deregulation, the air industry faces significant regulation. The DOT has maintained jurisdiction over many international matters and consumer protection issues such as advertising, denied boarding compensation, and baggage liability. The FAA, meanwhile, has jurisdiction over general flying operations, including personnel, aircraft, and security standards. For example, the FAA has recently issued a number of requirements that American Airlines is currently implementing such as enhanced ground proximity warning systems and Airbus A300 structural improvements.
In addition, air carriers face regulation from local governments and municipalities who own airports and whose environmental controls, allocation of gates and runways, and other regulations can be both considerable and inconsistent. Further, some (but not all) of the busier airports are regulated federally, in an (mostly ill fated) attempt to alleviate congestion.
International routes remain more heavily regulated that domestic routes, and restrictions remain in place that prohibits a foreign carrier from flying between two destinations ______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -4- within the US, and vice versa. The DOT maintains regulatory control over the approval of code share agreements and international route authorities.
With the recent terrorist attacks, the industry is likely to see increased regulation and government participation in all areas of its operations, from ticketing, check-in, and security to maintenance and in-flight procedures.
Recent Acquisitions In January 2001 AMR announced plans to purchase all of TWA's assets, and the assumption of over $3 billion in liabilities, for $625 million in cash. Since formally purchasing the assets in April 2001, TWA has been integrated into the American Airlines system, and as of December 2001, TWA aircraft bore the American Airlines name. The merger allowed American Airlines access to TWA's geographically valuable St. Louis hub and one of the most modern fleets in the US.
In addition to the TWA acquisition, AMR announced in January 2001 plans to acquire key assets from US Airways and a 49% stake in DC Air, with a first right of refusal on the remaining 51% stake. Internal Rivalry
Market Definition The AMR Corporation's core market is scheduled transportation of passengers and high priority cargo via jet aircraft between two airports, at least one of which is located in the United States. High priority cargo is defined as cargo with a required delivery time (from airport to airport) of less than 24 hours. Given this definition, AMR's 2002 North American Industrial Classification System (NAICS) title and code is "Scheduled Air Transportation" (48111), whose two subcategories of "Scheduled Passenger Air Transportation" (481111) and "Scheduled Freight Air Transportation" (481112) are particularly relevant.
Geographic Market Definition AMR provides service between cities located throughout the world, with the exception of Africa, on its two subsidiary airlines, American Airlines and American Eagle. The majority of North American and Latin American travel is routed through one of AMR's five hubs in Los Angeles, Chicago, Dallas/Fort Worth, St. Louis, Miami, and San Juan (Puerto Rico). Through AMR's participation in the ONEworld program, passengers are able to make transportation arrangements through AMR for travel between any combination of airports throughout the entire world, some segments of which may be on AMR aircraft, while others may be serviced by partner airlines such as British Airways, Cathay Pacific, FinnAir, Qantas, and others.
Competitors Given the definitions above, AMR's primary competitors include United Airlines, Delta, Northwest Airlines, Continental Airlines, and US Airways. AMR also competes against regional and niche airlines, including (but not limited to) Alaska Airlines, Southwest Airlines, Access Airlines, America West Airlines, American Trans Air, Atlantic Coast Airlines, Big Sky Airlines, Midway Airlines, Midwest Express Airlines, National Airlines, ______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -5- Shuttle America, and Skywest Airlines. This list does not include carriers that are outside the geographic market definition above but may compete with AMR in specific international routes such as AirFrance, British Airways, Virgin Atlantic, and Lufthansa among others.
Quantitative Market Measures In 2000 the domestic airline industry had a four-firm concentration ratio of 74.1 with American Airlines leading the industry with 24.0% market share. With a Herfindahl index of 1642, the industry is moderately concentrated. It should be noted, however, that this index does not include many of the small regional and niche firms-- it is based on AMR's primary competitors as defined above, with the addition of Southwest Airlines, and America West Airlines.i
While the industry as a whole is moderately concentrated, individual airports can be extremely concentrated, significantly affecting both the supplier power of the airport, but also competition in general within that city. Four-firm, year 2000, concentration ratios for major US airports are below, AMR hubs are in boldii:
Airport CR4 Dominant Firm (%Share) Cincinnati International (CVG) 96 Delta Airlines (62) Houston Hobby (HOU) 96 Southwest Airlines (83) Oakland International (OAK) 94 Southwest Airlines (68) Pittsburgh International (PIT) 92 US Airways (75) Dallas/Fort Worth International (DFW) 91 American Airlines (70) Houston George Bush International (IAH) 90 Continental Airlines (82) Saint Louis Lambert International (STL) 90 American Airlines (72) Chicago O'Hare International (ORD) 87 United Airlines (47) Minneapolis/St. Paul International (MSP) 87 Northwest Airlines (77) Hartsfield-Atlanta International (ATL) 85 Delta Airlines (72) Memphis International (MEM) 84 Northwest Airlines (71) Chicago Midway (MDW) 83 Southwest Airlines (45) Detroit International (DTW) 83 Northwest Airlines (63) San Jose International (SJC) 82 Southwest Airlines (33) Dulles International (IAD) 81 United Airlines (43) Philadelphia International (PHL) 80 US Airways (57) Ronald Reagan National (DCA) 69 US Airways (30) San Francisco International (SFO) 68 United Airlines (51) Seattle-Tacoma International (SEA) 67 Alaska Airlines (28) LaGuardia (LGA) 66 Delta Airlines (23) Boston Logon International (BOS) 65 Delta Airlines (22) Tampa International (TPA) 65 US Airways (21) Miami International (MIA) 64 American Airlines (48) Orlando International (MCO) 54 Delta Airlines (25) Los Angeles International (LAX) 53 United Airlines (23) John F. Kennedy International (JFK) 51 American Airlines (21)
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -6- Substitutes and Complements
Substitutes The main substitutes for air travel are high-speed rail, passenger bus transportation, and automobile travel. In general, all three provide competition more at a regional level than at a transcontinental level due to the slower speeds and the cost of time. For cargo, freight truck transportation provides significant competition at a lower price, although the speed is considerably slower.
High-speed rail is predominantly confined to the northeastern corridor, connecting cities such as Boston, New York, and Washington D.C. Still, rail transportation does have a presence throughout the continental United States, and current turmoil surrounding large debt and issues of privatization notwithstanding, rail travel offers an alternative to air transport for both passengers and freightiii. With modern trains reaching 165 miles per hour, and the relatively low cost of tickets, rail transportation may be a very close substitute for travel between cities located close to one another, especially when the potentially long airport waits are considered.
Passenger bus services such as Greyhound offer an inexpensive form of transportation throughout the United States. A critical drawback, however, is the duration of travel time, especially for longer distances. For example, a cross-country trip from Los Angeles to New York by bus requires nearly 70 hours (but at a cost of approximately $99), the same trip by plane can be accomplished in a little over 5 hours at a cost of nearly $200 (one-way, not including airport wait times).
Automobile travel provides many of the same benefits of bus service, although at higher cost. While scheduling flexibility may slightly decrease overall costs, the lack of a professional driver and higher per passenger fuel costs makes the Los Angeles to New York trip at least a 110 hour ordeal at a cost of over $175.iv
While the examples provided demonstrate that there are few good substitutes for longer flights, the relative costs (including time) between modes of transportation are much similar for trips of shorter distances. Thus, automobile travel may be an especially attractive substitute for air travel between Los Angeles and San Francisco, while being a poor substitute for the trip between Los Angeles and New York.
The transportation of cargo via rail or freight truck faces many of the same cost considerations, as outlined above, as passenger travel. As a result, cargo which is light weight, of high value, and time sensitive is likely to be shipped via air, while all other cargo will be sent using a substitute.
Complements There is a large range of goods and services that increase the demand for air travel. In the broadest sense, a strong domestic currency and a healthy economy will encourage both business and leisure travel in the United States and abroad. More directly, the price and availability of travel agencies and travel products such as a travel magazines
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -7- and guidebooks can significantly impact the demand for air travel. Perhaps, most importantly, however, the appeal of various destinations serves as a strong complement to air travel.
Business conferences, theme parks, resorts, and other attractions, along with the prices of hotels and transportation, all have a positive effect on air travel when their price is decreased or their availability/accessibility is increased. Conditions of Entry and Exit
The airline industry has substantial barriers to entry due to high capital requirements, limited inputs, and the threat of fierce post-entry competition. Still, any air carrier deemed fit by the U.S. Department of Transportation is free to operate, and the aforementioned barriers have historically not proved to be so large as to prevent niche firms from entering or new entrants from targeting neglected routes.
With the average airplane costing well over $50 million, and the additional expenses of maintenance, marketing, and insurance, the air industry is defined by its high fixed costs. Factoring in the high variable costs-- labor, food service, fuel, and airport fees-- it is not surprising that capital requirements alone provide a significant barrier to entry. Underscoring the large costs associated with the industry is the high inherent risk level. Like many consumer-orientated industries, the airlines are subject to the business cycle, especially for their high-margin seats in business and first class that cater to professionals.
If the costs associated with entering the airline industry are not prohibitive, the ability to service airports may be. In addition to the dominance of airports by a couple major airlines as illustrated by the concentration ratios above, many airports in the United States still have long-term binding contracts that prevent proper competition and hence entry.v An example are long-term "signatory" leases provided to major air carriers by the airports, which allow an existing air carrier to reject any additional expansion of the airport or the signing of a lease by a new air carrier. This power allows the incumbent to sublet gates of their terminal at substantially increased costs to any entering firm.
Should a new air carrier enter, the existing airlines are likely to compete in a number of different ways. First, the entrant will face fierce price competition. For example, in May of 1999 American Airlines was charged by the Department of Justice with predatory pricing against "low-fare" startups at Dallas/Fort Worth Airport (DFW).vi Entrants can also expect non-price competition. In the same suit brought by the Department of Justice, American Airlines was further accused of providing increased frequent flier miles to customer flying from the Dallas/Fort Worth Airport. Further, large airlines can increase capacity at a hub to prevent smaller airlines from gaining any substantial market share.vii
Entrants do have the benefit, however, of a proposal by the DOT in April of 1998, and restated in January of 2001, which would impose pricing and capacity rules in an attempt to limit the extent to which the existing major carriers could compete with entrant carriers. ______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -8- Exiting the industry requires liquidation of assets, most significantly the aircraft. Further, exit requires some acknowledgement of outstanding reservations-- if advanced notice of exit is available this may be through honoring all outstanding reservations and then terminating service, otherwise refunds could be offered, or in the case of bankruptcy, the reservations may simply not be honored and refunds not be provided. While it may be of little consequence for the exiting firm, the Air Safety Transportation Act (ASTA), enacted in November 2001, requires that air carriers honor tickets for suspended service on other carriers that have exited within 18 months of the passage of the ASTA.viii
Buyer and Supplier Power
Buyer Power Individual passengers and businesses make up the vast majority of AMR's customers, and they are, in general, able to exercise strong collective buyer power due to intense competition between carriers on highly competitive routes. This notwithstanding, there are routes which are less competitive, and frequent flyers who may face high switching costs such that buyer power is weakened.
Further, the present pricing schemes are such that the real extent of buyer power may be obfuscated. First, airlines heavily price discriminate by offering high fares very early (targeting inelastic leisure travel), then lowering prices (targeting more elastic pleasure travel), then re-raising prices (targeting inelastic business travel) before slashing prices shortly before the flight (targeting very elastic travel) in an attempt to capture as much surplus value as possible. Second, frequent flyer programs and membership in executive "clubs" impose significant switching costs that lower buyer power. Third, the current collusive pricing behavior of air carriers in which a price increase is posted on a Friday afternoon, and then is either matched over the weekend by competitors, or if the increase has not matched by Sunday afternoon, the increase is withdrawn leaving the lower prices in effect on Monday morning.ix Last, brand identity and the relative low volume of purchases further reduce buyer power.
While buyer power is reduced by the factors above, homogeneity of the product, low switching costs (especially for infrequent travelers), elasticity of demand, and a wide selection of firms increase collective buyer power. With the growth in online travel services, individual travelers can find price discrepancies for the exact same flight with the click of a mouse. Vacation travelers, who tend to be very price elastic, will exercise considerable search costs to find the best deal. Large businesses, however, may enter into exclusivity contracts and gain some level of buyer power as a result. Still, airlines have the ability to move their prices in tandem with the other carriers and force buyers to pay the market price.x This is the rule, not the exception, and the AMR Corporation enjoys this pricing power over most travelers.
In 1991, the Airline Tariff Publishing Company, which disseminates price change information to airline and travel agent computer systems, began an investigation in conjunction with the U.S. Department of Justice. When the investigation began, it was apparent that the airlines operated with a very sophisticated system for setting fares, determining the number of seats available at each price, and disseminating this ______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -9- information to customers, travel agents, and other airlines. The underlying concern in the airline industry has always been whether a clear incentive to compete on price exists. Because there are a small number of firms selling a homogenous good, and because monitoring one another’s prices and responding to changes quickly is possible, collusive pricing can result without explicit communication among firms.
For the cargo transportation segment of AMR's business, buyer power is more significant than in the passenger segment. Relationships exist between airlines and businesses in need of freight/cargo carriers. The product that AMR provides is identical to any other airline in the freight transport market. Thus, price is the only tangible tool that is available to lure customers in this segment.
Supplier Power With $18.3 billion in Year 2000 operating expenses, the AMR Corporation consumes significant variable inputs in the production of scheduled transportation of passengers and high priority cargo. Of this $18.3 billion, approximately 37.0% can be attributed to wages, salaries, and benefits; 13.6% to aircraft fuel; 6.0% to maintenance, materials, and repairs; 5.7% to agent commissions; 5.5% to rentals and landing fees; 4.2% to food service; and 3.3% to aircraft rentals. The remaining is attributed to depreciation and amortization (6.6%) and other expenses (18.2%)xi.
AMR's chief input, labor, is predominately provided through several AFL-CIO member unions, including, the Association of Flight Attendants (AFA)(AE), the Air Line Pilots Association (ALPA)(AE, TWA), the Transport Workers Union (TWU)(AA, AE), and the International Association of Machinists (IAM, TWA)xii. While the supplier power of these unions has been weakened since deregulation, they still exert significant monopolistic power on AMR-- through strikes and pilot "sick outs" the unions have maintained and flexed their bargaining power since the Transport Workers Union's first "dramatic win" over American Airlines in 1946xiii.
For fuel and food service inputs, AMR is free to contract with the company of its choosing (without any control exercised by the airport)xiv. However, given that these companies face considerable economies of scale, a relationship with an existing airline at a given airport can create a price-based barrier to entry that in turn will increase supplier power over AMR. LSG Sky Chefs, the "world's largest in-flight catering alliance", for example, provides 427 million meals per year to over 260 airlines with revenues of $3.5 billionxv. Clearly, these companies exert significant and oligopolistic (if not monopolistic) supplier power over AMR.
With 5.5% of expenses going towards rentals and landing fees, airports themselves are a significant input for AMR. Unfortunately, here too AMR faces monopolistic supplier power-- in any given market, there either exists a sole airport, or there exists multiple airports run as a single entityxvi.
Facing significant supplier power in the areas above, it comes with little consolation that travel agents collectively possess little supplier power over AMR. In November of 1994, the Association of Retail Travel Agents (ARTA), one of the two major travel agent trade groupsxvii, attempted to organize a boycott of airlines which refused to adhere to minimum commissions recommended by ARTA. ARTA eventually settled the case with ______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -10- the Department of Justice by consent decree. In addition to federally limited supplier power, travel agents face increasing competition from AMR's own direct sales through AA.com, which recently received a total of over a million visitors in a two day period and boasts annual revenue of $500 million (old number, needs updating). While the vast majority of ticket sales still originate through travel agents, their collective supplier power is very low.
At the end of 2000, American Airlines owned 451 aircraft all but 76 of which were purchased or leased from the Boeing Company (including McDonnell Douglas). American Eagle owned 165 aircraft, of all different manufacturers. In addition, AMR leases an additional 369 aircraft, at an expense of $607 million or 3.3%. While Boeing has the potential to exert significant supplier power, in practice the competition between Boeing and Airbus is such that the two firms frequently find themselves in bidding wars, limiting their supplier power. As Boeing pursues its Sonic Cruiser, and Airbus its A380, the two firms may begin to differentiate their products and as a result establish some amount of monopolistic supplier power.
Financial Overview
For the fiscal year ended 12/01, revenues fell 4% to $18.96 billion. Net losses from continuing operations and before extraordinary items totaled $1.76 billion, down from an income of $779 million for fiscal year 2000. These results reflect the effect of the recession, the September 11th terrorist attacks, and higher wages.xviii
Already suffering from the recession, the terrorist attacks further injured the airline industry. An increased fear of flying among passengers has led to levels of air travel that are below the break-even point. American Airlines is particularly vulnerable to these effects due to the fact that two of its planes were used in the attacks. Further, the overcapacity resulting from the TWA acquisition has added to the problem.
While a confluence of forces provided downward pressure on AMR's profits in 2001, a series of cost-cutting measures and an industry bailout by the federal government may increase profits. The bailout, valued at $15 billion, consists of $10 billion in loan guarantees and $5 billion in cash, of which AMR is expected to receive $900 million. Cost cutting measures have included a reduction in flight schedule by 20% and the trimming of the work force by 20,000 employees. Standard and Poor's predicts that these measures will allow AMR to hold revenues to a decrease of 15% in 2002, with operating losses continuing but moderating in each successive quarter as passenger loads begin to improve.
Stock Data (as of 4/17/02)
Price 23.165 52 Week Price Range 15.10 - 39.50 Market Capitalization (bn) 3.662 Shares Outstanding (mn) 154.5
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -11- AMR's stock performance closely matches that of the industry as a whole, indicating that much of the recently depressed price are representative of industry-wide issues and not limited exclusively to AMR. Further, while the stock price fell sharply following the terrorist attacks, it has gradually risen and will likely recover to pre-September 11th levels.
While Goldman Sachs analysts expect capacity to remain 15% below year ago levels for 1Q2002 and 2Q2002, the industry is expected to become cash flow positive by the summer as airline traffic improves faster than expected and oil prices remain far below forecasted levels.
AMR has reported in its 10k filing that as a result of the unpredictability of future traffic, business mix, and yields, the company continues to have difficulty in gauging the impact of the terrorist attacks. However, given the magnitude of these unprecedented events, the company expects that the negative consequences will continue to be significant in 2002. This high level of uncertainty has made AMR unable to provide an estimate for the full year 2002, although the company is expecting to incur a sizable loss in the first quarter, and incur an overall loss for 2002. According to Multex Global Estimates, analysts expect the Company to lose $3.04 per share in the first quarter and $4.00 per share in fiscal 2002. xix
Strengths, Opportunities, Weaknesses, Threats
Strengths AMR benefits from a strong brand image, economies of scale, and a long tradition of focus on the customer. This focus on the customer has allowed their AAdvantage
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -12- program to reach over 40 million people and is currently the largest loyalty program in the world.
AMR's sheer size is an important strength. With hubs from Los Angeles to San Juan and in between, AMR is able to offer more routes to more destinations than any other domestic carrier.
AMR has responded extremely well to the recession and the added financial uncertainties that September 11th has brought. The company has postponed orders for planes, accelerated the consolidation of its fleet from 14 types of planes to 7 by end of year 2002, reduced their schedule by 20%, and cut planned capacity growth by 4%. In addition, they've trimmed 20,000 jobs and have secured over $1 billion in emergency capital. All in all, AMR is expected to save $1.2 billion in 2002 from these measures. Last, AMR has received nearly $850 million in governmental relief.
AMR benefits from an fuel hedging program in which it enters into jet fuel, heating oil, and crude swap and option contracts, which has reduced expenses on fuel by $545 million in 2000xx.
Increasingly, airline reservations are made through online sources such as Expedia.com, Orbitz, or even AMR's own AA.com. These online "travel agents" generally receive smaller commissions than their traditional competitors, and while travel agents and agencies still make up a large percentage of reservations, AMR is expected to see increasing savings as customers shift from high commission agents to low commissions online services and direct sales.
Weaknesses As with all airlines, AMR faces considerable ongoing fixed operating costs from the ownership and maintenance of a large fleet of aircraft. Further, as outlined above, AMR faces considerable supplier power. The net effect is that AMR is considerably constrained by its expenses, while their customers have come to expect perpetually decreasing fares. With competition from discount Airliners such as SouthWest, American's AAdvantage program is insufficient as a preventative mechanism against switching.
AMR has consistently ranked below its peers in the American Customer Satisfaction Index, and (as with all airlines) has fallen in recent yearsxxi. And while there is evidence that customers are willing to exchange quality for price to some extent, given AMR's reliance on corporate travel a significant drop in customer satisfaction is a concern.
Opportunities Following the September 11th terrorist attacks and the widespread examination of the airline industry, AMR now has the opportunity to focus on inefficiencies and regulations that have long been ingrained within the industry. Given AMR's size and the current political climate, the company is likely to be a successful lobbyist both within governmental bodies but also public opinion.
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -13- Threats AMR's most significant threat comes from a prolonged decrease in the demand for airline travel. While they have the resources in place to withstand short lived dips, a long and severe decrease would cause significant damage to the company. This decrease could result from a severe recession, from additional terrorist attacks, or from some unknown source.
As a result of the September 11th terrorist attacks, insurers have significantly raised premiums and reduced the maximum coverage available for liability for individuals other than employees or passengers for claims resulting from terrorism, war, or similar events. While the federal government has provided supplemental coverage, they have done so only until March 20, 2002, with the possibility of renewal. Clearly, should the government choose to not renew this supplemental coverage, AMR will experience both greater liability exposure and also rising insurance costs.
AMR faces the continual threat that they will not be able to obtain the necessary airport slots that would be necessary for expansion due to changes in governmental policies.
While AMR's fuel hedging program has been extremely successful, the company estimates that a 10% increase in fuel costs will result in an increase of aircraft fuel expenses of $169 million, which due to the competitiveness of the industry, would be borne by the company and not passed on to customers. Strategic Analysis: Ensuring Corporate Vitality in a Changed Industry
Summary The airline industry has long been defined by two periods, divided by deregulation-- business practices and basic assumptions that applied prior to regulation in the late 70s no longer apply in the post-regulatory world of hub-and-spoke systems and intense price competition. The September 11th terrorist attacks mark a second turning point that requires AMR to adopt a three-tiered plan through which AMR will ensure its economic survival and in the process create barriers to entry and switching costs due to increased customer loyalty and product differentiations.
The proposed plan centers on intense political lobbying to ensure that a national resource-- air travel-- is protected; the continuation of development of corporate vitality through targeted cost savings and product development; and a renewed focus of customer service and satisfaction.
Political Lobbying In the aftermath of the terrorist attacks, the air industry has been hurt from all sides. The federal government has enacted reforms to increase air safety, whose cost has been born by travelers and air carriers. The private markets have increased insurance premiums and restricted coverage levels. And, of course, demand is sharply off the already low levels caused by the recession.
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -14- It is now essential that the AMR Corporation serve as the voice of the air industry to the federal government, and that a relationship be developed so that real reform can be enacted which provides the highest levels of safety for travelers while allowing air carriers to remain economically viable.
With federally-subsidized insurance expiring in March 2002, and with the work which must be done on customer service (as outlined below), the forming of this relationship will be key for the company's survival.
Corporate Vitality With AMR's breakeven load factor reaching 78.1% in 2001, up from 65.9% and 63.8% in 2000 and 1999, respectively, it is now of the utmost importance that AMR focus on its corporate vitality through a series of cost cutting measures and product development.
First, in the TWA acquisition, AMR added St. Louis to its group of hubs. Following this addition, AMR should carefully examine whether the Chicago hub continues to be necessary. The Chicago O'Hare International Airport (ORD) is one of the nation's busiest, is federally regulated by slot assignments, and is dominated by United Airlines with 47% market share. The St. Louis Lambert International Airport (STL) offers American a hub at an airport they already dominate with 72% market share, freedom from slot regulation, geographic centrality, and perhaps most importantly, the consolidation of hubs which are separated by roughly 250 miles-- a one hour flight.
While cost cutting measures such as the elimination of the Chicago hub will be essential to AMR's vitality, careful product development could yield a tremendous windfall. To this end, AMR should explore the introduction of limited commuter service that would complement its full-service American Airlines business and short haul American Eagle service. In doing so, AMR would be better positioned to compete against successful discount and niche players such as Southwest. At the same time, the company would be tapping into a market that it could then up sell the more profitable American Airlines routes to through frequent flyer miles and connections.
Ideal locations and routes include the Northeastern corridor, connecting Boston, New York, Pittsburgh, Philadelphia, and Washington D.C.; the technology corridor connecting the San Francisco area to Austin and Seattle; the Midwest connecting Chicago, St. Louis, Detroit; and the Californian market including San Francisco, Los Angeles, and Las Vegas.
While the addition of a commuter service is a high-cost, high-risk, and potentially high- yield endeavor, the acquisition of AT&T's now defunct AirPhone service could be a low- cost, low-risk method to raise the value of AMR's product and create barriers to entry. The acquisition would allow AMR to develop an "Office in the Sky" product for frequent travelers that would provide exclusive connectivity on AMR aircraft.
Customer Service and Satisfaction It may be that the terrorist attack's lasting impacts are not felt most severely by the airlines themselves, but rather by air travelers in the form of increased waits and inconveniences. As a result, it falls to the air carriers to ensure that they do not further alienate their customers by providing low levels of customer service. ______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -15- To do so, AMR should explore incentives for employees to provide the highest-level of service possible. While this may be accomplished through "mystery shopper" programs, surveys, and benefits, AMR may be able to achieve higher levels of performance at a lower cost through the introduction of an employee stock ownership plan (ESOP), such as those implemented by Untied Airlines or Home Depot. Studies have shown that, with time, employees participating in such a plan begin to think as owners of the firm, and productivity and service levels rise. While the stock price is currently attractive to fund this option through a massive stock buy back program, a shareholder approved offering could create the necessary shares to implement the plan.
Beyond employee incentive programs, AMR must take the dogma behind its successful "More Room Throughout Coach" campaign and apply it to all aspects of the business. Ticket reservations and purchasing must be streamlined, check in must be simplified, boarding must be expedited, and in-flight services must be at their highest levels.
Many of these initiatives will require close cooperation with federal regulators, and many have limited competitive advantage over other air carriers due to the low cost of implementation. Still, AMR has the opportunity to gain the reputation as the "carrier who brought service to the skies," which, when paired with the recommended cost savings and product developments outlined above, and AMR's position as the largest domestic carrier in an industry defined by economies of scale, will ensure the AMR Corporation's dominance in the skies for generations to come.
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -16- i http://www.activemedia-guide.com/totalusairline_mrkt.htm ii Fitch Report iii Karow, Julia. “Almost on Time: High-Speed Trains in the U.S.” Scientific American on the web 24 March 2002.
______Carnegie Consulting 425 N. College Avenue s Claremont, CA 91711 -17-