Arpey predicted American's predicament By Trebor Banstetter Star-Telegram Staff Writer FORT WORTH - Gerard Arpey couldn't have made his case more strongly: "One=20 of the greatest threats confronting the established carriers today," he=20 wrote, "is competition from low-cost, highly productive" airlines such as=20 Southwest. It could have been an excerpt from American Airlines' 2002=20 annual report, a year when the carrier lost $3.5 billion amid stiff=20 competition from discounters. But Arpey, who recently became American's=20 chief executive, wrote those words 20 years earlier -- in a 1982=20 dissertation he submitted for his master's degree in business=20 administration at the University of Texas at Austin. At the time, the=20 industry was newly deregulated, and the major airlines were still adapting= =20 to the changing environment. Low-fare king Southwest Airlines had just=20 begun adding flights outside of Texas, and the industry "was in a panic"=20 over the emerging, low-fare airlines, said consultant Michael Boyd of the=20 Boyd Group of Evergeen, Colo. "It was almost like the Red Scare of the=20 1950s," Boyd said. "It was the low-fare scare." In his thesis, The Airline Industry in Transition -- from Regulation to=20 Deregulation, Arpey outlined a long-term strategy he believed that the=20 established carriers could use to adapt to the growing competition and=20 survive in a low-fare environment. Arpey concluded that the major carriers= =20 should focus on reducing labor costs and increasing productivity to better= =20 compete with low-fare carriers. He also wrote that airlines should increase= =20 the efficiency of their aircraft fleets and adjust routes. nd he=20 recommended that airline executives win the cooperation of union members by= =20 warning them about the poor financial state of the industry, and use other= =20 failed carriers as an example of what would happen if changes weren't made.= =20 For the most part, American and other big carriers didn't adapt, and=20 discounters continued to expand and acquire market share for two decades.=20 But today, the big airlines are restructuring to meet low-fare competitors= =20 head on. And American's turnaround strategy -- crafted last year with=20 Arpey's close involvement and now under his complete control -- bears a=20 remarkable resemblance to the steps he recommended as a 23-year-old=20 business student in 1982. Though all of the major airlines have cut costs to some extent, American=20 was the first out of the gate last year and has been the most aggressive.=20 It has slashed $4 billion in annual expenses through steep labor=20 concessions, cutting flights, by smoothing out schedules at its hub=20 airports and by retiring nearly 100 airplanes. Many industry analysts have= =20 lauded the strategy as a model for reshaping a traditional carrier. "The=20 company has set the stage for a recovery," said analyst Ray Neidl of=20 Blaylock & Partners in New York. "With the right cost structure, it should= =20 be a tough competitor." But others caution that cost-cutting alone might=20 not be enough to save the large carriers. Traffic remains weak, the=20 airlines are still saddled with enormous debt loads, and their ability to=20 borrow more money has been sharply curtailed. "Continued cost progress is imperative, as is industry recovery and access= =20 to capital," said analyst Jamie Baker of J.P. Morgan Securities. "Lacking=20 any of of the three likely results in a Chapter 11 challenge by this time=20 next year." American has also resisted some of the bold actions taken by=20 Delta Air Lines. Delta decided to take on discount carrier JetBlue by=20 launching a low-fare unit called Song, which not only challenged JetBlue on= =20 East Coast routes but echoed the discounter's laid-back style. Delta has=20 also dramatically increased its use of cost-efficient, regional jets,=20 particularly at Dallas/Fort Worth Airport, where the Atlanta-based carrier= =20 operates a small hub. Arpey, who declined to be interviewed for this=20 article, has shown little interest in the "airline-within-an-airline"=20 concept. Though American plans to ramp up its use of regional jets, it=20 hasn't yet launched an initiative to match Delta's. American also chose not= =20 to file for bankruptcy earlier this year, unlike its rival United Airlines.= =20 Although bankruptcy can be a "horrible and costly" process, said William=20 Warlick, a bond analyst with Fitch Ratings in Chicago, avoiding it may=20 leave American at a permanent cost disadvantage on items like aircraft=20 leases and debt service costs. Under Arpey, American has introduced some innovations, such as a $299=20 walk-up fare from JFK International Airport in New York to three California= =20 destinations. And he recently reversed American's "More-room-in-coach"=20 campaign on 25 percent of its aircraft. But, like Carty before him, Arpey's= =20 chief focus is on slashing costs -- something the major airlines have been= =20 unable to do on a large scale until now. Consultant Boyd said American and= =20 other executives talked endlessly about adapting to low-fare competitors=20 during the 1980s. They were unable to make significant cost reductions,=20 however, because of labor battles and a continued focus on business=20 travelers, which requires more expensive operations to reduce connection=20 times. "It's one thing to say it, and another thing to do it," Boyd said.=20 "It may have taken a catalyst like 9-11 to really bring change to this=20 industry." Growing threats In the early 1980s, discount carriers were just beginning to emerge as a=20 industry force. Southwest, New York Air and People's Express offered=20 no-frills, cheap flights for people who couldn't afford the expensive fares= =20 on big carriers like American or United. But at the time, the discount=20 carriers were still minor players. For example, in 1982, American Airlines= =20 carried 12 times more passengers than Southwest, according to the Air=20 Transport Association. Last year, American had just three times more=20 passengers than Southwest, and the Dallas-based discounter now competes=20 with American on more than 85 percent of its routes, according to American= =20 officials. Arpey, however, recognized that the low-cost operating structure= =20 of these carriers had the potential to make them aggressive competitors on= =20 a national scale. "Because of their comparatively low cost structures,=20 [discount carriers] can charge fares well below the level at which [major=20 airlines] can operate profitably," he wrote in his thesis. The discounters= =20 had steep advantages in labor costs, productivity, cost-efficient=20 city-to-city route structures and no-frills marketing, he said. He=20 predicted that the established carriers would eventually have to change=20 dramatically to compete against the new wave of nimble, cost-efficient=20 upstarts. "As these new carriers grow and continue to gain market share, it is clear= =20 that the existing carriers will have to adapt to the new cost structures=20 against which they must compete," he wrote. Bob Crandall, who headed=20 American when Arpey was hired, said the young executive's analytical=20 abilities were evident early and helped distinguish him as someone who had= =20 the potential to climb to senior management. "His analytical ability is one= =20 of his greatest strengths," Crandall said. "He's a good analyst, a good=20 communicator and very comfortable with numbers and statistics." Arpey never= =20 forgot the central tenet of his graduate paper. He repeatedly warned=20 analysts of the low-fare competition during the 1990s, when he was a=20 fast-rising American executive, and accurately predicted that discount=20 carriers would eventually expand into long-haul markets to challenge the=20 major airlines. "Southwest may be offering better value" than American,=20 Arpey said during a 1992 conference with airline industry analysts,=20 suggesting that American come up with a strategy to compete in those=20 markets. And in 1994, he said that "it's just a matter of time before the=20 Southwests of the world and new-entrant carriers get into long-haul=20 markets." Today, lengthy transcontinental routes are the area of fastest=20 growth among discounters like Southwest and JetBlue. American did attempt=20 to bring its costs down at various times during the past two decades=20 through tough labor negotiating or operational changes, but none of its=20 efforts persisted. By the late 1990s, the carrier had among the highest=20 costs in the industry and spent billions buying bankrupt airline TWA.=20 Southwest, meanwhile, retained its efficient structure. When the economy=20 slowed, and high-paying business travelers vanished, American stumbled into= =20 the worst losses in the carrier's history. Strategic flashback In August 2002, American unveiled the first phase of its plan to deal with= =20 the growing financial crisis. As president and chief operating officer,=20 Arpey was closely involved in the plan and, with chief executive Don Carty,= =20 co-signed letters in February to labor leaders requesting concessions. The key elements of the airline's turnaround strategy can all be found in=20 Arpey's 1982 thesis, including: =95 Reducing labor costs. "Labor is probably the biggest cost advantage the= =20 new entrants have over larger [established] carriers," he wrote.=20 "[Airlines] must take significant steps in narrowing the divergence in=20 labor costs between themselves and the new [low-cost carriers]." Labor cuts made up nearly half of the American's cost-cutting strategy,=20 with $1.6 billion in payroll reductions through concessions approved this= year. =95 Enlisting the cooperation of workers by emphasizing the problems in the= =20 industry. Arpey wrote that "airline management must first adequately convey= =20 the seriousness of the problem to the rank and file union members," and=20 said the demise of Braniff Airlines could be used as an example of what=20 could happen without a cut in labor costs. Last year, American executives began an intense process of communicating=20 the airline's dire financial condition to union leaders and members through= =20 a process they called "active engagement." Executives frequently cited=20 bankrupt carrier United Airlines as an example of how much worse things=20 would be without cost savings. =95 Improving employee productivity. Arpey noted in his thesis that= Southwest=20 "obtains roughly 50 percent more actual flight time from its cockpit=20 employees than do the established carriers." The new contracts will increase the amount of time pilots and other workers= =20 spend on the job by tightening and eliminating many long-standing work= rules. =95 Making operations more efficient. Arpey advised that airlines should=20 increase the productivity of their aircraft and realign routes where=20 needed. American has taken those steps by smoothing out hub schedules,=20 reducing the different types of aircraft in its fleet and adding strategic= =20 city-to-city flights to compete with discounters like Southwest and JetBlue. One point Arpey made as a student has not yet panned out. In discussing the= =20 need for airlines to reduce labor costs, he noted that, historically, it=20 was extremely difficult to persuade union members to voluntarily reduce=20 labor costs unless an airline was on the brink of collapse. "It is to be=20 hoped that in the future, airlines will not have to be in such a precarious= =20 financial position in order to obtain union concessions," he optimistically= =20 predicted. As American's chief operating officer, Arpey and the rest of the= =20 carrier's top management were unable to win concessions this year until=20 airline lawyers were on the verge of filing a Chapter 11 case. *************************************************** The owner of Roger's Trinbago Site/TnTisland.com Roj (Roger James) escape email mailto:ejames@xxxxxxxxx Trinbago site: www.tntisland.com Carib Brass Ctn site www.tntisland.com/caribbeanbrassconnection/ Steel Expressions www.mts.net/~ejames/se/ Mas Site: www.tntisland.com/tntrecords/mas2003/ Site of the Week: http://www.natalielaughlin.com/ TnT Webdirectory: http://search.co.tt *********************************************************