Hit hard by low-cost airlines, American tries to fly like one By SCOTT MCCARTNEY The Associated Press 6/7/04 8:32 AM The Wall Street Journal AMR Corp., the parent of American Airlines, has lost more than $6.6 billion since the travel industry plunged into its worst slump ever in 2001. A year ago, the airline was a hairbreadth from bankruptcy as low-cost airlines cut into its business and a union balked at wage cuts. The labor confrontation cost AMR's chief executive his job and foreshadowed a rocky future. But now American, the world's biggest airline, is clawing its way back. It's expected to turn a profit in the current quarter and Wall Street believes American will be the only nondiscount airline to hit that mark. American got to this point by confronting problems caused by overcapacity and price warfare in the airline and other industries. Instead of just slashing labor costs, American rejected the longstanding industry assumption that to make money it was necessary to lure big-spending business travelers. For decades, the airline had maintained a cumbersome and expensive structure designed to capture that business. But now that market barely exists; to survive, American is changing the way it operates by trying to more-closely mimic discount airlines. "Today, customers are unwilling to bear the cost of inefficiency," says Gerard Arpey, AMR's 45-year-old chairman and chief executive. His prescription seems simple, but it's an enormous change in an industry that until recently valued size above all else. American now spreads out its schedule rather than bunching flights closely together at hubs. Customers who value tight connections now have to wait longer. But grouping flights required manning many gates and aircraft simultaneously. Now, American saves millions by flying the same number of flights with fewer staffers and planes. First-class blankets come from China instead of Italy. Light bulbs over seats are changed less frequently. As a result, American has slashed $2.2 billion in annual costs on top of $1.8 billion in cuts given up by its labor unions. American used to be one of the highest-cost carriers among the U.S.'s older airline operators. Now it has the lowest costs of that group. There are long-term risks associated with such a strategy. Rigorous cost cutting might diminish the distinction between no-frills players and full-service carriers who can never hope to ape their rivals' cost structure. American's on-time performance and baggage handling have suffered recently. A frequent complaint: American is skimping too much on its food service. "The powers at American have decided to let all of us members of the great unwashed in coach eat cake," says Kenneth Swift, a frequent flier on both American and UAL Corp.'s United. "Actually, cake would be an improvement." High fuel prices, which will add as much as $700 million to the company's costs this year, could also threaten American's recovery. Until the rise of discount airlines such as Southwest Airlines, JetBlue Airways and AirTran Holdings Inc., carriers thought they needed to be big to succeed. The airline with the most flights drew high-paying customers who valued flexibility and also bought dominance at key regional hubs. Larger airlines had more clout with airports, travel agents and corporate travel managers. Today, little of that matters thanks to new competitive dynamics. Low-price airlines pay lower wages and benefits to employees and offer cheap fares because they don't provide some services, such as assigned seating or meals. As a result, the $2,000 round-trip fares paid by business travelers -- on which American relied -- have all but disappeared. An American business-travel ticket between Los Angeles and New York that once cost $2,500 now goes for as little as $622. American acknowledges it can't reduce costs to the level of discount airlines. Instead, it's banking that corporate clients, who still pay more than vacationers, will maintain their loyalty in return for international service, first-class seats, airport clubs and frequent-flier miles. Three years into the industry's downturn, fueled by recession, terrorism, increased competition and high oil prices, most of the nation's older airlines are casting about for solutions. United has been mired in bankruptcy reorganization for 17 months, hoping for government loan guarantees. Delta Air Lines recently warned of a possible bankruptcy and Northwest Airlines and Continental Airlines are enmeshed in critical union negotiations. US Airways Group Inc. warned in May that it may end up in bankruptcy court for a second time. In total, the U.S. airline industry has accumulated $22 billion in losses since 2001. Mr. Arpey, who took over AMR in April 2003, immediately started undoing some of his predecessor's work. Former CEO Donald Carty increased the breadth of American's service by acquiring Trans World Airlines in 2001 to give the airline a hub in St. Louis. He also removed seats in coach to boost legroom and lure business travelers. In November, Mr. Arpey shrank TWA's St. Louis hub and shifted flights to more profitable routes out of Dallas and Chicago. Mr. Arpey added seats back to American's Boeing 757 and Airbus A300 jets and used those aircraft solely on low-fare leisure routes. While that stymied a marketing push to trumpet how much space American offered in coach, it gave the airline more seats to sell. American previously customized some planes for specific markets, such as providing MD-80 aircraft with more front-cabin seats for business routes, such as Dallas to New York. No more. In a bid to simplify its operations, all American's MD-80s are the same, making scheduling more efficient and planes cheaper to maintain. Employees and aircraft also are working harder. American's aircraft now fly as many hours a day -- 11.4 on average -- as Southwest's jets. That's more efficient but increases the risk of delays. With fewer planes sitting idle, it's not easy to draft reinforcements. In an effort to appeal to business travelers, American used to regularly replace every passenger window, at $1,000 apiece, even if they were in good condition. It now changes windows only when necessary. Instead of polishing its silver airplanes annually, American buffs exteriors once every two years. "Over time, programs get very inflated ... and we're not even sure why," said Robert Reding, senior vice president of technical operations, who came to American after many years at low-cost carriers. The total of $4 billion in savings, from increased efficiency and union concessions, reduced American's annual costs by 20 percent, the company says. In the first quarter, American spent 9.49 cents to fly one seat one mile, 3 percent less than Continental, which had previously been the lowest-cost carrier among nondiscount airlines. American's unit costs -- flying one seat one mile -- are still 25 percent higher than discounter America West Airlines and 56 percent higher than JetBlue, which is posing a huge threat in New York, an important American market. Customers say they don't mind losing cosmetic touches as long as the price is right and service is good. "I do not care about blankets or window-pane replacement. Zippo," says Steve Morstad, a frequent traveler from California who recently switched to flying American from Northwest and United. But there's a limit to customers' patience. Ryan Forshee, who logged 50,000 miles in the air in the first quarter, mostly on American, says his biggest complaint is the time he has to wait between connecting flights. "If I thought for a minute that any corners were being cut, I would jump ship," says Mr. Forshee. "I can deal with dirty seats or windows, but anything more is a deal-breaker." Mr. Reding says American hasn't skimped on maintenance but simply eliminated unnecessary work. With all the changes, American's on-time performance and baggage handling have suffered. Between October and March, the most recent period reported by the Department of Transportation, American ranked next-to-last among the 10 major airlines for timeliness. In baggage handling, American has ranked last or next-to-last among major airlines for most of the past year. Historically, American has been in the middle of the pack. Greg Newton, an American frequent flier, flew JetBlue on his most recent cross-country trip, paying $400 less than he would have for the equivalent American coach flights he was able to find. He was impressed with short lines, good legroom and flights that took off on time. "Head-to-head in peasant class, JetBlue is hard to beat," he said. Mr. Arpey blames American's late flights and baggage snafus on congestion in Chicago, where a spike in the number of flights from American and United overloaded the air-traffic-control system. A spokesman for American says the company has made progress in improving its customer service. In the first quarter, the frequency of customer complaints to the Department of Transportation about American was unchanged from a year earlier. American racked up the sixth most complaints among the 10 majors. Some customers say American crews have been a little friendlier. "The in-flight personnel seem a bit more mellow now rather than the old grouchy attitude American became famous for," says Daniel Kasle of New York, who has flown American a dozen times in the past six months. The airline isn't so sure. Prompted by customer complaints about flight crews, American sent a chiding letter March 30 to flight attendants based in Boston, New York and Washington. The letter noted that poor service could scare off business travelers. The Association of Professional Flight Attendants said the letter was disrespectful. The union argues that its workers are overtaxed by conditions imposed by a new contract. "Morale is understandably very low," says John Ward, the union's president. "I guess you can't go through what the employees went through in the last year and not have a whole lot of residual bad feelings." American's unions weren't thrilled with their new contracts but acknowledge that their situation is better than if American had sought bankruptcy protection. Compared with past showdowns -- including a flight attendants' strike in 1993 and a pilot sickout in 1999 -- relations have been relatively smooth. Mr. Arpey hired a consulting firm to act, in his words, as a "marriage counselor" between the company and the union. Workers are included in some management planning sessions and every month, union leaders get a top-level financial briefing. "Now at least we have a better understanding of things," said John Darrah, president of the Allied Pilots Association. Meanwhile, employees are beginning to see some benefits. Last year, in exchange for wage cuts, employees were granted 38 million options to buy AMR shares at $5 a share. The options began vesting in April. In 4 p.m. New York Stock Exchange composite trading Friday, AMR's stock was up 17 cents to $11.87. http://www.mlive.com/newsflash/business/index.ssf?/newsflash/get_story.ssf?/ cgi-free/getstory_ssf.cgi?f0014_BC_WSJ--American-Comebac&&news&newsflash-fin ancial