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# 108137 Cust: Cengage Au: Hill Jones Pg. No. 219 Title: Strategic Management Server:
C/M/Y/K Short / Normal / Long
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Case 16: AB Electrolux Challenges Times in the Appliance Industry C219
125,000 5,000
4,000
3,000
In co
m e fo
r th e p
erio d
, S E
K m
2,000
1,000
0
100,000
75,000
N et
s al
es , S
E K
m
50,000
25,000
0 2002 2003 2004 2005 2006 2007 2008 2009
Sales (SEK) Income (SEK)
Exhibit 5 Sales & Net Income (8 year period)
Exhibit 7 Cash & Long-Term Debt to Equity
0.70
0.60
0.50
0.40
0.30
0.20
0.10
2006 2007 2008 2009 0.0
14
12
10
8
6
4
2
0
C ash
(S E
K )
Lo n
g -T
er m
d eb
t to
e q
u it
y
LT Debt/Equity Cash(SEK)
Exhibit 6 Quarterly Sales
29,000
28,000
27,000
26,000
25,000
S al
es (
S E
K m
)
24,000
23,000
22,000
21,000 Q1 Q2 Q3 Q4
YTD 20102008 2009
25843_case16_ptg01_hr_C209-C223.indd 219 1/20/12 2:07 PM
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
# 108137 Cust: Cengage Au: Hill Jones Pg. No. 220 Title: Strategic Management Server:
C/M/Y/K Short / Normal / Long
DESIGN SERVICES OF
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Section A: Business-Level StrategyC220
4.5 4.0
3.5
3.0
2.5
O p
er at
in g
m ar
g in
, %
2.0
1.5
1.0
0.5
0.0 2005 2006 2007 2008 2009
120,000
100,000
80,000
60,000
40,000
20,000
0 2005 2006 2007 2008 2009
Inventories Net salesAccount receivables
240 Electrolux AB
220 200 180 160 140 120
P ri
ce
100 80 60 40 20 0 2005 2006 2007 2008 2009 2010 2011
0 2 4 6 8 10 12 14
E arn
in g
s & d
ivid en
d s p
er sh are
16 18 20 22 24
Price Earnings Dividends
Exhibit 8 Operating Margin
Exhibit 9 A/R, Inventory & Sales
Exhibit 10 Electrolux 5 Year Stock Price Performance
25843_case16_ptg01_hr_C209-C223.indd 220 1/20/12 2:07 PM
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
# 108137 Cust: Cengage Au: Hill Jones Pg. No. 221 Title: Strategic Management Server:
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Case 16: AB Electrolux Challenges Times in the Appliance Industry C221
On August 4 Keith McLoughlin was appointed Chief Operations Officer Major Appliances. Keith McLoughlin was previously President and CEO of Major Appliances North America.
President and CEO Hans Stráberg
Major Appliances Europe
Enderson Guimarães
Professional Products
Alberto Zanata
Floor Care and Small Appliances
Morten Falkenberg
Major Appliances Asia/Pacific
Gunilla Noroström
Major Appliances Latin America
Ruy Hirschheimer
Major Appliances North America
Kevin Scott
Human Resources and Organizational Development
Carnia Malmgren Heander
Communications and Branding Lars Göran Johansson
Legal Affairs Cecilia Vieweg
Chief Financial Officer Jones Samuelson
Exhibit 11 Electrolux Organization Structure
Future manufacturing footprint
Why keep plants in HCC?
In 2011, Electrolux will have approximately 60% of its plants in LCC. The remaining approximately 40% will be in HCC due to reasoning described in the figure to the left.
No net-present value case 20%
Efficient, profitable plant 10%
Declining segments 10%
HCC 40%
LCC 60%
HCC
Exhibit 12 Manufacturing Footprint
25843_case16_ptg01_hr_C209-C223.indd 221 1/20/12 2:07 PM
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
# 108137 Cust: Cengage Au: Hill Jones Pg. No. 222 Title: Strategic Management Server:
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Section A: Business-Level StrategyC222
Works Cited
BusinessWeek. “Electrolux Redesigns Itself.” November 27, 2006.
China Daily. “No Cheap Labor? “China Increase Minimum Wages.” July 2, 2010.
Dale, Larry. Relative Price Elasticity of Demand for Appli- ances. Economic Analysis. Berkely: United States Department of Energy, 2008.
“ECOSAVINGS.” Welcome to Electrolux USA. Web. 26 July 2010.
Electrolux Annual Report 2009.
Electrolux Blogspot. 18 March 2008. 15 July 2010
GE Appliances. 20 July 2010
Electrolux Company History.
Electrolux Product Overview.
Electrolux. “Electrolux Professional Laundry Systems.” Elec- trolux Professional Laundry Systems—Home. Web. 25 July 2010.
Goldman Sachs. “Global Economics Paper No: 170.” 7 July 2008. Web.
Google Finance Electrolux. 15 July 2010
Google Finance GE. 10 July 2010
Google Finance Whirlpool. 20 July 2010
Google Patents. July 2010
Hunger, J. David. “The U.S. Major Home Appliance Industry (1996): Domestic versus Global Strategies.”
LG. 20 July 2010 www.marketresearch.com/product/display.asp? productid52614446>. “Microsoft Hohm.” Conserve Energy, Save Money—Micro- soft Hohm. Web. 26 July 2010. Rising, Malin, “Electrolux Q2 Profits Rise, Helped by Cost Savings,” iStockAnalyst. Sandstrom, Gustav. “Electrolux’s Net Nearly Doubles—WSJ. com.” Business News & Financial News—The Wall Street Journal—WSJ.com. Web. 26 July 2010. Schmit, Julie. USA Today. 23 February 2010. 20 July 2010 Times Colonist. 3 July 2010. 20 July 2010 United States Department of Labor. “Thailand.” United States Government American Recovery and Reinvest- ment Act. Yahoo Finance. 2010. 8 July 2010 Yahoo Finance. 9 July 2010 Yahoo Finance Electrolux. 7 July 2010 The Electrolux process for consumer-focused product development ensures that a product is not created until a decision has been made regarding the consumer need that it will fulfill and the consumer segment that will be targeted. STRATEGIC MARKET PLAN IDENTIFICATION OF CONSUMER OPPORTUNITIES PRIMARY DEVELOPMENT CONCEPT DEVELOPMENT COMMERCIAL LAUNCH PREPARATION PRODUCT DEVELOPMENT Exhibit 13 Electrolux Product Development Process 25843_case16_ptg01_hr_C209-C223.indd 222 1/20/12 2:07 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. http://www.chinadaily.com.cn/china/2010-07/02/content_10053553.htm C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services Case 16: AB Electrolux Challenges Times in the Appliance Industry C223 Endnotes 1 Electrolux 2009 Annual Report. http://ir.electrolux.com/ files/Elux_ENG_Ars09_Del1.pdf 2 Market Research, http://www.marketresearch.com/ product/display.asp?productid52614446 3 USA Today, http://www.usatoday.com/tech/news/2010- 02-23-energyrebates23_ST_N.htm 4 Relative Price Elasticity of Demand for Appliances, Larry Dale 5 Appliances Industry Overview, http://biz.yahoo.com/ ic/310.html 6 Whirlpool Competitors, http://finance.yahoo.com/q/ co?s5WHR1Competitors 7 Appliances Industry Overview 8 Whirlpool Competitors 9 GE Appliances, http://www.geappliances.com/?cid53113& omni_key5ge_appliances 10 Google Finance, http://www.google.com/finance?q5ge& rls5com.microsoft:en-us&oe5UTF- 11 Whirlpool Competitors 12 LG, www.lg.com 13 “United States Government American Recovery and Reinvestment Act.” www.recovery.gov 14 China Daily. “No Cheap Labor? “China Increase Mini- mum Wages.” July 2, 2010. http://www.chinadaily.com. cn/china/2010-07/02/content_10053553.htm 15 Goldman Sachs, http://www2.goldmansachs.com/ideas/ global-economic-outlook/expanding-middle.pdf 16 Electrolux 2009 Annual Report 17 Electrolux 2009 Annual Report 18 Electrolux 2009 Annual Report 19 Electrolux 2009 Annual Report 20 Electrolux 2009 Annual Report 21 Electrolux 2009 Annual Report 22 Electrolux 2009 Annual Report 23 Electrolux 2009 Annual Report 24 Electrolux 2009 Annual Report 25 Electrolux 2009 Annual Report 26 Electrolux 2009 Annual Report 27 Electrolux 2009 Annual Report 28 Electrolux 2009 Annual Report 29 Electrolux 2009 Annual Report 30 Electrolux 2009 Annual Report 31 Electrolux 2009 Annual Report 32 Electrolux 2009 Annual Report 33 Electrolux 2009 Annual Report 34 Electrolux 2009 Annual Report 35 Electrolux 2009 Annual Report 36 Electrolux 2009 Annual Report 37 Electrolux 2009 Annual Report 38 Electrolux 2009 Annual Report 39 Electrolux 2009 Annual Report 40 Electrolux 2009 Annual Report 41 Electrolux 2009 Annual Report 42 Electrolux Professional Laundry Systems, http://www . l a u n d r y s y s t e m s . e l e c t r o l u x . c o m / n o d e 2 3 7 . aspx?lngNewsId51122 43 Electrolux 2009 Annual Report 44 Electrolux 2009 Annual Report 45 Electrolux 2009 Annual Report 46 Electrolux 2009 Annual Report 47 Electrolux 2009 Annual Report 48 Electrolux 2009 Annual Report 49 Electrolux 2009 Annual Report 25843_case16_ptg01_hr_C209-C223.indd 223 1/20/12 2:07 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. http://ir.electrolux.com/ C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services CASE 17 Since the passage of the Airline Deregulation Act in 1978, eight major U.S. air carriers filed for bank- ruptcy. All were old, established carriers flying do- mestic as well as international routes. Three of the major carriers—Pan American Airways, Eastern Air- lines, and Trans World Airways (TWA)—were even- tually liquidated and their assets were sold to rival carriers. Two others—Continental Airlines and U.S. Air—filed for bankruptcy protection at least twice. And the remaining three—United, Delta, and North- west Airlines—were operating in 2005–2006 under Chapter 11 of the Bankruptcy Code. Alone among all U.S. international majors, American Airlines (AA) had never filed for bankruptcy protection. American’s financial position was stronger than that of its competitors all through the era of deregu- lation. During the first two decades of the new era, Robert Crandall ran AA, first as President (1980– 1985), and then as CEO (1985–1998). An executive widely regarded as the industry’s most innovative strategist, Crandall introduced the frequent-flier program and the two-tier wage system, expanded American globally, formed alliances with other car- riers, and established a successful regional airline af- filiated with AA. As Crandall retired in 1998, Donald Carty was selected CEO. An insider whose tenure was over- shadowed by the terrorist attack of September 11, 2001, Carty was a lackluster leader, and his career ended in a public scandal that led to his replacement by Gerald Arpey in April 2003. Arpey needed to act quickly. Following the unprecedented losses incurred by American as a result of the September 11 attack— a loss of over $5 billion dollars during 2001 and 2002, and an additional loss of over $1 billion in the first quarter of 2003—American Airlines was on the brink of bankruptcy. What should Arpey do? Should Arpey follow the strategies undertaken by Crandall to cut operating cost, improve AA’s finan- cial position, and turn the carrier profitable? Should Arpey, rather, reject some of the policies introduced by his predecessor? Or should he, instead, introduce brand new innovative strategies applicable to the airline industry in the 21st century? To assess Arpey’s strategic choices, this case looks back at the experience of his legendary predecessor. How precisely did Robert Crandall manage to turn American around? The Airline Industry The airline industry dates back to the Air Mail Service of 1918–1925. Using its own planes and pilots, the Post Office Department directly operated scheduled flights to ship mail. With the passage of the Air Mail Act (Kelly Act) of 1925, the Post Office subcon- tracted air mail transport to private companies and thereby laid the foundation of a national air trans- port system. The Post Office paid contractors sub- stantial sums and encouraged them to extend their routes, buy larger planes, and expand their services. The formative period of the private airline indus- try was the Great Depression. The five or six years following Charles Lindbergh’s 1927 flight across the Atlantic were years of mergers and acquisitions in which every major carrier came into existence, mostly through the acquisition of smaller lines. American, American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 This case was presented in the October 2006 Meeting of the North American Case Research Association at San Diego California. Copy- right Isaac Cohen and NACRA. I am grateful to the San Jose State University College of Business for its support. Reprinted by permission of North American Case Research Association. Copyright © 2006 by Isaac Cohen and the North American Case Research Association. All rights reserved. Isaac Cohen San Jose State University C224 25843_case17_ptg01_hr_C224-C239.indd 224 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 225 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C225Case 17: American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 by an interstate airline servicing the Chicago- Minneapolis city pair market (339 miles) were more than double those charged by an intrastate airline (Pacific Southwest Airlines) serving the Los Angeles- San Francisco market (338 miles). The experience of Southwest Airlines in Texas—like that of Pacific Southwest Airlines in California—Breyer and Ken- nedy concluded, demonstrated the efficiency of the free market and the urgent need for deregulation.4 Three years later, in 1978, Congress deregulated the airline industry. Company Background The early history of American Airlines dates back to 1929 when dozens of small airline companies merged together to form American Airways, a subsidiary of an aircraft manufacturing /airline service conglomer- ate called the Aviation Corporation (AVCO). From the outset, American Airlines shipped mail along the Southern sub-continental route from Los Angeles to Atlanta via Dallas. With the passage of the Air Mail Act of 1934, Congress prohibited aircraft manu- facturing firms from owning airline companies and redistributed existing airmail contracts on a new, competitive bidding basis. To bid successfully on the new contracts, American Airways changed its name to American Airlines, and reorganized itself as stand alone company, independent of AVCO. Winning back its original government contracts, AA resumed its airmail operations and moved aggressively to ex- pand its nascent passenger service.5 For the next 35 years, 1934–1968, a single CEO—Cyrus Rowlett Smith—ran American Airlines. A Texan, C. R. Smith managed to improve AA per- formance in the 1930s and led the company to sus- tained growth during the following three decades. He paid particular attention to two critical aspects of airline management, namely, aircraft technology and labor relations. Smith played a key role in the introduction of the DC-3 aircraft in 1936, a well-designed, and ef- ficient plane with two piston engines. The first com- mercially viable passenger aircraft ever produced, the DC-3 dominated the world’s airways until after WWII. Because AA operated the largest fleet of DC- 3s in the industry, it soon became the industry leader, carrying about 30% of the domestic passenger traf- fic in the late 1930s.6 United, Delta, Northwest, Continental and Eastern Airlines were all formed during this period. The in- crease in passenger transport during the 1930s led, in turn, to growing competition, price cutting, bank- ruptcies, and serious safety problems. It convinced the architects of the New Deal that the entire trans- port system—not just the air mail—required federal regulation. The outcome was the passage of the Civil Aeronautics Act (CAA) of 1938.1 The CAA had two major provisions. First, it prohibited price competition among carriers, and second, it effectively closed the industry to newcom- ers. The Civil Aeronautics Board (CAB) required that all air carriers flying certain routes charge the same fares for the same class of passengers. Similarly, the CAB required all applicants wishing to enter the in- dustry to show that they were “fit, willing and able” to do so and that their service was “required by the public convenience and necessity.” Typically, between 1950 and 1975 the board denied all 79 applications it had received from carriers asking to enter the do- mestic, scheduled airline industry.2 The number of scheduled air carriers was reduced from 16 in 1938 to just 10 in the 1970s, following mergers, consoli- dations, and route transfers among carriers.3 By the mid-1970s, the airline industry had expe- rienced serious financial troubles. Rising fuel prices, an economic recession, and the introduction of ex- pensive wide-body aircraft (Boeing 747s, Lockheed L-1011s, and McDonnell Douglas DC-10s) led to climbing costs, higher fares, reduced traffic, falling revenues, and a growing public demand for opening up the airline industry to competition. As a result, in 1975, a Senate subcommittee chaired by Edward Ken- nedy held hearings on the airlines. Working closely with Kennedy was a Harvard law professor named Stephen Breyer, who later became a U.S. Supreme Court Justice. A specialist in regulation, the author of Regulation and Reform, and the Staff Director of the Kennedy hearings, Breyer helped Kennedy build up a strong case against airline regulation. Together, Breyer and Kennedy contrasted intra- state air service—which had never been regulated by the CAB—with interstate service—which had been regulated since 1938. The figures were astounding. Air fares charged by an interstate carrier flying the New York-Boston route (191 miles) were almost double the fares charged by an intrastate carrier (Southwest Airlines) flying the Houston-San An- tonio route (also 191 miles), and air fares charged 25843_case17_ptg01_hr_C224-C239.indd 225 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 226 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C226 Section A: Business-Level Strategy Spater to resign in 1973 and invited C.R. Smith to rejoin American as a caretaker for a short transi- tional period. Smith served just seven months until the board recruited Albert Casey, a media executive, to head the company.10 Casey’s early years at American coincided with the political debate over airline deregulation. On the one side, AA financial results during these years were impressive: Casey turned a loss of $34 million in 1975 to a record profit of $122 million in 1978, and raised AA’s cash position from $115 million in 1974 to $537 million in 1978. But on the other, Casey opposed deregulation. Casey’s management team believed that airline deregulation would pro- mote competition with low-cost carriers and shift passenger traffic away from transcontinental and semi-transcontinental routes—AA’s most profit- able ones—to short and medium haul routes. “We opposed [deregulation] all the way,” Casey recalled years later. “We had the wrong route structure. We had the wrong aircraft . . . We weren’t equipped right. [And w]e had very unfavorable union contracts.”11 Notwithstanding his opposition to deregulation, Casey expected Congress to pass the deregulation act. To prepare for the passage of the act, Casey undertook two early initiatives which later contrib- uted to AA’s eventual success under deregulation. First, he established a major hub airport at Dallas/ Fort Worth (D/FW) and moved the company’s headquarters from New York to Dallas. Second, he promoted Robert Crandall to the presidency of American Airlines. The Crandall Era, 1980–1998 Crandall’s management style was distinctly differ- ent from that of Casey. Casey had a personable, re- laxed, and jolly manner. Crandall was famous for his charismatic, intense, and combative style. Casey was diplomatic. Crandall was forthright, temperamental, and impatient. “The [airline] business is intensely, vigorously, bitterly, savagely competitive,”12 Cran- dall once said, adding, “I want to crush all my com- petition. That is what competition is about.”13 Crandall served as AA President for five years, and as CEO for 13 years. During the early period of 1980–1985, Casey turned over to Crandall the day-to-day operation of the company, and focused his attention on American’s financial performance.14 Working together with Donald Douglas on the design and development of the DC-3, C. R. Smith lay the foundations for long lasting relations be- tween AA and the Douglas (since 1967, McDonnell Douglas) Corporation. Not until 1955 did Smith se- lect a Boeing model over a Douglas one [AA ordered its first jet—the B-707—from Boeing),7 but soon thereafter American Airlines resumed its customer relations with Douglas. The two companies con- tinued cooperating for decades. In 2005, long after C.R. Smith had retired, and nearly a decade after the Boeing Company bought the McDonnell Douglas Corporation, American Airlines’ fleet was made up of 327 MD-80 McDonnell Douglas planes, and 320 Boeing planes (the B-737, 757, 767, and 777 mod- els), a 46/45% mix which reflected AA’s traditional ties with the McDonnell Douglas Corporation.8 C. R. Smith, in addition, played a central role in shaping AA’s labor relations. AA employees, like the employees of virtually all other major airlines, had become highly unionized by the late 1940s, and sub- sequently, the company experienced growing labor troubles. Responding to two large-scale pilot strikes that shut down American airlines in 1954 and 1958, C. R. Smith proposed the establishment of a coop- erative arrangement among air carriers known as the Mutual Aid Pact (MAP). Thinking in terms of the en- tire industry, Smith saw the pact as a self- protecting measure designed to check the rising power of unions. Originally established in 1958 by American and five other carriers (United, TWA, Pan American, Eastern, and Capital), the pact authorized airlines benefiting from a strike that shut down one or more carriers to transfer their strike-generated revenues to the struck carrier(s), an arrangement which re- duced the financial losses of the struck carrier(s) and thereby increased management bargaining power across the industry. In its several different forms, the MAP survived for twenty years, providing AA and its rival carriers with a measure of protection against lengthy strikes.9 Smith’s last four years at American Airlines, 1964–67, were AA’s most profitable. In 1968, he re- tired, and was succeeded by George Spater, a corpo- rate lawyer whose tenure at American was marred by recession and scandal. Spater not only failed to improve AA’s performance during the recession of the early 1970s, but he also admitted making ille- gal corporate contributions to President Nixon’s re- election campaign. As a result, the AA board forced 25843_case17_ptg01_hr_C224-C239.indd 226 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 227 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C227Case 17: American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 Introducing the Two-Tier Wage System Dubbed “the father of the two-tier pay scale,” Crandall had little to do with the origins of the two-tier plan. The idea grew out of management’s endless discussions of the need to achieve low cost growth. Rejecting em- ployee concessions as an insufficient means to attain a low cost operation, Crandall nurtured the two-tier idea and transformed it from an abstract notion into a concrete policy—practical, consistent, and effective.18 The two-tier wage system distinguished between two types of employees: current employees paid by an A-scale and newly-hired employees paid by a B-scale. Initially, under the system established by Cran- dall at American, the two scales were not intended to merge at all; in other words, the top pay received by B-scale employees was expected to be significantly lower than the top pay received by A-scale employees. To persuade AA’s labor unions to accept the two-tier plan, Crandall offered employees job security, job ex- panding opportunities, higher wages and benefits, and profit sharing. He also threatened to shrink the carrier unless the unions accepted the two-tier deal. Believ- ing that lay-offs were eminent, American unionized employees agreed to the new wage structure, and in 1983, AA signed the industry’s first two-tier contracts with its principal unions, the Allied Pilots Association (APA, representing the pilots), the Transport Workers Union (TWU, representing the machinists and other ground workers), and the Association of Professional Flight Attendants (APFA, representing the flight atten- dants). AA’s major competitors—United, Delta, U.S. Air, and others—negotiated similar labor agreements. Consequently, the number of two-tier union contracts signed in the airline industry jumped from eight in 1983, to 35 in 1984, and then to 62 in 1985.19 AA’s two-tier wage plan resulted in a significant pay gap between old and new employees. A newly- hired B-727 captain with a five year experience earned $68 an hour or less than half the $140 paid to his/her veteran counterpart. Such a wage gap led to substantial cost savings: between 1984 and 1989 American Airlines’ labor cost fell from 37% to 34% of the carrier’s total expenses.20 Creating a Holding Company In 1982, Crandall oversaw the formation of the AMR Corporation—a holding company created “to provide [American] with access to sources of During the later period, Crandall assumed full re- sponsibility for AA’s financial performance, be- coming one of the industry’s longest serving chief executives. As both President and CEO, Crandall developed a large body of corporate level strategies which helped American gain a competitive advan- tage over it rivals. Developing the Hub and Spoke System The hub and spoke system was the product of airline deregulation. During the regulatory era, government rules restricted the entry of carriers into new travel markets. With the coming of deregulation, such re- strictions were removed, and airlines were free to es- tablish their own connecting hubs for the purpose of transferring passengers from incoming to outgoing flights. Utilizing the hub-and-spoke system, carriers were able to cut costs in at least two ways. First, cen- tralizing aircraft maintenance in hubs reduced the fleet’s maintenance costs, and second, increasing the carriers’ load factor and bringing it close to capacity resulted in a more efficient operation. In addition, the hub-and-spoke system resulted in greater flight frequency for passengers—a service benefit valued especially by business travelers.15 Throughout the first two years of his presidency, 1981–1982, Crandall added 17 new domestic cities to AA’s D/FW hub, and seven new international des- tinations (in Mexico as well as the Caribbean). The sheer number of daily flights AA operated in D/FW climbed from 100 to 300 in 1981 alone. Building its central hub in D/FW, American shifted passen- ger traffic away from other carriers serving Dallas’s outlaying cities, subjecting these carriers to relentless competitive pressure. Braniff International Airways is a case in point. The leading carrier serving the D/FW airport in the 1970s, Braniff filed bankruptcy and suspended operation in 1982 largely as a result of the cutthroat competition it was subject to by American Airlines in the Dallas area.16 Under Crandall’s direction, AA expanded its hub and spoke operations in the 1980s, establishing ma- jor hubs in Chicago, Miami, and San Juan, Puerto Rico, and focusing on long-haul fights, the most profitable segment of the industry. By the mid 1990s, these new hubs—together with the D/FW one— had all become major international airports serving passengers flying to destinations in Europe, South America, Central America, and the Caribbean.17 25843_case17_ptg01_hr_C224-C239.indd 227 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 228 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C228 Section A: Business-Level Strategy destinations in the U.S., Canada, and the Caribbean; employing 10,000; and generating $1 billion in rev- enue, American Eagle was named “Airline of the Year” by Commuter World magazine in 1998.24 American Eagle’s growth helped improve AMR’s financial results. Originally, American Eagle operated as a regional carrier feeding passengers to American Airlines flights. But by the mid-1990s, Crandall had replaced a growing number of routes flown by AA pilots with routes flown by American Eagle pilots, a move which resulted in substantial labor cost sav- ings, given the higher pay received by American than Eagle pilots (in 1997 AA pilots earned an average yearly pay of $120,000 and Eagle pilots $35,000).25 Upgrading the Computer Reservation System (CRS) The Sabre computer reservation system was born in 1962, following a decade-long research effort carried out jointly by American Airlines engineers and IBM technicians. Initially, Sabre lagged behind comparable CRS systems used by its competitors, namely, United’s Apollo, TWA’s PARS, and Eastern Airlines’ System One. But by the mid-1970s, with the appointment of Crandall to the position of AA’s Vice President for Marketing, Sabre received a new lease of life. As marketing chief, Crandall controlled the company’s budget for technology research and development. He recruited a strong team of Sabre computer engineers, and supplied the team with ample funding. At the same time, he launched a cam- paign to build an industry-wide CRS owned jointly by the major airlines, and used by travel agents. Con- fident that its own CRS was ahead of its competitors, United declined to join the industry-wide project, and instead, decided to sell its Apollo system’s ser- vices directly to travel agents. Crandall reacted quickly. Implementing a carefully crafted back-up plan, he sent hundreds of sales people and techni- cians to travel agents all across the country, offering them a variety of Sabre services. Caught unprepared, United was unable to deliver its own computer reser- vation system’s services until months later. The result was a swift victory of American over United in the race to wire travel agents.26 Sabre provided American Airlines with several in- formation technology services. First, it calculated the yield of each American flight, setting and resetting the price of every seat sold. Second, it managed an financing that otherwise might be unavailable.”21 AMR owned American Airlines together with sev- eral other non-airline subsidiaries, an arrangement which gave management greater flexibility in shift- ing assets among airline and non-airline subsidiaries, and in identifying new profit sources. Equally impor- tant was the protection AMR gave the airline from the swings of the business cycle: profits generated by AMR’s nonairline units were expected to mitigate the impact of the industry’s periodic downturns. Consider the following example. During the downturn of 1990–1993, Crandall devised a “tran- sition plan” that called for shifting assets from AMR’s unprofitable airline operation to its profit- able nonairline businesses. He even suggested leav- ing the airline business altogether. As AA’s losses were mounting—and profits generated from AMR’s non-airline units were increasing—Crandall threat- ened to sell AA and keep instead AMR’s nonairline subsidiaries only.22 AMR’s principal subsidiary—apart from AA— was the Sabre computer reservation system. Owned by AMR, Sabre (Semi Automatic Business Research Environment) had become AMR’s most profitable unit during the 1990s, generating far higher returns on sales than the airline itself. In 1995, for instance, Sabre recorded total sales of $1.5 billion, or 9% of AMR revenues, and an operating profit of 19%.23 Building a Regional Airline Another subsidiary of AMR was American Eagle. American Eagle was established in 1984 as AA’s re- gional affiliate. Operating under the affiliate name, several small regional airlines were franchised by AA to supply connecting flights to American air services. From the start, American Eagle offered customers “seamless service,” that is, assigned seats, boarding passes, and frequent flyer mileage. In 1987, AMR be- gan acquiring American Eagle’s franchised carriers, and in 1990, it consolidated these carriers into six airline systems that served the D/FW, Nashville, New York City, Chicago, Raleigh/Durham and San Juan regional markets. To better coordinate planning, op- eration, schedules, training, and marketing of com- muter services, AMR sought further consolidation. Accordingly, in 1998, it merged the six regional air- lines into a single entity carrier, the America Eagle Airlines, creating the world’s largest regional air- line system. Operating 1,450 daily flights to 125 25843_case17_ptg01_hr_C224-C239.indd 228 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 229 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C229Case 17: American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 any seat traveling any distance at any time. It could find out how early business travelers booked their flights, how far in advance coach passengers did so, and how sensitive each of these two groups was to fare price changes. With Sabre’s growing computer capabilities, American began offering a large vari- ety of discounted fares, as Don Reed, author of Bob Crandall and American Airlines, explained: Instead of offering first-class, coach, and one level of discount fares, American began offering several layers of discounts. The bigger the savings off full- fare prices, the more restrictions the tickets had. The more modest the savings, the fewer restrictions. So fourteen-day and seven-day advance purchase dis- count fares cost more than twenty-one-day fares, but they were less restricted. Because of this sliding scale of discounts, American could juggle the per- centage of seats on any airplane allocated to one fare type or another. . . . By the late 1980s American would be able to, and often did, juggle the mix of fares right up until the moment of departure.30 Sabre’s yield management system gave American a clear competitive advantage over its rivals. On any given flight, AA was able to offer a variety of dis- counted fares using projections based on past experi- ence. Sabre’s technology permitted Crandall to match or undercut the cheaper fares offered by competitors by simply lowering American’s own discount prices for some seats and/or increase the number of seats available at the lowest price category. There was no need to reduce fares on all seats. While competitors lacking American’s technology were unable to match AA’s price flexibility, they soon introduced their own yield management systems; nevertheless, American Airlines managed to retain its leadership position in the field for decades. Pioneering the Frequent-Flyer Program Just as Sabre promoted the development of AA’s yield management system, so did it facilitate the in- troduction of American’s AAdvantage frequent flyer program, an innovation that allowed regular passen- gers to earn free tickets on miles traveled with Amer- ican. And just as the hub-and spoke system was the outgrowth of deregulation, so was the frequent flyer program. While deregulation promoted competition, the frequent flyer program protected carriers from the competitive market forces by creating brand loy- alty among travelers. inventory of close to one billion spare parts used by American’s fleet in its maintenance facilities. Third, it directed the routing and tracking of all baggage and freight. And fourth, it supplied American with ongoing data on aircraft fuel requirements, take off weight, and flight plan.27 More important were Sabre’s travel services. Sa- bre provided travel agents around the world with fares and schedules for flights offered by hundreds of carriers, not only American and American Eagle. In 1997, Sabre signed a comprehensive 25-year agree- ment to manage the information technology infra- structure of U.S. Air, and in addition, it renewed a five-year contract with Southwest Airlines to oper- ate the carrier’s reservation and inventory systems. Sabre and Canadian Airlines International signed a similar agreement in 1994. Sabre’s clients, it should be noted, were not lim- ited to the airline industry. Both the London Un- derground and the French National Railway were Sabre’s customers in the 1990s, the first contracted Sabre to manage its train and crew scheduling, the second, to design its computer reservation system. Under Crandall’s leadership, furthermore, Sabre signed agreements with both Dollar Rent-a-Car and Thrifty Rent-a-Car to manage each company’s reser- vation system.28 Under Crandall’s leadership, Sabre had become the U.S. largest computer reservation system with a 40% share of all travel agent bookings in 1996. Nearly 30,000 travel agent offices in 70 countries subscribed to Sabre, and more than 2.5 million indi- vidual passengers subscribed to Travelocity, Sabre’s Internet service. In 1995, the total value of travel- related products and services reserved through Sabre was estimated at $40 billion.29 Promoting Yield Management Developing a revenue maximizing process called yield management was impossible without enhanced computer capabilities. To fill all empty seats on a given flight, American Airlines needed to obtain information pertaining to the desirable number of seats that could be sold at full versus discount fares, and the optimal mix of fares that could maximize the yield of a given flight. Obtaining such informa- tion required complex computer calculations based on the carrier’s past performance. Hence the key role played by Sabre. Sabre could track any passenger on 25843_case17_ptg01_hr_C224-C239.indd 229 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 230 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C230 Section A: Business-Level Strategy into new travel markets, promoted the development of hub-and-spoke systems, and as such, prompted the leading domestic airlines—United, American, and Delta—to begin serving a growing number of international destinations. From the outset, AA’s domestic hub system sup- ported international expansion, helping the car- rier fill empty seats on overseas flights. In the early 1980s, Crandall extended AA’s route network to Mexico and the Caribbean, but not until 1990 did he launch a massive drive at global expansion, add- ing many more overseas destinations in Europe and Latin America. Crandall’s decision to extend AA’s international route network was informed by air-traffic projec- tions. Over the ten-year period 1990–2000, U.S. air traffic was expected to grow at a modest rate of 3%-4% a year while transatlantic air traffic, as well as traffic between the U.S. and Latin America’s destinations, was projected to increase at an annual rate of 6%-7%. To take advantage of these projec- tions, Crandall committed $11 billion, or half of AA’s investment budget, to global expansion over the five year period, 1990–1995. He also made two important acquisitions, both in 1989–1991. He first bought TWA’s Chicago-London route in 1989, and six more TWA-London routes in 1991. He next ac- quired Eastern Airline’s Latin America route system in 1990. In the Latin American market, AA used its strong Miami hub to handle traffic from 20 cit- ies in 15 South and Central American countries. In the European market, Crandall embarked on what he called a “fragmentation strategy,” namely, the break-up of the traditional route system linking one international city to another, for example, New York—London (and flying large commercial aircraft such as the 400-seat Boeing B-747), and replacing it with a route system that linked less congested cites like Chicago and Brussels or Chicago and Glasgow (and flying smaller 200-seat aircraft such as the Boeing B-767).35 Five years later, Crandall’s plan achieved its main goals. By the mid-1990s, AA had become the dominant U.S. carrier serving Latin America, and the number two U.S. carrier serving Europe, closely behind Delta. In Latin America, AA carried 58% of all U.S. airline traffic to and from the region, served 27 nations, and opened two new U.S. gateway hubs, one in New York, the other in Dallas/Fort Worth, in addition to its principal one in Miami. In the Crandall introduced the AAdvantage program— the first in the industry—in 1981, a year after he became president. Managed by Sabre, the frequent flyer innovation was an effective marketing pro- gram which lowered the advertising costs by target- ing individuals AAdvantage card-holders reachable through mailing and/or email distribution lists. Sabre had been gathering information on passen- gers early on. As Mike Gunn, AA’s Vice President for Marketing under Crandall noted: “one reason we were able to seize the competitive edge was that we already knew who many of our best customers were and how to reach them quickly. As other air- lines struggled to match our initiative and identify their base of frequent-flyers, we were already placing AAdvantage cards and welcome letters in the hands of our best customers.”31 More than one million passengers joined AAd- vantage before the end of 1981, and another million joined the frequent flyer programs introduced by other airlines in 1981 in response to AAdvantage. Ten years later, 28 million travelers were card- carrying members of at least one frequent flyer pro- gram, and they held, on average, membership in 3.5 programs. American Airlines’ program was the industry’s largest. In 1991, American’s frequent flier program had one million members more than that of its closest competitor, United, and four million more than Delta, the nation’s third largest carrier.32 At the time Crandall left office in 1998, the frequent flyer program had become an airline in- dustry standard feature. It impacted other indus- tries as well and generated both revenues and profits for the airlines. American sold miles to a variety of companies which awarded, in turn, AA miles to loyal customers as an incentive. In 1998, over 2,500 companies awarded miles to custom- ers using the AAdvantage Incentive Miles program, most of which were retail stores and food serving establishments.33 Expanding Internationally Before the passage of the airline regulation act in 1978, American Airlines had virtually no interna- tional presence. The dominant U.S. international carriers at the time were TWA and Pan America World Airways, and neither United nor Delta Air- lines served any foreign destinations.34 The Deregu- lation Act removed government restrictions on entry 25843_case17_ptg01_hr_C224-C239.indd 230 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 231 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C231Case 17: American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 Escalating the War with the Unions, 1990–1998 AA’s labor relations under Crandall may be divided into two, distinctly different, periods: 1980–1989 and 1990–1998. In the 1980s, relations between labor and management at American were, for the most part, cooperative and peaceful. Crandall, as discussed, managed to convince the leadership of the pilots’, flight attendants’, and machinists’ unions to negotiate and sign two-tier labor agreements which allowed management to place newly hired employ- ees on a lower, B-type wage scale. In the 1990s, by contrast, labor relations at American were stormy and contentious. Contract negotiations were long and difficult to conclude, and labor disputes triggered strikes, strike threats, and repeated instances of federal intervention to avert strikes. As a consequence, labor disputes were costly, resulting in revenue and income losses. One major cause of the 1990s labor troubles was the lingering dissatisfaction—expressed by AA employees—with the two-tier wage system. For any unionized job, B-scale employees were paid much lower wages than their veteran counterparts, and over the years, these lower paid employees had turned extremely resentful toward management. As Crandall hired a growing number of B-scale re- cruits in the 1980s and 1990s, the “B-scalers” had eventually become the majority of all AA’s union- ized employees. Two labor disputes at American during the 1990s stand out. The first involved a strike staged by the Professional Association of Fight Attendants. In 1993, 21,000 fight attendants struck American airlines during Thanksgiving Day weekend, crip- pling the carrier and ruining whatever prospects management had of posting profits that year (AA ended the year with a small loss of $110 million on $15.8 billion in revenues). Union leaders pointed out that Crandall’s unwillingness to bend during negotiations precipitated the strike. Industry ana- lysts agreed, noting Crandall’s compulsion to keep labor cost-low. As the strike entered its fifth day, President Clinton intervened and pressured both sides to accept binding arbitration. The dispute was later settled, but the flight attendants remained disgruntled.38 A pilots’ strike-threat underlay the second la- bor dispute. In November 1996, the Allied Pilots transatlantic travel market, AA’s share accounted for 23% of all airline traffic. In 1995, American derived 14%-15% of its airline revenues from the Latin America market, and 13% from the European market. As expected, both international markets were quite profitable: in 1996, AA generated an op- erating profit margin of 10% in Latin America, and 8% in Europe.36 Forming Alliances Signing code-sharing agreements with foreign car- riers was another growth strategy undertaken by Crandall. Code-sharing allowed American to as- sign its two letter code—AA—to flights operated by another carrier, thereby offering passengers flights to destinations not served by American. Enhanced by shared computer reservation systems and joint frequent-flyer programs, such agreements enabled American to increase its passenger traffic without extending its own route network, hence saving the carrier the expensive and risky cost of starting new international services. American signed its first code-sharing agreement with Canadian Airlines International (CAI) in 1995. The agreement extended AA’s route network to doz- ens of Canadian cities served by CAI and linked CAI route system to dozens of U.S. destinations served by AA. Seeking to extend AA’s route structure to Asia, Crandall signed another code-sharing agreement with CAI in 1997. The 1997 agreement offered AA passengers trans-Pacific service on flights operated by CAI between Vancouver and Taipei. To further increase its Asia-bound traffic, American formed an alliance with China Eastern Airlines in 1998—the first code-sharing agreement between a U.S. car- rier and an airline based in the People Republic of China. Under the agreement’s provisions, American placed its code on fights operated by China Eastern from Los Angeles and San Francisco to both Shang- hai and Beijing, thereby offering passengers from destinations as distant as Latin America full service to Mainland China. Finally, in September 1998, a few months after Crandall stepped down, Ameri- can Airlines announced the formation of OneWorld Alliance, a code-sharing agreement signed by five international carriers: American Airlines, British Airways, Canadian Airlines International, Qan- tas Airway (Australia), and Cathy Pacific Airlines (Hong Kong).37 25843_case17_ptg01_hr_C224-C239.indd 231 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 232 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C232 Section A: Business-Level Strategy Donald Carty and the September 11, 2001 Terrorist Attack Donald Carty served as American Airlines CEO for five years. An AA’s career executive, he was hand picked by Crandall to lead the carrier, first as Presi- dent, and then, following Crandall’s retirement in 1998, as CEO. Carty’s five year tenure was marred by labor troubles, recession, and terrorism, and ended in a public scandal: as a result of the September 11, 2001 attack, American Airlines was losing sev- eral million dollars a day, yet in Spring 2003, at the time the carrier was inching towards bankruptcy, AA’s senior executives—including Carty—received undisclosed bonuses and pension guarantees worth millions of dollars. Carty’s labor problems began early on. In 1999, he convinced the AMR board to acquire a small Association’s board of directors approved a tentative pilots’ contract, and presented it to the union mem- bership for ratification. Persuaded by a dissident group of grassroots union activists made largely of B-scale pilots, the membership rejected the contract by a margin of almost two to one. The union leader- ship, in turn, hardened it position, and threatened to strike the carrier. As the strike deadline approached, President Clinton intervened, invoking a rarely used provision of the 1926 Railway Act which empowered him to appoint a three-member emergency board to help settle the dispute. In the meantime American’s losses were mounting. By April 1997, AA lost at least $100 million in advanced bookings, as passengers avoided flying an airline facing impending walkout days. The contract was eventually ratified, but here again, the pilots remained embittered, and they con- tinued resenting Crandall’s heavy-handed manage- ment methods.39 Improving Financial Results, 1985–1997 AA’s financial performance under Crandall needs to be analyzed in conjunction with Crandall’s evolv- ing strategy. Serving as CEO for 13 years, Crandall shaped and reshaped his strategy, paying close atten- tion to changes in the business cycle. In the 1980s, Crandall undertook a growth strategy that resulted in a rapid expansion of American Airlines’ fleet, as well as workforce. The larger AA grew, the lower were its costs, the higher its revenues, and the larger its profits. In the early 1990s, as the air travel mar- ket slid into a protracted recession, and AA experi- enced four years of losses, Crandall embarked on a retrenchment strategy, laying off employees, ground- ing old planes, exiting unprofitable markets, and out- sourcing selected services. Following the recession of 1990–1993, the industry expanded once again, and Crandall introduced a second growth plan. His re- newed efforts at increasing revenues and improving profits were sustained by AA’s industry-leading yield management system, its formidable AAdvantage fre- quent flyer program, and its extensive global route network. Notwithstanding the labor troubles of 1996–1997, the carrier had become profitable again, posting a net income of over $1 billion in 1996, close to $1 billion in 1997, and $1.3 billion in 1998, as Exhibit 1 shows, and reducing its debt as a percent- age of capitalization from 83% in 1994 to 66% at the end of 1996.40 Revenues Net Income Income as ($Mil.) ($Mil.) % of Revenues 1985 6.131 346 5.6% 1986 6.018 279 4.6% 1987 7,198 198 2.8% 1988 8,824 477 5.4% 1989 10,480 455 4.3% 1990 11,120 (40) — 1991 12,887 (240) — 1992 14,396 (935) — 1993 15,816 (110) — 1994 16,137 228 — 1995 16,910 167 1.0% 1996 17,753 1,067 5.7% 1997 18,570 985 5.3% 1998 19,205 1,314 6.8% Exhibit 1 Robert Crandall’s American Airlines Highlights of Financial Data, 1985–1998 Sources: “AMR Corporation,” Hoover’s Handbook of American Business, 1992, p. 110, 2002, p. 165. 25843_case17_ptg01_hr_C224-C239.indd 232 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 233 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C233Case 17: American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 $550 million during the first half of 2001.43 Less than three months later, the 9/11 terrorist attack erupted, destroying two AA passenger jets at mid air, and shut- ting down all airline travel in the U.S. for two days. The impact of the 9/11 attack on American’s fi- nancial performance was long lasting. As shown in Exhibit 2, AA lost $1.8 billion in 2001, and a record $3.5 billion in 2002. In April 2003, following an- other loss of a billion dollar during the first quarter of the year, American Airlines was nearly bankrupt. To avoid filing bankruptcy under Chapter 11, Carty asked the three unions representing the ma- jority of AA employees to agree to major wage and benefit concessions. The leadership of each union accepted management’s demand for a concessional contract and put the issue before the membership for a vote. Within two weeks, AA employees ratified a collective bargaining agreement that gave the carrier back a total of $1.8 billion, or 20% of the carrier’s annual payroll.44 A day later the deal began to unravel. Follow- ing the contract ratification, union leaders, as well as members, learned from news reports that the AMR corporation awarded Cary and five other executives bonuses that equaled twice their annual salaries, and set aside a $41 million trust that was intended to protect the pensions of 45 executives in the event of bankruptcy. As it turned out, the carrier delayed fil- ing a report detailing these executive compensation plans with the Security and Exchange Commission until after the contract vote was completed.45 The belated disclosure angered the employees and prompted two of the three unions to call for another contract vote. Carty, in turn, sent a letter to low-cost commuter airline called Reno Air. The pro- posed acquisition evoked a staunch opposition on the part of American pilots. Believing that Carty planed to replace them with low-paid Reno pilots, members of the Allied Pilots Association staged an 11 days sickout which forced American to cancel 6,700 fights, left 600,000 passengers stranded, and cost the carrier $225 million in lost earnings. Also in 1999, AA flight attendants rejected a tentative contract offer and threatened to strike the carrier. In 2001, AA’s flight attendants agreed to accept a con- tract agreement only after exhaustive negotiations that ended hours before a strike deadline.41 Notwithstanding these labor differences, Carty moved to expand the airline by merger, purchas- ing TWA—a trunk-line carrier experiencing serious financial problems. Approved in April 2001, AA’s merger with TWA created the nation’s largest air- line, adding 188 commercial airplanes to American’s fleet (TWA’s 104 McDonnell Douglas MD-80 jets fit nicely into AA’s fleet), and providing American with a central hub at St. Louis. The cost of the transaction was just $742 million—a modest sum by any indus- try standards—and more important, the merger was supported by all major unions. Backed by the union- ized employees of both carriers, Carty managed to integrate the two companies smoothly, earning the praise of industry analysts.42 Yet the TWA acquisition was untimely. The merger was approved at the time the entire airline industry was moving rapidly into a recession. Fol- lowing the merger’s approval in Spring 2001, busi- ness travel dropped precipitously, leisure travel fell too, and fuel prices were rising. As a result, AA lost Revenues Net Income Income as Stock Prices ($Mil.) ($Mil.) % of Revenues FY Close 1998 19,205 1,314 6.8% $26.54 1999 17,730 985 5.3% 29.95 2000 19,703 813 5.7% 39.19 2001 18,963 (1,762) — 22.30 2002 17,299 (3,511) — 6.60 Exhibit 2 Donald Carty’s American Airlines Highlights of Financial Data, 1998–2002 Source: “AMR Corporation,” Hoover’s Handbook of American Business, 2005, p. 88. 25843_case17_ptg01_hr_C224-C239.indd 233 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 234 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C234 Section A: Business-Level Strategy for Mr. Arpey . . . I can honestly [say] there’s not a person I have more respect for or trust in.”49 Arpey’s turnaround plan was based on several elements. First, Arpey believed that in order to com- pete successfully in the post 9/11 world, American Airlines needed to shift its strategic focus from rev- enue growth to cost reduction. To achieve this goal, he introduced a cooperative labor management scheme, a continuous improvement program, and other labor cost cutting-measures. Second, Arpey realized that American could take advantage of its global positioning to expand profitable interna- tional operation and curtail unprofitable domestic services. To achieve this goal, he sought to form closer alliances with foreign carriers. Altogether, Arpey embarked on four distinct strategies in his ef- forts to turn American around: International Expansion. Referring to his plan to expand AA’s international operation, Arpey explained: One of the things that we can capitalize on is the depth and breath of our network. Its one of the ways that we can compete more effectively with low-cost carri- ers that operate primarily in the domestic market . . . We have very aggressive plans internationally . . . Our strengths include a very broad network that spans the globe. . . the [industry’s] largest frequent- flyer program, Admiral airport clubs, and a great first-class product. . . [W]e get more revenue per pas- senger than the low cost carrier[s and] . . . we can sustain a revenue premium.50 Arpey expected AA’s international service to grow from over 30% of capacity in 2005 to 40% by the end of the decade. He planned to expand, above all, trans-Pacific travel service. In 2005, American in- troduced two nonstop services to Japan, operating flights between Chicago and Nagoya, and between Dallas and Osaka. Similarly, in 2005, AA started a nonstop service to India, flying the 7,500-mile route between Chicago and New Delhi, American’s lon- gest, in 14–15 hours. American also competed ag- gressively over the contested rights to serve China, planning to introduce a Chicago-Shanghai nonstop service as early as approval by the Chinese govern- ment was granted. Additionally, AA formed alliances with Aloha Airlines and Mexicana Airlines, on the one side, and consolidated its code sharing agree- ment with British airways, on the other.51 Labor-Management Cooperation. To improve his relations with the unions, Arpey instituted an open AA employees apologizing for his conduct, and an- nouncing the cancellation of the proposed bonuses: “My mistake was failing to explicitly describe these retention benefits . . . Please know that it was never my intention to mislead you.”46 The disclosure, in addition, surprised several members of the AMR board who felt misled by top management, believing that Carty had discussed the executive compensation package with the union leaderships prior to the con- tract vote. In response to the mounting public outcry over the disclosure, AMR board of directors sought Carty’s resignation. Pressured by the board, Carty promptly stepped down, and the directors moved at once to elect a new CEO.47 The Future: Gerard Arpey’s American Airlines, 2003— A few board members suggested rehiring Robert Crandall. Others rejected Crandall’s choice and sought instead a candidate that was likely to cre- ate a sense of management continuity in AA and act quickly to save the company from filing bankruptcy. Such a candidate, the majority of directors agreed, was American Airlines President Gerard Arpey. Elected by the board to replace Carty, Arpey had 24 hours to save the carrier. Crafting a revised labor management agreement that included the essential $1.8 billion cuts in wages and benefits, and offered the employees a number of additional nonmonetary gains, Arpey managed to convince the union lead- erships to approve the new labor agreement and thereby save the carrier from filing for bankruptcy protection. Passing his first test as a chief execu- tive, Arpey outlined a key management objective he would strive to accomplish throughout his tenure as AA CEO: “There is a definite need to rebuild trust [between management and labor} within the com- pany. I hear that loud and clear. . .and I commit my- self to earning everybody’s trust.”48 Gerard Arpey spent his entire career at Ameri- can Airlines, joining the company as a financial analyst in 1982. Before accepting the top job, the 46 year old Arpey sought, and received, the ap- proval of AA’s union leaders: “He said he wouldn’t take the position unless . . . he had our support, “ John Darrah, President of the Allied Pilots Associa- tion recalled, adding, “I have a great deal of respect 25843_case17_ptg01_hr_C224-C239.indd 234 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 235 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C235Case 17: American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 In addition to the team headed by Arpey and the union presidents, Overland facilitated the formation of seven regional JLTs located in different airports and maintenance bases throughout AA network. A local JLT met once a month to review the region’s fi- nancial performance and to evaluate employee cost- saving ideas.56 Overland presence at AA enhanced employee motivation and morale. The higher level of em- ployee motivation was reflected, first and foremost, in the growing number of cost savings suggestions initiated by employees. While AA management rou- tinely ignored employee suggestions in the past [one union leader observed], Overland consultants now encouraged the adoption of such suggestions. And while Arpey’s management team was actively solicit- ing employee ideas, no employee whose ideas were adopted received any compensation; on the con- trary, helping the company was the employee’s sole motivation.57 As a result of implementing employee-identified cost-saving ideas, AA saved about $100 million in 2004.58 The overall decline in labor cost was larger. Partly as a consequence of introducing cost-saving ideas, and partly as a result of implementing the landmark concessional contract of April 2003, AA unit labor cost under Arpey declined by more than 20% in two years, as shown in Exhibit 3. door policy. During his first two years in office, Arpey spent more time meeting union leaders than the time spent for this purpose by any other chief executive in the company’s 75 years history. “You demonstrate commitment by where you put your time,” he told a Financial Times reporter in 2005. “We are trying to make our unions our business partners.”52 Unlike Crandall and Carty, Arpey constantly highlighted the importance of getting AA employees involved in the business of airline management. Once elected CEO, he traveled widely, visited AA operations in one city after another, conducted town-hall meetings with AA employees, and solicited employee suggestions. “I try to spend as much time as I can [with the em- ployees] when I travel,” Arpey explained in a 2004 interview, “going to break rooms, talking to agents at the gate, talking to flight attendants on board [of] the airplane, riding jump seats, and . . . answering all the e-mail[s I] get.”53 Still, Arpey was unable to change AA’s climate of labor-relations single-handedly. He needed external help. To improve labor management relations at American, Arpey hired an employee- relations consultancy called the Overland Resource Group in Summer 2003. Instrumental in improving labor-relations at Boeing, Ford, and the Goodyear Corporation, the Overland group instructed AA managers to follow three fundamental principles, or maxims, in their relations with AA’s employ- ees: “Involve before Deciding,” “Discuss before Implementing,” and “Share before Announcing.” More important, the Overland group created a Joint Leadership Team (JLT) chaired by Arpey and the national presidents of AA’s three main unions (representing the pilots, flight attendants, and me- chanics and ground workers), and attended by the company CFO as well as four vice presidents, on management side, and three representatives of each union, on labor side. The team met once a month to discuss issues ranging from AA’s corporate- level strategies to union demands and grievances. The team also reviewed AA’s financial data on a quarterly basis, an arrangement that helped senior union officials understand the airline business.54 To help team members communicate, two Overland consultants attended all JLT meetings, acting as the dialogue facilitators. To ensure an honest, open, and free-flowing discussion with no fear of repri- sal, each JLT participant signed a non disclosure agreement.55 Network 4Q-02 CASM 4Q-04 CASM American 3.93 3.12 Continental 3.10 30.2 Delta 4.01 3.67 Northwest 3.98 3.82 United 4.51 3.25 U.S. Airways 4.15 3.11 Network 4.01 3.34 Exhibit 3 Labor Cost of U.S. Network Carriers, 4th Quarter 2002 and 4th Quarter 2004, Cents Per Available Seat-Mile (CASM) Sources: Eclat Consulting, Aviation Daily, May 4, 2004, p. 7, and May 26, 2005, p. 7 25843_case17_ptg01_hr_C224-C239.indd 235 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 236 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C236 Section A: Business-Level Strategy assembly. Together, the two teams helped AA cut an engine’s overhaul turnaround time from 53 days in 2003 to 40 days in 2004, an improvement of 25% in a single year.62 Continuous Improvement teams helped AA cut costs in still other ways. To service American Airlines fleet, company mechanics used thousands of drill bits monthly at a cost of $20 to $200 a piece. Two AA mechanics invented a drill bit-sharpening tool which refurbished bits for reuse at a cost saving of $300,000–400,000 a year. And in 2004, a CI team came up with the idea of reusing parts of obsolete DC-10 coffee makers on other AA airplanes, gener- ating a one-time savings of $675,000.63 Taken together, all these improvements helped AA reduce its maintenance cost by 34% in two years (2002–2004). A comparison between American’s main- tenance cost reduction and that of five other U.S.-based network carriers shows that AA led the way, exceeding the industry average by 13 percentage points, and well ahead of any of its competitors (Exhibit 4). Other Cost Cutting Measures. “Simplification and standardization drives efficiency,”64 Arpey said in 2004, and he moved quickly to both simplify and standardize AA’s fleet of aircraft. To simplify the fleet, Arpey reduced the number of aircraft types flown by American from 14 to 6, retiring many old mod- els. The move reduced American spending on spare parts as well as crew training, especially pilots and Continuous improvement The Continuous Improvement (CI) program was implemented across all AA’s maintenance facilities. During 2001–2004, United Airlines, Northwest Airlines, and U.S. Airways closed several of their maintenance bases, and sought instead to outsource heavy maintenance to outside contractors.59 Ameri- can Airlines, by contrast, kept maintenance work in house, and launch a massive drive at efficiency, seek- ing productivity gains in the shop floor. The Continuous Improvement program had three main goals: the elimination of waste in any form, the standardization of maintenance work, and the op- timal utilization of “human talent.” The idea—and practice—of CI was based on the assumption that workers, not managers, were the real experts, and that employee empowerment was critical for build- ing effective work teams. The CI program addressed a variety of issues ranging from shop floor reorga- nization to engine-overhaul turnover time reduc- tion. To achieve these objectives, a “5S” technique (“sort, strengthen, standardize, shine, sustain”) was introduced throughout AA’s maintenance facilities. At American’s largest maintenance base in Tulsa, Oklahoma, for example, Continuous Improvement teams in the avionic shop used the 5S technique to free nearly 12,000 sq. ft. of floor space and thereby save the company $1.5 million in inventory cost.60 Employee-identified CI ideas included new ways to reduce the cost of replacing aircraft parts and com- ponents. On the McDonnell Douglas MD-80 model, for instance, the cargo door torque (spring) tube needed to be replaced once a year. To do so, the com- pany bought new tubes at a cost of $660 per tube. The CI team investigated the issue and ascertained that repairing broken tubes at a cost of only $134 per unit saved the company a total of $250,000 a year. On the Boeing 737, similarly, AA economized by replacing passenger light bulbs and cabin windows only when needed. In the past, AA replaced all light bulbs and cabin windows at the same time regardless of whether the bulbs were burned out or the windows worn out. The selective replacement of light bulbs and cabin windows saved AA $100,000 per year.61 American used CI teams to reduce engine over- haul times as well. One team of engine mechanics drafted a series of diagrams showing the most ef- ficient way to disassemble a jet engine. Another de- vised a “point-of-use tool box” which contained all the tools necessary for an engine’s assembly and dis- Network 4Q02 CASM 4Q04 CASM % CASM American 1.65 1.09 34% Continental 0.96 0.93 3% Delta 0.98 0.92 6% Northwest 1.43 1.08 24% United 1.41 1.24 12% U.S. Airways 1.67 1.30 22% Network 1.36 1.08 21% Exhibit 4 Maintenance Cost of U.S. Network Carriers, 4th Quarter 2002 and 4th Quarter 2004, Cents Per Available Swat Mile (CASM) Source: Eclat Consulting, Aviation Daily, May 4, 2004, p.7, and May 26, 2005, p.7 25843_case17_ptg01_hr_C224-C239.indd 236 1/20/12 2:09 PM Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. # 108137 Cust: Cengage Au: Hill Jones Pg. No. 237 Title: Strategic Management Server: C/M/Y/K Short / Normal / Long DESIGN SERVICES OF S4-CARLISLE Publishing Services C237Case 17: American Airlines Since Deregulation: A Thirty-Year Experience, 1978–2007 any other network carriers save Continental. Ameri- can’s stock prices too performed well. Following a sharp drop in AMR stock price during the post 9/11 years, AMR’s stock more than doubled in value in 2005, rising 101% and outperforming the share prices of all major U.S. carriers, including Southwest Airlines. AA’s cash position, furthermore, was stron- ger than that of other network carriers. AA managed to increase its cash surplus from $3 billion in 2004 to $4.3 billion in 2005, a margin sufficiently com- fortable to give the carrier a greater staying power in the industry than its rivals.68 Nevertheless, American Airlines still faced a number of daunting challenges. First and most im- portant was the need to achieve profitability. During Arpey’s first three years in office, AMR continued to post large losses that amounted to $1.2 billion in 2003, $0.8 billion in 2004, and $0.9 billion in 2005. While analysts were impressed by AA’s cost-cutting measures (as well as its collaborative labor manage- ment relations, strong cash position, rising fares, and trimmed capacity), and while AA stock doubled in value in 2005 in anticipation of profits in 2006, the continual increase in fuel costs during 2006 clouded AA’s recovery prospects.69 Another concern pertained to labor relations. AA employees resented a stock-related bonus paid to American managers in 2006. The payout was au- thorized by an 18 year old “Long Term Incentive Program” which tied executive pay to AA’s stock
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