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May222008

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I am beginning to believe that there is a silver lining in the high price of oil.

Last month, I wrote a piece entitled The Elastic Induced Ride to Inelasticity. With seat belts on, seat backs and tray tables up, we are ready for takeoff. Yesterday, while American and Southwest were holding their Annual Meetings of Shareholders, I was on an airplane back from Honolulu. So I missed the news flying out of those meetings that found its way onto the wires as rapidly as it could be transcribed. I missed the latest $4 per barrel rise in the cost of crude oil that now equates to $4+ per gallon of jet fuel. I missed …….. or, did I really miss anything?

Oh, I missed something all right. Whereas I believed the industry would transform itself more through merger and acquisition activity, I am now a believer that the price of oil, and the market, is truly what is needed to fully address the many structural ills that have plagued this industry for years. I would like to return to a few paragraphs I wrote in an Airline Business piece earlier this year: Are US carriers really ready for competition?

Despite claims to the contrary, nothing is new in the US. The same old ways of doing business remain intact, which calls into question whether the industry’s fabled “restructuring” has made any meaningful changes in the competitive profile of the US airline business. Despite deep cuts, many outmoded, and troubling, business practices remain.

Following an industry life cycle of value destruction, US legacy carriers now face a dilemma: whether to invest in their core businesses or not? Certainly the tendency to legislative and regulatory gridlock did not get restructured. An inflexible labor construct did not get restructured. The fragmentation of the US domestic market did not get restructured. The infrastructure, whether it be ATC or the airport system, did not get restructured. And the historic mindset that capital will be forever recycled among manufacturers, vendors, labor and government imposed actions did not get restructured.

Little has changed when it comes to labor and regulator views on consolidation. The mindset among the 535 decision makers on Capitol Hill still assumes that any congressional district with a runway, a terminal building and security is entitled to air service. Compounding this sense of entitlement is labor’s sense that the industry will return to its previous “pattern bargaining” – a supposition that fails to recognize the structural change in markets, labor and city pair.

Gerard Arpey’s Words

The full text of Mr. Arpey’s comments to his shareholders can be found here: Remarks Of Gerard Arpey At American Airlines Shareholders Meeting. As we approach the 30th birthday of US Airline Deregulation, it is the price of oil that is demonstrating its power to force the industry to address the many legacy mindsets that did not get restructured during the post 9/11 period. Among many, it includes the customer’s assumption that they actually pay the “all-in” price of the service and are therefore entitled to multiple access points to the air transportation system. NOT.

In this morning’s Wall Street Journal front page, column six, story by Susan Carey and Paulo Prada, they wrote: “If oil prices keep climbing, rising fares could start to push a significant percentage of travelers away from flying entirely. That could reverse one of the most dramatic effects of the industry’s deregulation in 1978, which led to a huge increase in flights, and brought intense fare competition, opening the world of air travel to millions of people”.

Ms. Carey and Mr. Prada are right. And the industry is right to evaluate the cost of providing the product at every juncture. And the industry is absolutely right to charge what it costs to produce the product. From the time the customer logs onto the internet to consider purchasing the ticket; to the actual purchase of the ticket; to the airport experience including check-in; the trip through security; down the jetway; taxi out; inflight service; taxi in; deplane; and collect luggage. Everything has a cost. And the management teams of each and every airline are being forced to “drill down” as never before in order to fully calculate those costs. And after calculating the costs of provision, many, many difficult decisions are being made.

Now this does not make any CEO popular. But being a CEO today is not a popularity contest during these difficult times. [And the most popular CEO of all time, stepped down from a 40+ year career BOD position yesterday] Being a CEO today means having the fortitude to say no. Being a CEO today means questioning anything and everything just because that is the way it has always been done. Being a CEO today means making the tough decisions even though dislocations of certain stakeholders might occur. And being a CEO today means having the guts to say out loud what CEOs knew before them but failed to act.

Mr. Arpey said and the WSJ highlighted: “The airline industry will not and cannot continue in its current state”.

Concluding Thoughts

With all of the actions being taken by the industry to charge for things that were never charged for before, what is interesting is how each carrier is sure to ensure that their most important customers will not pay those fees. Loyalty programs have just become a/the most important asset to an airline – not that they were not before – but rather it is this “inelastic” air traveler that the industry needs to rediscover. And cater to. And build for. And so on. And maybe this is why Mr. Arpey suggested that it was just not a good idea to sell its AAdvantage program. And maybe the market will begin to rethink how it values these currently undervalued assets.

This industry is now recognizing that it cannot be everything to everybody. Yes the industry has met its match – and it is not labor, government, or the macro economy. It is the high price of fuel that is causing the industry to continue the process of fully transforming the way business is done. My guess is that if we had not faced this potentially murderous economic period, then the industry would not have been forced to fully examine itself. The current industry architecture is a picture of what the deregulators envisioned – and the industry delivered. But the architecture produced does not work.

So Mr. Arpey, as your unions marched, I for one am glad you spoke. And you spoke clearly as to how American is moving forward. Your message was not popular. Your message pushed the envelope a little further and added to the debate significantly. No one knows how all of this will really play out. There has to be recognition before there is action. The industry is taking action and one can only hope that labor and government begin to recognize that we are not going back to the same old, same old.

Except for the fact that each airline will "return their attention" to those core, “inelastic”, customers that are willing and able to pay for the service being provided. And those customers will complain less over time. As for the rest of the traveling public and lawmakers that believe they are entitled to air service - well you are not.

More to come.

Reader Comments (3)

Thanks for the interesting article.

I personally think AA's decision to charge for bags is a bad one. And here is why.

1. It's not an obvious charge, and therefore it's not fair. Agents won't double check to make sure a customer buying a ticket understands that a cost of ticket does not include checked-in bags. When was the last time an average passenger read Terms of Carriage?

2. Even if I pay to check in my bag, will airline make sure I get seated next to someone who also paid for their bag instead of someone who will spend 15 minutes trying to squeeze her oversize bag under the seat in front of her and delay our on-time departure? You and I both know the answer is no, airline's IT systems won't be able to handle that. Hence, why should I pay for the bag but enjoy same level of service as someone who didn't? Or will they deny boarding? Now *that* would be interesting...

Analogy: Who pays for parks in your town? Everybody does, from their taxes. Because it's nearly impossible to recover park maintenance costs from those who actually use the parks.

3. Rationally, if you have a relatively small bag, you'd be better off not checking it in if you are seated in group 1 or maybe 2. Your chances of finding space for your bag in group 3 are very low. But you don't get a boarding pass until AFTER you made a decision if you check in bags or not. I think we will see a lot of chaos due to this problem.

4. Antagonizing your employees (esp. front line) is not necessarily the best strategy. You and I know that CSRs and FAs will be the first to hear from angry customers who did not understand or failed to get informed about the change.

All in all, if supply makes it impossible for vendors [airlines] to pass their costs down to consumers [passengers], supply needs to be reduced or the costs are out of line. There is no way around that. Trying to charge people in an attempt to cover overblown costs is not sustainable in the face of competition.

AA is attempting to get away with hidden costs, but methinks it will backfire, even if it's the right thing to do.

Please keep writing this blog - I enjoy your writing very much!

05.22.2008 | Unregistered CommenterDmitriy S

Dmitry

4 very good points.

On the charging for the first bag, I too am concerned with the execution at the counter, at security and at the gate and on the aircraft. Not sure if many passengers have ever read the terms of carriage.

Your point on delays is well taken and we certainly do not need another reason for them. And your point on the impact of front line employees only exacerbates the situation they face in delay scenarios.

While not crazy about the first bag idea generally, I do like the fact that Arpey spoke decisively for AA. In terms of your point on hidden costs, their labor cost disadvantage is quite evident to the world and the fuel issue only serves to highlight this point even more.

As we move down this ancillary revenue road, I am sure that some of the ideas will work and others will not. I will not put the first bag idea at the top of my list of successes, but this environment will make loyalty even more important in terms of consumer decision making in my view.

AAdvantage, Mileage Plus and a combined Delta-Northwest program certainly would seem to have some real benefits in this brutal environment.

Great comments and thanks for taking the time to stop by.

05.22.2008 | Unregistered CommenterSwelbar

I read the fee as move of an effort to shift cost burden back to TSA and the Federal Government.

When the 3 ounce liquid rules came out far more people checked their bags, thus shifting a labor/cost burden from TSA by decreasing the volume of bags to be inspected and putting it on ticket agents and bag handlers at the airline.

This no doubt increased the weight load on aircraft, which obviously makes them more costly to fly. (Such as, if you've got room to pack more, why not?)

Even if this is a small incremental cost, we've seen before that small changes add up in this world.

By encouraging people to carry their bags on, they've nearly guaranteed themselves a cut in weight and fuel cost plus the cost to handle all of those checked bags - which is expensive from a labor standpoint as well. Of course, AA will have to figure out how to manage all of those bags inside the secure zone when boarding, but that's small potatoes in comparison.

I agree with the ideas you've presented, but I also read the fee announcement as a response to TSA. Their inefficiencies have as much to do with the problems in the industry as the carriers not updating their business models.

05.23.2008 | Unregistered CommenterA'Dell

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