Date: Thu, 20 Nov 1997 15:55:26 GMT Server: NCSA/1.4.2 Content-type: text/html Last-modified: Thu, 13 Nov 1997 19:34:52 GMT Content-length: 18028 American Airlines - Remarks to the National Press Club by Robert L. Crandall, Chairman, AMR Corp. Communications

[OnBoard]


AMERICAN AIRLINES

REMARKS OF ROBERT L. CRANDALL
CHAIRMAN AND CEO
AMERICAN AIRLINES
NATIONAL PRESS CLUB
WASHINGTON, D.C.

November 13, 1997


Good afternoon, ladies and gentlemen. I appreciate your invitation to address this prestigious group, but will admit that visiting Washington, D.C. always elicits mixed emotions.

While this is a great city, lots of people -- including myself -- wish that we could spend more time running our businesses and less time worrying about what folks here in Washington are deciding for us.

Nonetheless, it's a pleasure to be here and to have an opportunity to talk about the emerging debate about re-regulating the domestic airline industry -- a subject I think everyone will agree is important -- not just to American and other airlines -- but to the economy and the country as a whole.

The airline industry is an important part of our nation's economic infrastructure. And as we all know, it is also the subject of both fascination and controversy. Everybody flies, so quite naturally, everybody has an opinion about what the airlines should and should not do. While we welcome the advice, we often think that our business is a bit like church: many attend, but few understand.

In recent months, that misunderstanding -- about how the airline marketplace works and about the industry's recent history -- has generated an increasingly cacophonous debate about a number of proposals which, if adopted, will amount to a fairly substantive re-regulation of the domestic industry.

To put the issue in the proper context, we need to recall that only twenty years ago, in the late 1970s, we were in the midst of a great debate about whether commercial aviation should remain a regulated industry or, alternatively, be deregulated.

Prior to 1978, for almost half a century, the airlines had operated as a highly regulated quasi-utility, with each carrier permitted to fly only explicitly authorized routes at prices established by the civil aeronautics board, or cab.

In 1978, all that changed when congress passed the airline deregulation act. While international aviation remains heavily regulated, the airline deregulation act freed the domestic carriers to fly where they chose, and to charge what they wished.

The theory was that free-wheeling competition would lead to more and better service at ever-lower fares. And that's exactly what has happened. If there ever was a proving ground for the teachings of Adam Smith, the airline industry of the last two decades has been it.

By most economic measures, deregulation has been a resounding success. But for the established carriers, it was -- at least in its early years -- a disaster. The dinosaurs, as the academics of deregulation characterized us, were badly equipped for a deregulated environment. The route systems that had evolved under regulation were uneconomic; the fleet choices that had been made on the basis of those route systems were inappropriate; the labor contracts which had evolved were inflexible; and the management structures of the day were unresponsive.

To make matters worse, new competitors quickly emerged which were able to employ lower cost labor, used planes, route flexibility and lots of imagination to offer new services and lower fares.

Not everybody realized what a threat deregulation represented for the major carriers. And once the threats became apparent, no government entity stepped in to help as they struggled to adjust to the new era of unfettered competition. It was strictly sink or swim -- and as you know, some famous names sank!

In the years since, we have learned that the three most important factors in our business are price, price and price. After that, schedule frequency, network breadth, consistent service standards, distribution strength, consumer incentives, cost effectiveness and marketing innovation all have a role to play.

At American, we -- like other carriers -- have worked hard to be responsive to those consumer messages. We have structured large hubs to offer our customers many origin-destination combinations, built alliances with foreign carriers to extend our networks around the world, and scheduled lots of flights in the markets most important to our core business customers.

We've also done lots of creative things like creating the tremendously popular frequent flyer idea, crafting carefully structured incentive programs for travel agents, and building the world's largest on-line travel reservation system, which we call SABRE.

Finally, we've done all we can to manage our costs. Unfortunately, the by-products of our cost control efforts have all too often been long and bitter labor disputes and customers upset by things like smaller seats, fewer closets, and reduced food service.

While our efforts have thus far sustained some of the pre-deregulation carriers, the financial performance of American and the rest of the industry remains distinctly marginal. Even in 1997 -- which may turn out to be the airlines' most profitable year ever -- the industry's return on equity will lag well behind that of the S&P 500.

Although these are good times by our standards, no one who has been in the airline business for long is ever very secure; the best description of airline economics I know is the old saying that the only sure way to make a small fortune in the airline business is to start with a big one.

While the deregulated airline industry has been and remains difficult, deregulation has benefited most consumers by providing ever-more service at ever-lower prices. Despite what large-type headlines sometimes proclaim, average airline fares remain a bargain -- since 1990, for example, consumer prices in general have risen twenty percent faster than average airline prices.

Despite the acknowledged overall success of deregulation, the airline marketplace – like most free markets – has spread its benefits unequally, and in less predictable ways, than the theoreticians of deregulation imagined it would. For example, when deregulation happened, there were many academics who believed that the established carriers would operate Ritz Carlton airplanes, that low-cost airlines would operate motel 6 airplanes, and that other competitors would operate in-between airplanes -- all on the same routes.

The reality is that all types of customers want to go at every hour of the day – and carriers have found that the best way to serve any given market is to offer variously priced products on every flight.

That means, as I'm sure you know, that airlines do not charge the same price for every seat. That's true because different seats have different value. One of the many aspirations of every airline executive is rubber airplanes -- which could be stretched when used on Friday afternoon flights and shrunk for mid-week and early morning flights. Unfortunately, even the geniuses at Boeing haven't figured out a way to do that.

To deal with the problem of fixed-sized units, we and other airlines vary the prices we charge on any given route based on total demand, competition, and the different values that different customers attach to time. We sell some seats on every airplane at very low prices and some -- to people who decide they need to go at the last minute -- at full retail. And in between, we offer various products with different time values to accommodate the needs of different customers.

The process of deciding exactly how many seats to sell at what prices is called "yield management," which we and other established carriers have raised to an art form by investing millions of dollars in people who understand how to devise the statistical and arithmetic decision rules needed, and in the computers capable of doing the extraordinarily complex computations required.

We have also built large hub airports, which allow us to use airplanes very productively. The hub and spoke system works because it allows airlines to multiply the number of products they offer. An airline which uses 25 airplanes to connect 25 point As to 25 point Bs will only serve 25 city-pairs, or markets. But, by using the same 25 airplanes to fly from 25 places on one side of a hub to 25 places on the other side of the hub -- an airline can provide transportation between 675 city-pairs.

In addition to all this, I think it's fair to say that the theoreticians did not anticipate the magnitude of the labor cost differences that exist between new-entrant and established carriers. The airline business is fast-paced and interesting, and there is no shortage of airline entrepreneurs – nor is there a shortage of people willing to work at low rates of pay, and without restrictive work rules, for anyone who starts a new airline.

At the established carriers like my own, on the other hand, unions jealously guard the high wages, generous benefits and restrictive work rules which are the by-product of more than 50 years of history. Since labor makes up the largest variable cost in our business, the labor cost differences that exist between new-entrant and established carriers mean that established airlines will never be able to compete, on a pure cost basis, with new-entrant carriers that offer simple services across limited networks.

Our challenge – and the challenge of those who run the other established carriers – is to provide sufficient added value so that a respectable percentage of the public will continue to choose to fly with us rather than our low-cost competitors. It's no easy task!

Unfortunately, some folks in Washington -- particularly at the D.O.T. -- now seem inclined to launch a re-regulatory effort designed to strip the established carriers of their right to use the competitive weapons they have developed, and to establish regulatory handicaps which favor low-cost, new-entrant carriers who promise low fares, service to small cities, or some other politically defined objective which the market has not satisfied.

These interventionist voices are calling for limits on which markets the established carriers can serve, on how frequently we may fly, and for restrictions on how much – and even how little – we can charge in specific circumstances. There have even been suggestions that some of our slots – which are take-off and landing rights at the four U.S. Airports which are slot constrained – Chicago O'Hare, Washington National, LaGuardia, and Kennedy – should be confiscated and reallocated to new-entrant or foreign-flag airlines.

None of that sounds much like a free market, or a deregulated industry, to me.

In defending intervention, our critics have made much of the strength my own and other carriers have developed at our principal hubs, and of the difficulty new-entrant carriers encounter when they challenge a major airline in a hub city.

It is worth mentioning, I think, that while American has three major hubs today – in Dallas/Fort worth, Chicago, and Miami – we had additional hubs in Nashville; Raleigh-Durham; and San Jose, California just a few years ago. After investing hundreds of millions of dollars to build each of them, we found – for a variety of reasons – that our offering was not competitive. Because the market is unforgiving, we closed them, took the necessary financial hit, and put our assets to use elsewhere.

Our experiences in those cities were painful for us, and costly for our shareholders – but they were the consequences of the marketplace at work.

In many other markets around the country, our inability to match the fares offered by low-cost carriers has forced us to withdraw. In those situations, the various tactics and strategies we've developed have proved insufficient to combat the cost advantage of our opponents.

In other markets, however, we have been able to add sufficient value to sustain ourselves. Moreover, there are some markets whose strategic value is so great that we cannot exit. While no airline can win in every market, every airline's network includes some markets in which it must win if it is to survive in the long term. The imperative to defend those core markets means that, when challenged, we will compete aggressively with whoever challenges us.

Those who favor re-regulation of the industry have suggested that it is unfair for large carriers to match the low fares introduced by low-cost carriers, or to increase capacity in markets where low-cost carriers are attempting to launch service. Those who complain fail to recognize that an established airline which rises to the challenge of a new-entrant is doing only what any business in a free market must do – seeking to increase the attractiveness of its product.

One of the unique aspects of the airline business is that it is one of the few in the world where increasing output is a method of raising quality. Since our customers favor frequent service, it is only natural that an incumbent carrier challenged in a core market will match the newcomer's prices – since every consumer's first concern is price – while simultaneously increasing the number of flights it offers to enhance the quality of its product offering.

Unhappily, a double standard is emerging: when a low-cost carrier enters a market and lowers fares, it is applauded for providing healthy competition. But when an established airline chooses to defend a market by matching the lower fares, or increasing capacity, or both, it is denounced as predatory.

That's a peculiar characterization in a marketplace where matching prices and improving quality is normally considered standard competitive behavior. Moreover, from a consumer perspective, matching prices and increasing flight frequency results in more service and lower fares – which is exactly what congress had in mind when it deregulated the industry 20 years ago.

The idea that the government should respond to these market phenomena by tilting the playing field in favor of new-entrant carriers strikes me as entirely inconsistent with the intent and spirit of deregulation. It is also ironic that – at a time when our government is doing its best to convince countries around the world to open their markets to more competition – there is growing ambivalence in the united states about whether a free market is appropriate for the domestic airline industry.

There is no disputing the fact that competition – particularly in our business – can get messy. To use a slightly twisted sports metaphor, we often say that life in the airline business is a bit like Dennis Rodman's hair. On any given day, you're not sure what you're going to see – and most of the time, what you see ain't very pretty.

Over the years, many of the things we've had to do to remain competitive haven't been very pretty either. We've closed hubs, abandoned markets, suffered through labor disputes, restructured our network, modified our product, re-engineered our work processes, endured fare wars, and changed our game plan more times than I care to count.

Competition is messy, and it's hard. And by its very definition, it creates winners and losers. The good news is that if we all play the same game – by the same rules – then the customer gets to decide who wins. And that's what business is all about.

Thanks very much for having me here today – it's been my pleasure to be with you. Since there's been some time set aside for a Q&A, I'll be glad to answer whatever questions about this crazy business you might have.


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