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Cost-cutting Is Not Enough: Lessons From American Airlines

29 November, 2011

Airline company AMR, owner of the popular American Airlines, filed bankruptcy last week. To which most people responded: Again? The reaction was less about AMR, which is having a first-time filing, and more about airline bankruptcies overall. People are simply used to airlines failing.

Most people are so used to everything about airlines sucking that the news of a major filed bankruptcy simply wasn’t surprising. What they cared most about were two questions: Is my ticket any good? And another is: Do I get to keep my frequent flyer miles?

Conceptually, business is not hard to understand. Create a product or service that people want. Make it appealing enough so that people will pay enough to cover costs and make a profit, allowing you to re-invest in growth and repay your investors. Pretty simple.

But AMR, like most airlines, simply doesn’t understand this concept. Yes, people want to fly. But ever since deregulation, service has become worse and worse. Ask anyone what they think of American (or United or Delta or any ‘major’ airline) and answers are the same. They hate them.

  • Pricing is incomprehensible. You may pay $800 for a ticket and the person beside you $200, and the reason is completely unclear.
  • There is never enough room on the plane for all the carry-on luggage, but that is free while the airline charges for checking bags. What they don’t want (carry-ons) is free, what they want (check your bags) requires you to pay?
  • You are charged for a checked bag, but if the bag is late, damaged or items are stolen, you have no recourse to the airline.
  • When planes are late or cancelled, nobody cares how much customers are inconvenienced. Literally. You have no recourse to bad or failed service.
  • Planes are cramped and dirty, often looking well worn or worn out.
  • Every year planes are becoming smaller and less comfortable.
  • The food is gone or wildly expensive. And that little bottle of rum costs as much as a fifth at home.
  • Employees appear uncaring at best or simply rude. It’s like there are way too many customers and not enough of them. So “PLEASE stay back and do what we tell you to do!”

This list could go on forever (readers, feel free to comment on your favourite stupid policy or practice of any airline). Why? Because the airline’s leaders have completely lost track of what business is all about. In the rush to cut prices, trying to sell that last empty seat on that midnight feeder flight to Omaha, the entire industry has driven out all the customer satisfaction, and profitability. Everyone has learnt that it doesn’t matter how much you pay, the experience is going to suck. So the industry has taught customers to be price sensitive, above all else.

Shortly after deregulation, Robert Crandall became AMR’s Chairman. He was a notorious cost-cutter. The Wall Street Journal ran a front page article highlighting his efforts to build American, highlighting how on a flight Crandall noticed that a few customers were eating the three black olives on their salad. He reportedly went back to company managers and told them to remove the olives, thereby saving (ostensibly) $700,000/year.  Nobody would notice, he claimed, and money was saved.

And that has been the trajectory for American ever since. Cut this, cut that. Shave costs everywhere, including employee pay, benefits and pensions. And after 30 years, the sum total is that not only are the olives gone the whole meal has disappeared! While working at an airline was once considered a great job (pilot, flight attendant, gate agent or baggage handler), today compensation has been cut and complicated (remember tiered compensation that has two people doing the same job, but at different pay just because of hire date?), so that employees are largely overworked, under-appreciated and constantly being pushed by management in one direction, while pulled by customers in another.

Where once we didn’t mind flying, maybe even enjoyed it, now everyone thinks of flying as the opportunity to learn what life is like as herded, and penned, livestock!

It has been a fallacy of ‘modern management’ that leaders have a primary job to optimise the business largely by limiting innovation and cutting costs. The famous business guru, Jim Collins (author of Good to Great), actively advocates that businesses focus exactly on the kind of business optimisation that has driven AMR to bankruptcy! His recommendations have inevitably lead businesses down a road of commoditisation as they offer less and less to customers, and fall into vicious price wars. Inevitably, a market shift happens that undercuts their ability to compete at all!

Great companies do not fall into this trap. They constantly add customer value, utilising new technology and business processes to improve performance. They grow revenues, rather than focus on cutting costs.

Think about how Google has made doing research easier and placing Internet advertisements. Or how Apple has improved personal music and mobile information access. Or how Whole Foods has delivered more organic and tasty products. Or how Amazon has made access to books, periodicals and much of retailing a better experience. These companies have seen their market capitalisation explode as they eschewed optimisation in favour of innovation to make things better not just cheaper. Where AMR’s value went from $40/share to zero in the last five years, you would have had big gains in these companies that focused on innovation and delivering better customer results.

Chart Source Yahoo 1 December, 2011

AMR’s leaders, and airline industry analysts, can try to put perfume on this bankruptcy pig by saying it is a ‘strategic action’ taken to re-align costs (CuriousCapitalist.com). That’s code for union-busting, in yet one more effort to ignore the real problem of no innovation. Rather than actually improve the airline, this is more of the same old strategy  cut more olives (cost,) chasing the spiral yet further down toward even worse performance.

It’s time to be honest. AMR’s bankruptcy is a failure. Leadership’s inability to address customer needs well enough to price at a profit. Gimmicks like loyalty programmes, bag charges, reservation fees, change fees, seat location fees and drink charges merely obscure the fact that the leaders cannot profitably run an airline! Their service is so poor that they cannot charge enough to cover costs. Continuing to cut costs, further hindering service, is NOT the answer in a service industry!

It certainly is possible to make money in service industries. Most do. It is even possible to make money as an airline just look at Southwest (which has made more profit than all its [much larger] competitors combined). And the first step is for AMR to recognise that its strategy for 30 years is wrong!  The company needs to end the cost-price spiral and introduce some innovation! Change the game AMR, or you will forever remain a crappy company for investors, customers and employees.


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Cost-cutting Is Not Enough: Lessons From American Airlines

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