Are Legacy Costs Really American Airlines' Biggest Problem?

A commenter writes:

Can you give some specific advice to the big airlines on how they can cut costs and become profitable? I don't think you really understand their situation. To compare the big airlines with the budget ones is like comparing a Ford and GM plant with a Toyota one. Ford and GM has massive legacy costs of high salaries and benefits, and so do the big airlines. American is one of the few (or is it the only one?) of the big airlines that hasn't filed for Chapter 11 in recent years, which would have let them reduce costs and renegotiate legacy employee agreements.

Thank you for the comment. Unfortunately, it simply isn't true that legacy costs are the problem for American (AMR). In fact, Southwest (LUV) actually spent more on wages, salaries, and benefits than American did in the first quarter.

As you can see from the Q1 summary below, American's cost structure is higher than Southwest despite the fact that it spends less than Southwest on compensation expense. The difference in fuel costs is due to Southwest's hedges (which tapers off over time) and it is too late to hedge those now.

However, AMR operating losses in Q1 amounted to 3.3% of sales, which just so happens to be the difference in "other" operating costs. So, if AMR could simply get its non-fuel cost structure in line with Southwest's, they would have broken even in the first quarter.

AMR employs 152% more people (85,500) than Southwest does (33,895) yet AMR only has 125% more in revenue. So staffing levels are another area it could cut to get its revenue per employee ratio down.

Full Disclosure: No positions in the companies mentioned at the time of writing.

Comments

[C130:]

The problem with the legacy carriers has nothing to do with labor costs. I have an uncle that is a pilot with Southwest that makes over $50,000 more a year than I do with one of the Legacy carriers. We are both B737 Captains and both of us have the same number years of seniority. Southwest also has much better work rules, more days off, because their management knows how to utilize their aircraft.

2008 May 25 07:42 AM

[bigdogs:]

Get a clue...I get mad when someone doesn't get it. The airlines, specifically AA has CUT cost ten-folds. The work groups have collectively given up at least 1.8 BILLION dollars in wage cuts annually, benefits, etc. only to have ALL that sacrifice absorbed into OIL...figure it out. Cheap tickets (and they still are relatively....) ARE subsidized by the cheaper labor that's out there and NOW it's all naught by OIL. ARGH-H-H-H-H.....

2008 May 25 08:12 AM

[Wingnut:]

I was on a Southwest flight to Paris last week......ops, Southwest doesn't fly to Paris, or Rome or London, or Africa or Tokyo or ............ You can not compare theater operations of a legacy carrier to Southwest. Yes, it takes more employess to operate a lecacy carrier for obvious reasons. Southwest has done a good job of skimming high yield domestic routes. Lets see what happens at 30 West in a B737-300.

2008 May 25 08:17 AM

[bigpoppi:]

You see, most airlines are charging for every thing now, because they're too stupid to raise fares accordingly so they make a profit and keep them there. They think that Southwest is going to take away their customers. If Southwest filled every seat on their planes, they still couldn't carry everybody. So then, what's the problem? If all the low fare airlines, combined, filled every seat, they still couldn't carry everybody. Again, what's the problem? Mismanagement is the problem. And why is it that the first thing mgmt. wants to do is cut pay and cut labor? Why do you want to cut the very people that make your airline work everyday. People are not stupid enough to think that are don't need to go up. If you brought back good cust. svc. and got rid of these bogus fees and charges, charged a fare that covers your costs and gives you a profit, then people would pay for it. It's what they get for what they pay for that could make all the difference here, and the powers that be still don't get it. With this bad economy, most people want quality for their hard earned money and the ones that don't want to pay for quality will fly Southwest, Airtran, Jetblue, Spirit, etc. The only thing left for the big five to do that they haven't done yet and should have done six years ago is raise the fares to cover their costs and make a profit. This isn't brain surgery. I've even read many comments from customers who say to stop nickel and diming them to death and raise the fares to where they should be and nobody's listening. They just don't care. It's called GREED, STUPIDITY and MISMANAGEMENT. And these are people who have a Masters Degree in business. Go figure.

2008 May 25 12:21 PM

[bigpoppi:]

You see, most airlines are charging for every thing now, because they're too stupid to raise fares accordingly so they make a profit and keep them there. They think that Southwest is going to take away their customers. If Southwest filled every seat on their planes, they still couldn't carry everybody. So then, what's the problem? If all the low fare airlines, combined, filled every seat, they still couldn't carry everybody. Again, what's the problem? Mismanagement is the problem. And why is it that the first thing mgmt. wants to do is cut pay and cut labor? Why do you want to cut the very people that make your airline work everyday. People are not stupid enough to think that are don't need to go up. If you brought back good cust. svc. and got rid of these bogus fees and charges, charged a fare that covers your costs and gives you a profit, then people would pay for it. It's what they get for what they pay for that could make all the difference here, and the powers that be still don't get it. With this bad economy, most people want quality for their hard earned money and the ones that don't want to pay for quality will fly Southwest, Airtran, Jetblue, Spirit, etc. The only thing left for the big five to do that they haven't done yet and should have done six years ago is raise the fares to cover their costs and make a profit. This isn't brain surgery. I've even read many comments from customers who say to stop nickel and diming them to death and raise the fares to where they should be and nobody's listening. They just don't care. It's called GREED, STUPIDITY and MISMANAGEMENT. And these are people who have a Masters Degree in business. Go figure.

2008 May 25 12:21 PM

[joeeb:]

Well, Bigpoppi hit it right on the head. Charge more! In my opinion this crisis is not due to mismanagement, it's direct cause is the aftermath of the world situation after 9-11, coupled with of course the financing of the Iraq war. Regardless of the causes, the industry is unregulated, free market, which should include increases in fares, along with decreases of fares. Why do they keep charging $69 fares for Portland to Denver, for example?

2008 May 25 01:57 PM

[Lawtraveler:]

It continues to boggle my mind that the traveling public thinks it has a right to cheap air fares at the expense of the very product being sold. In short, you get what you pay for - and the airlines are responding to the demands of the public. So service is cut, routes are cut, more cities will see airliners disappear, and and the airline employees that are left are surly and too often take out their frustrations on the customer. This is what we've bought as the customer. Airline seats have become just another commodity because the customer by his/her purchases have made it so.

We have nobody to blame but ourselves. Too long the customer has shown that all he/she wants is a cheap seat, so that's what you get. Don't expect more than that.

The only way to have a viable air transportation system in this country is to have fares honestly reflect the true cost of flying. If that means fewer people fly in their dirty t-shirts, shorts and flip-flops (holding a garbage bag as a carry-on), so be it.

2008 May 25 02:29 PM

[missourim43:]

Raising fares is not as easy as it sounds....anti-trust restrictions and failure of fare increases to take hold by all carriers threatens market share and placement on travel search engines that display by price reference. Everyone thinks they can run an airline better than those actually running them, but history is littered by remains of those who thought they could but cant.

2008 May 25 06:46 PM

[Former Fly Guy:]

User actually has hit the nail on the head. It's not about being profitable on a single flight. In fact, if the legacy carriers cancelled everything but their profitable flights, there would be nothing left domestically to feed traffic to the very few international routes they'd continue to operate.

Moreover, the loyal "frequent flyers" who use them because they can get miles to everywhere would vanish and head for where the perks are -- not to mention the fact that with fares as they've been, the guy who gets a free ticket by buying groceries and gas with his FF credit card is now a better source of income to the carriers than the frequent flyer who wants his upgrade on a $299 fare.

I spent ten years working in management at "the" major carrier of the day. And while I feel for my friends and colleagues who remain in the industry, I'm happy to say that I made it out and have found success in other pastures. Still, I miss the birds and the wonder of going to work every day to bring people together around the world.

Realit is, it's an awful place to work -- the airline business of today. And the price of jet fuel is going to continue to make it a tempestuous life for everyone whose bread and butter comes at the ticket-buying decisions of the flying public.

Aloha, ATA and many others who've suffered a similar fate have my deepest sympathies. There was a time when the amazement of what we did in the airline business seemed almost like magic -- making the world smaller and smaller. Now, the only thing getting smaller is the light of hope for those who stay in the turbulence. The slipstream of the late ninties a distant memory.

And though I wish I could say that management bonuses were the problem. They really weren't. The real problem is the billions in profits making their way to the oil companies that are gauging not only the airlines, but also the driving public.

This summer is shaping up to be a mess for anyone who has to go anywhere that cannot be reached on a Schwin.

2008 May 26 12:51 AM

[BusDriver:]

The blame can be shared by all.
We have airline managements with boards of directors who say they look out only for the 'shareholder.' In reality, they only look out for themselves. Managers and CEO's hop from airline to airline to wherever will pay them the most. Lower level managers (who only stay at a company long enough to get their ticket punched on their resumes) make short term, short sighted budgetary decisions that hurt the employees and the company in the long run. The frequent flyer program started by Bob Crandall is a perfect example of a great idea initially that has turned into absolute nightmare for the airlines to manage. Frequent flyer programs helped out American early, but now just pisses their customers off when they find they can't use them when they want to. Ever tried to get from the mainland to Hawaii on a frequent flyer ticket?
The employees are to blame (along with management). Management is unwilling to reward employees in the good times and labor is unwilling or inflexable enough to give up gains when times are bad. In the late 90's, Northwest pilots went on strike for 13 days over a what would turn out to be shabby gains. Management caused the loss of $1.8B in revenue and lost customer goodwill over a contract that would have cost the company $550M over the life of the contract. On the flip, it took bankruptcy proceedings to get those same Northwest pilots to give up 15% initially (later a total of 45% after bankruptcy) to bring expenditures in line.
The government is to blame for flooding the market with seats in the post 9/11 aviation world. If government would have followed its own laws in abiding by the Deregulation Act of 1978, United and USAirways would have gone chapter 7 instead of chapter 11. The subsequent 23% loss of capacity would have enabled more financially stable carriers like Delta, American, and Northwest from filing or threatening to file bankruptcy papers. Instead, the flying public benefited from $99 New York to LA fares while the airlines were left with major losses. Throw in its insufficient funding and idiotic planning for upgrading the national aerospace system and its inability to regulate airport arrival and departure slots and the whole system gets gummed up.
The media is to blame. Its sensationalistic reporting of how terrible the legacy carriers are and how little darlings like Virgin, JetBlue, and Southwest can't do any wrong (even SWA's $10M fine was glossed over in the press) convinces the public that it is the legacy carriers fault for everything. In reality, the legacy carriers are just making things work with what's been given to them. They have to overschedule airport slots with CRJ's and small props to preserve them, lest the airport authorities give up those slots. Anyone remember how American and United voluntarily gave up slots at ORD a few years back to ease congestion. As soon as they did that, port authorities awarded slots to JetBlue and AirTran to 'increase competition.'
The general public is to blame. When it comes to new airports, NIMBY is the word. Not in my back yard. And the airports we do have are an embarassment and in disrepair. New York City is supposed to be the apple of this countries eye. If you've ever passed through LaGuardia, especially the Delta concourse....looks like a third world airport. I've been to airports in Africa that look better.
The general public also treats the airlines like public transportation instead of the high tech transportation system it should be. People show up looking like slobs instead of the well dressed folk of 30 years ago. The wipe their snot under the seats, leave dirty diapers in seat back pockets and treat those safety professionals called flight attendants like dirt. Then they have the audacity to yell at an employee who's been on his/her feet for 13 hours with 4-5 hours of sleep the night before who's also had their pay cut by 30%+ in the last three years. And they stand and brag about how they saved $5 on their ticket through screwtheairlinefare.co...
In the end, remember the one thing your mother should have taught you...."you get what you pay for!"

2008 May 26 12:17 PM

[treatem poorly:]

Its not labor its management, if you take away the million of dollars of bonus management got,The airline would of made a profit, its called false accounting just like wall street. Its time to cut management and ceo pay and have long term incentives not short term, its time management stops acting like king and queen of france, because its time to say off with managements head. not let the employee's eat? cake?

2008 May 26 01:28 PM

[Robert Herbst:]

Mr. Brand,

Your AMR chart above provides misleading data specific to American Airlines (AA).

AMR Corporation is a holding company for various entities including Financial Services and American Eagle Airlines.

AMR provides separate SEC filings for American Airlines (AA).

AMR Corporation (the data you provide above) includes revenue and expenses that are not categorized for American Airlines (AA).

Typically, approximately 10% of AMR's revenue comes from Regional Affiliates. A similar regional affiliate expense is accounted for by the use of Capacity Purchase Agreements (CPA's)

Specifically for the 1st qtr '08-

"AA" reported $5.092 billion in operating revenue plus $581 million in airline affiliate revenue accounted for from CPA's.

Specific expenses for "AA" mainline were:

Labor cost was; $1.484 billion (29.14% of revenue).
Fuel cost was; $1.587 billion (31.17% of revenue).
Other Operating Expenses were; $1.98 billion; (38.89% of revenue)

"AA" Operating Loss was $229 million after reconciling regional affiliate revenue and expenses.

Regards,

Robert Herbst
AirlineFinancials.com

2008 May 26 11:54 PM

[BioInvestor:]

BigDogs, I don't see the logic of what you're saying!

2008 May 27 01:31 AM

[BioInvestor:]

bigpoppi, your analysis off the mark. There's no evidence to suggest that legacy carriers are reluctant to raise airfares. They try and it often doesn't take. The sad fact is that airlines are price takers. Airlines are stuck in the toughest of all situations: their primary, non-employee cost, fuel, is very inelastic; fares are very elastic. I am sure you have read many complaints from passengers about various nuisance expenses, but the fact is that, letters aside, if an airline raises prices, consumers push back.

2008 May 27 01:37 AM

[BioInvestor:]

treatem poorly, your comment is nonsense. You can dig up the financials carriers and, with just a few minutes and a spreadsheet, see clearly that management pay/bonus is nowhere close to the collective losses of the industry.

2008 May 27 01:46 AM

[Lizzy:]

Re Bus Driver comment-- you CAN get a FF ticket to Hawai'i if you plan ahead. We just flew our daughter over to Hawai'i with no problem.... BUT we booked the ticket 4 months in advance. You can't wait until the last month and then hope to get a low miles ticket.

I fly to Hawai'i from DFW about 4 times a year. This may well drop to 3 times per year here very soon because of the fares. I'm one of the ones saying "stop nickle & diming us to death and just raise the fare to cover the dang fuel increases". But by the same token, I do tend to gag when I look at the fares (now) and realize that I'll pay about $400 more for a ticket for Sept. than I paid for the same ticket the same time last year. That's about a 33% increase.

The thing that galls the sox off me right now is that stupid $15 charge to check the FIRST bag. What a public relations screw-up that little move has been. Why didn't they just call it a fuel cost increase and be done with it?

2008 May 27 03:42 AM

[Lizzy:]

Re BioInvestor comment about the bonuses-- I agree, the salaries & bonuses wouldn't cover the losses American has had this year. But under the circumstances, wouldn't it have looked a lot better to the public and the employees if the AA management had either foregone bonuses for at least seriously reduced them since they were announcing big losses? It's kind of stupid to say "we're losing this much money" and then turn around and write a bonus check. Makes a lot of people wonder "well, where's the bonus money coming from then if you're already operating at a loss". I know a LOT of big companies in DFW that cut bonuses entirely during lean years. We might not have liked the situation, but it was understandable. And the bottom line is, people really need to learn to live on their SALARY and to look at a bonus as just that, a bonus.

2008 May 27 03:48 AM

[User 200305:]

Sadly, this is another example of someone in the media being given WAY too much latitude to explain something they're are not at all familiar with...then using a single data point to prove their point even though that data point is not a very good example. If that person wants to comment on the grammar of my first sentence, then have at it, but I can not for the life of me understand what MSNBC sees in them to give them the voice they have. Simply saying that AA should just lay off a few thousand people to solve their problems shows a complete and utter lack of understanding of the business. Does ANYONE realize how recently Sears was larger than Wal-Mart? Legacy business' with fixed assets have an extremely difficult time trying to compete with new businesses. They very way that Wal-Mart finances their infrastructure is different in what was available to Sears. Same with AA...the way they built their business was different that what Southwest deals with.

2008 May 27 10:11 AM

[BioInvestor:]

On a point of clarification: my comment was that the bonuses paid to management over the long haul--say the past twenty to thirty years at least--don't come close to the accumulated losses over that same period. If you subtract out the $5 billion or so dollars transferred from the federal government to the industry after 9/11, the situation is even worse!

Regarding payment of bonuses, if the contact with management specifically stated that the bonus isn't payable if the airline is not profitable, that's fine. Otherwise, the issue of how payment of a bonus appears isn't germane. Sure, the media may create a stir and some people will complain, but frankly, the story doesn't have legs and in the grand scheme of things, it doesn't matter to most people. Nice thing gripe about, but that's it.

2008 May 27 03:50 PM