Overview and Strategy American AirlinesCase Study

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American Airlines is one of the largest airlines in the United States. The airline filed for Chapter 11 bankruptcy protection in 2011, and emerged from this two years later. The Chapter 11 was brought about by a combination of difficult industry conditions and by legacy expenses relating to employee pension plans. The industry conditions have improved significantly in the past few years, allowing for American to be profitable in 2014 following many years of losses (MSN Moneycentral, 2015). The company has also merged with U.S. Airways, continuing a trend towards consolidation in the industry (American Airlines 2015 Form 10-K).

The Company

After the merger with U.S. Airways, American Airlines is the largest passenger airline in the U.S., according to the Bureau of Transportation Statistics (2015). The combined carrier has a market share of 20.2%, compared with rivals Southwest (17.7%), Delta (16.9%) and United (14.8%). Smaller carriers that operate regionally or in niche markets include JetBlue, Alaskan, SkyWest, Spirit, ExpressJet, and the remaining 14% of the market is held by even smaller airlines, ranging from established players like Hawaiian to start-ups. American's domestic operations typically are structured in the hub-and-spoke system, with key hubs being major airports at JFK, Miami, LAX, O'Hare, DFW and some hubs inherited from U.S. Airways such as Charlotte, Phoenix and Philadelphia as well.

The post-merger American Airlines has around 113,300 employees. The airline has struggled in recent years with its service, noting in its most recent annual report that service issues have increased, something that could make it vulnerable to competition going forward. The airline is a member of the OneWorld Alliance, which offers code-sharing between member airlines. OneWorld is the third-largest such alliance, despite the fact that among its members are several of the world's most high-profile flag carriers, such as JAL, BA and Cathay Pacific.

All told, American Airlines serves around 160 destinations. This includes a comprehensive domestic service, along with international service to 49 countries, with a focus on the Americas along with a handful of major Asian and European destinations. American Airlines competes in part on the basis of its presence in major airports around the U.S. and on the size of its network. On this basis, the airline's size becomes an important differentiating factor, so it is imperative that American maintain the size of its route network and its large market share in order to remain competitive.

The Industry

By the Herfindahl-Hirschman Index standard used by the Department of Justice to evaluate the competitiveness of an industry, the airline industry in the U.S. is moderately concentrated with an HHI of 1434 (Investopedia, 2015). This degree of competition allows for the competitors to operate more independent of one another, in an environment of monopolistic competition, rather than fighting directly for share as in an oligopoly. That said, the drivers of the market dictate that there is little differentiation between industry players. The U.S. airline market is deregulated in the sense that firms within the industry can enter and exit routes freely, and have freedom to price as they wish. This creates a competitive environment, and consumers have essentially opted for low-cost travel over other aspects of the airline experience. As such, U.S. airlines operating domestically have become oriented towards price competition, which manifests in base pricing and fees for every added service.

Additionally, there are other key success factors in the airline industry. One such key success factor is the load factor. The principle is simple -- when a plane flies, any unsold seat is a revenue opportunity that is lost forever. Airline pricing, therefore, is driven by complex algorithms intended to maximize revenue, based on variables such as price, demand at different points in time, with the intention of selling as many seats as possible at the highest possible price, something that is a challenge in a highly-competitive environment. As such, the routes with the most -- and more reliable -- traffic tend to have very competitive pricing, airlines seeking the path of maximizing load factor, and smaller routes in which an airline might have a monopoly are used for maximization of revenue. This is a practice called yield management (Voneche, 2005).

The other key success factor is on the cost side. While contracts with unions and key suppliers can allow airlines to control much of their cost structure, jet fuel prices are highly volatile. Airlines typically hedge their fuel, buying forward contracts on fuel in order to lock in prices, so that they can set prices more effectively. This practice is common, but is basically a form of gambling -- if the price moves the wrong way, the airline could pay more than it needed to for its fuel. The record profit recorded by American in 2014 was in large part due to favorable price movements in fuel, and the fact that American did not hedge its fuel costs in the middle of 2014, allowing it to take full advantage of the crash in fuel prices in the latter part of the year (Martin, 2015).

Strategies

With the U.S. Airways merger, American is well-positioned in the market, though it still has significant financial issues. The U.S. airline industry has been more profitable the past few years, largely because fuel costs have declined while ticket prices have not (Isidore, 2015). American, however, only enjoyed profits in 2014, and that was because it had not hedged its fuel exposure. The company therefore has not been profitable otherwise in many years. There are some positives. Its revenues are increasing steadily. It has cut some of its administrative and selling expenses over the course of the last several years. In that sense, the company is on a positive path towards profitability, but it is reasonable to assume that it would not be profitable if the fuel prices were higher.

The company's large network, better internal cost control and the fact that it has the largest market share all contribute to strong positioning within the market. American has a strong brand that is widely-recognized in the industry, and more hubs means that it can offer better routing than ever before, and can compete with the other major airlines in the U.S. American's international business is also fairly strong, owing to the fact that its international hubs are major airports in major cities. American, if nothing else, is dealing from a position of strength.

But the ongoing financial issues are enough to provide pause with respect to its future. There is little doubt that it will still be around in five years, as it has successfully navigated bankruptcy once and has stable revenue streams on which to build for the future. It is worth noting, however, that the company only emerged from bankruptcy protection in late 2013, so while 2014 was the first profitable year in a long time for the company, it was also the first full year out of bankruptcy (American Airlines, 2013). In the six full quarters since the company emerged from bankruptcy protection, American has been profitable in all six. Anything before would have been under a different financial structure. The only real point of concern is the reduction on year-over-year income in the first two quarters of 2014 and 2015, which indicates a shrinking business. This is typical when airlines complete a merger -- as the merger occurs some routes are shed and competition often makes gains, but it is still never a good sign to see Y-over-Y declines in revenues. Profits were better year over year in both cases, but this again relates mostly to fuel prices, as selling and administrative expenses were higher as a percentage of sales in each case.

The most reasonable conclusion to make about the future of American Airlines is that it will continue to be a major player in U.S. aviation. It may not be able to maintain its share of the U.S. domestic market, but it still has a strong international presence. It will be one of the top four airlines five years from now, but will be challenged to contain costs even more than it already is in order to maintain profitability over the long run. Without maintaining profitability, it may turn to further mergers in order to maintain its size, though arguably there is little room left for mergers among the industry's major players, and international mergers are typically not possible in the airline business.

Recommended Strategies

American has to accept the industry reality that consumers want low cost flights, and are willing to accept a certain amount of indignity in order to achieve that. The current strategies pursued by American and its competitors are, on one hand, not particularly popular with consumers, but on the other hand they are the strategies that drive the market. Access to flights that are cheap and relatively convenient is what drives the market, so American must continue to provide that.

The two keys to success for American are going to lie with cost containment and route strength. Costs are important, because without the decline… [END OF PREVIEW]

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