Arpey's 1982 Thesis

The Strategy to Gut American’s Labor Contracts was Outlined in Arpey’s 1982 Thesis

This article from the Dallas Morning News suggests that Gerard Arpey was the architect behind American's 2003 restructuring plan. The article further points out that the key behind this "strategy" was to get the unions to help promote the company's position by incorporating a technique the company refers to as "active engagement."

Jun. 08, 2003
Arpey predicted American's predicament
By Trebor Banstetter
Star-Telegram Staff Writer

FORT WORTH - Gerard Arpey couldn't have made his case more strongly: "One of the greatest threats confronting the established carriers today," he wrote, "is competition from low-cost, highly productive" airlines such as Southwest.

It could have been an excerpt from American Airlines' 2002 annual report, a year when the carrier lost $3.5 billion amid stiff competition from discounters.

But Arpey, who recently became American's chief executive, wrote those words 20 years earlier -- in a 1982 dissertation he submitted for his master's degree in business administration at the University of Texas at Austin.

At the time, the industry was newly deregulated, and the major airlines were still adapting to the changing environment. Low-fare king Southwest Airlines had just begun adding flights outside of Texas, and the industry "was in a panic" over the emerging, low-fare airlines, said consultant Michael Boyd of the Boyd Group of Evergeen, Colo.

"It was almost like the Red Scare of the 1950s," Boyd said. "It was the low-fare scare."

In his thesis, The Airline Industry in Transition -- from Regulation to Deregulation, Arpey outlined a long-term strategy he believed that the established carriers could use to adapt to the growing competition and survive in a low-fare environment.

Arpey concluded that the major carriers should focus on reducing labor costs and increasing productivity to better compete with low-fare carriers. He also wrote that airlines should increase the efficiency of their aircraft fleets and adjust routes.

And he recommended that airline executives win the cooperation of union members by warning them about the poor financial state of the industry, and use other failed carriers as an example of what would happen if changes weren't made.

For the most part, American and other big carriers didn't adapt, and discounters continued to expand and acquire market share for two decades.

But today, the big airlines are restructuring to meet low-fare competitors head on. And American's turnaround strategy -- crafted last year with Arpey's close involvement and now under his complete control -- bears a remarkable resemblance to the steps he recommended as a 23-year-old business student in 1982.

Though all of the major airlines have cut costs to some extent, American was the first out of the gate last year and has been the most aggressive. It has slashed $4 billion in annual expenses through steep labor concessions, cutting flights, by smoothing out schedules at its hub airports and by retiring nearly 100 airplanes.

Many industry analysts have lauded the strategy as a model for reshaping a traditional carrier.

"The company has set the stage for a recovery," said analyst Ray Neidl of Blaylock & Partners in New York. "With the right cost structure, it should be a tough competitor."

But others caution that cost-cutting alone might not be enough to save the large carriers. Traffic remains weak, the airlines are still saddled with enormous debt loads, and their ability to borrow more money has been sharply curtailed.

"Continued cost progress is imperative, as is industry recovery and access to capital," said analyst Jamie Baker of J.P. Morgan Securities. "Lacking any of of the three likely results in a Chapter 11 challenge by this time next year."

American has also resisted some of the bold actions taken by Delta Air Lines. Delta decided to take on discount carrier JetBlue by launching a low-fare unit called Song, which not only challenged JetBlue on East Coast routes but echoed the discounter's laid-back style.

Delta has also dramatically increased its use of cost-efficient, regional jets, particularly at Dallas/Fort Worth Airport, where the Atlanta-based carrier operates a small hub.

Arpey, who declined to be interviewed for this article, has shown little interest in the "airline-within-an-airline" concept. Though American plans to ramp up its use of regional jets, it hasn't yet launched an initiative to match Delta's.

American also chose not to file for bankruptcy earlier this year, unlike its rival United Airlines. Although bankruptcy can be a "horrible and costly" process, said William Warlick, a bond analyst with Fitch Ratings in Chicago, avoiding it may leave American at a permanent cost disadvantage on items like aircraft leases and debt service costs.

Under Arpey, American has introduced some innovations, such as a $299 walk-up fare from JFK International Airport in New York to three California destinations. And he recently reversed American's "More-room-in-coach" campaign on 25 percent of its aircraft.

But, like Carty before him, Arpey's chief focus is on slashing costs -- something the major airlines have been unable to do on a large scale until now.

Consultant Boyd said American and other executives talked endlessly about adapting to low-fare competitors during the 1980s. They were unable to make significant cost reductions, however, because of labor battles and a continued focus on business travelers, which requires more expensive operations to reduce connection times.

"It's one thing to say it, and another thing to do it," Boyd said. "It may have taken a catalyst like 9-11 to really bring change to this industry."

Growing threats

In the early 1980s, discount carriers were just beginning to emerge as a industry force. Southwest, New York Air and People's Express offered no-frills, cheap flights for people who couldn't afford the expensive fares on big carriers like American or United.

But at the time, the discount carriers were still minor players. For example, in 1982, American Airlines carried 12 times more passengers than Southwest, according to the Air Transport Association.

Last year, American had just three times more passengers than Southwest, and the Dallas-based discounter now competes with American on more than 85 percent of its routes, according to American officials.

Arpey, however, recognized that the low-cost operating structure of these carriers had the potential to make them aggressive competitors on a national scale.

"Because of their comparatively low cost structures, [discount carriers] can charge fares well below the level at which [major airlines] can operate profitably," he wrote in his thesis.

The discounters had steep advantages in labor costs, productivity, cost-efficient city-to-city route structures and no-frills marketing, he said. He predicted that the established carriers would eventually have to change dramatically to compete against the new wave of nimble, cost-efficient upstarts.

"As these new carriers grow and continue to gain market share, it is clear that the existing carriers will have to adapt to the new cost structures against which they must compete," he wrote.

Bob Crandall, who headed American when Arpey was hired, said the young executive's analytical abilities were evident early and helped distinguish him as someone who had the potential to climb to senior management.

"His analytical ability is one of his greatest strengths," Crandall said. "He's a good analyst, a good communicator and very comfortable with numbers and statistics."

Arpey never forgot the central tenet of his graduate paper. He repeatedly warned analysts of the low-fare competition during the 1990s, when he was a fast-rising American executive, and accurately predicted that discount carriers would eventually expand into long-haul markets to challenge the major airlines.

"Southwest may be offering better value" than American, Arpey said during a 1992 conference with airline industry analysts, suggesting that American come up with a strategy to compete in those markets.

And in 1994, he said that "it's just a matter of time before the Southwests of the world and new-entrant carriers get into long-haul markets." Today, lengthy transcontinental routes are the area of fastest growth among discounters like Southwest and JetBlue.

American did attempt to bring its costs down at various times during the past two decades through tough labor negotiating or operational changes, but none of its efforts persisted.

By the late 1990s, the carrier had among the highest costs in the industry and spent billions buying bankrupt airline TWA. Southwest, meanwhile, retained its efficient structure.

When the economy slowed, and high-paying business travelers vanished, American stumbled into the worst losses in the carrier's history.

Strategic flashback

In August 2002, American unveiled the first phase of its plan to deal with the growing financial crisis. As president and chief operating officer, Arpey was closely involved in the plan and, with chief executive Don Carty, co-signed letters in February to labor leaders requesting concessions.

The key elements of the airline's turnaround strategy can all be found in Arpey's 1982 thesis, including:

  • Reducing labor costs. "Labor is probably the biggest cost advantage the new entrants have over larger [established] carriers," he wrote. "[Airlines] must take significant steps in narrowing the divergence in labor costs between themselves and the new [low-cost carriers]."
  • Labor cuts made up nearly half of the American's cost-cutting strategy, with $1.6 billion in payroll reductions through concessions approved this year.
  • Enlisting the cooperation of workers by emphasizing the problems in the industry. Arpey wrote that "airline management must first adequately convey the seriousness of the problem to the rank and file union members," and said the demise of Braniff Airlines could be used as an example of what could happen without a cut in labor costs.
  • Last year, American executives began an intense process of communicating the airline's dire financial condition to union leaders and members through a process they called "active engagement." Executives frequently cited bankrupt carrier United Airlines as an example of how much worse things would be without cost savings.
  • Improving employee productivity. Arpey noted in his thesis that Southwest "obtains roughly 50 percent more actual flight time from its cockpit employees than do the established carriers."
  • The new contracts will increase the amount of time pilots and other workers spend on the job by tightening and eliminating many long-standing work rules.
  • Making operations more efficient. Arpey advised that airlines should increase the productivity of their aircraft and realign routes where needed. American has taken those steps by smoothing out hub schedules, reducing the different types of aircraft in its fleet and adding strategic city-to-city flights to compete with discounters like Southwest and JetBlue.

One point Arpey made as a student has not yet panned out. In discussing the need for airlines to reduce labor costs, he noted that, historically, it was extremely difficult to persuade union members to voluntarily reduce labor costs unless an airline was on the brink of collapse.

"It is to be hoped that in the future, airlines will not have to be in such a precarious financial position in order to obtain union concessions," he optimistically predicted.

As American's chief operating officer, Arpey and the rest of the carrier's top management were unable to win concessions this year until airline lawyers were on the verge of filing a Chapter 11 case.

Staff Writer Jennifer Autrey Contributed to This Report.


Trebor Banstetter, (817) 390-7064