New Works 04/19

American Airlines (AA)

Name
New England College
Course and Semester

Agenda
American Airlines Details and Introduction
US domestic airline market, competition and structure
Economic Concepts
Demand – Supply Analysis Concepts (Right/ Wrong analysis?)
of diminishing marginal returns (Right/ Wrong analysis?)
Network effect by creating hubs (Right/ Wrong analysis?)
What should AA do to comeback strongly (Right/ Wrong analysis?)
Conclusion
References

Talk through agenda
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American Airlines
Founded: April 15, 1926
Headquarters: Fort Worth, Texas
Services offered
Operations of a major network air carrier providing air transport to passengers
Providing freight services
Providing financial services to airline secondary services
In-flight services
Major competitors
United Airlines
Delta Airlines
Southwest Airlines
Market Structure – Oligopolistic market with strong barriers to entry
Regulation Authority – Federal Aviation Authority (FAA)

Talk through deregulation: The airline industry in the United States of America has had a major shift after the Airline Deregulation Act of 1978, and then has been subject to the full force of the market. The airline industry dates back to 1918, when subsidies and regulation drove the Post Office to use its first airplanes to deliver mail. This changed to Post Office giving contracts to private carriers to carry mail through the Kelly act, in 1925 (Cook, 1996).

A significant acquisition in Transworld Airlines in 2001 and a merger with US Airways made American Airlines Group (AAG), one of the prominent players in the airline industry today (Duignan, 2013).

The market structure of the airline industry is oligopolistic which means that there are only a few major players that provide the service. AA’s competitors include other major airlines such as Southwest Airlines, Delta Airlines and United Airlines with market share of 20%, 16% and 11% respectively.
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American Airlines: Market & Competition
American Airlines market share at 15% in an oligopolistic nature as market structure
Despite having 30% market share, American Airlines has not been the most profitable or the most cost saving airline

American Airlines
Group All Industry Ratios

Debt Ratio 0.68 0.88

Current Ratio 0.45 1.5

Quick Ratio 0.3 0.67

Profit Margin 3.70% 5.60%

Operating Margin 7.30% 10.50%

Oligopoly: a state of limited competition, in which a market is shared by a small number of producers or sellers.

Ratio analysis: the analysis of different statistics on the balance sheet of the company
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Economic Concepts – ( Analysis)

Demand – Supply
Analysis Concepts
1

3

2
Demand
Increased income and good economy effects
Related goods pricing
Number of buyers
How customers perceive the future
Supply – pricing, technology, operations

of diminishing marginal returns
Network effect by creating hub

Cancellation of routes
Conserving cash
Cutting operational expense
Creating more direct routes
Improve perception

Cost Analysis
Concepts
Covid Comeback
Analysis

For AA, the demand curve can be determined through three different determinants – income of the people using the service, pricing of related goods, and the number of buyers.

While the production costs incurred in the airline industry are pretty commonly discussed, I would like to talk through two new concepts that I learned in chapter 8 of this course. There are two major cost concepts that perfectly relate to the airline industry in general and AA in particular. These are namely., the law of diminishing marginal returns and the network effect.

One may be able to judge from the above discussion around the pandemic, that AA will have a tough time on the demand curve for the next few years. People losing jobs in turn leading to a loss in income, the negative sentiment about travel among the people, and the volatility in fuel pricing will hurt AA’s demand. The future also looks bleak considering the fact that there is no current vaccine available to treat the disease and people will postpone travel both for business as well as leisure which happen to be the main source of income for AA.
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Demand – Supply Analysis Concepts
If Peoples’ Income rises
If pricing of related goods (crude oil) rise
If number of buyers increase
If Outlook improves
Demand
DETERMINANTS

DETERMINANTS
If fuel and the landing slots pricing increases
If there are Improvements in technology
If the weather is good
If Outlook improves
Supply

This is the strategy that AA has gotten right over the years where they have been able to manage demand and supply

Talk through the determinants on both demand and supply side.

From the above, we can understand that the airline pricing is highly elastic. This means that an increase in pricing reduces the demand. This can lead to either usage of substitute goods such as a competitor or even a different mode of transport. Thus AA has to be very careful to ensure constant demand to maintain a good price.
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of diminishing marginal returns
Busiest route
AA Revenue
$ 675 Million
Delta Revenue
Diminishing marginal returns is an effect of increasing input in the short run after an optimal capacity has been reached. The law states that this increase in input will result in smaller increases in output.

Nash Equilibrium: a stable state of a system involving the interaction of different participants, in which no participant can gain by a unilateral change of strategy if the strategies of the others remain unchanged.
AA’s options to increase revenue from this route
Total Revenue
$ 464 Million
$ 1 Billion +
Nash equilibrium and of diminishing marginal returns
Increase the number of flights on the routes
Reduction in profitability of route by increasing flights cause customers may not increase
Delta could retaliate by doing the same thing
Do nothing
limited availability of seats keeps this route very profitable
AA does not gain a unilateral advantage by change of strategy

This is the strategy that AA has gotten right over the years where they have been able to avoid the diminishing returns

The law of diminishing returns states that after some optimal level of capacity is reached, adding an additional factor of production will actually result in smaller increases in output (Hayes, 2019). The Los Angeles – New York route (LAX – JFK) has turned out to be the most profitable route for AA making 675 Million USD. Delta Airlines made 464 Million USD. Together they control over a billion dollars of the traveler’s market in this route (Grant, 2019). AA could decide to increase the number of flights on this route considering demand, but it will have to face two major issues – it cannot guarantee the number of passengers will keep increasing, which would reduce the profitability of the route. Moreover, if AA increases the number of flights, Delta could do the same further reducing profitability. If Delta decided not to increase the flights then AA might get some more market share from Delta but, the possibility of this happening is really low. Thus, the companies have maintained a Nash equilibrium by making sure the limited availability of seats keeps this route very profitable. AA does not gain a unilateral advantage by change of strategy, if Delta’s strategies remain unchanged. In other words, the market share could increase by adding a few more flights on the route but in general, the profitability could reduce.
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Network effect by creating hubs
Network Effect: The network effect is created when increased numbers of people improve the value of the goods or service.
Hub and spoke model of the airline industry helps reduce costs.
Out of 7 hubs for AA, Charlotte is the most profitable costing 2.28$
Charlotte also shares the revenue per take off with AA
The purpose serves three things
Increased convenience and more choice for passengers
Cheaper costs of flying for both airline and customer
Cost center being converted to a revenue center

This is the strategy that AA has gotten right over the years where they have been able to manage hubs

The airline industry works on the hub and spoke model. The hub and spoke models allow the airliner to focus/concentrate passenger traffic and operations at a particular airport. AA has its six biggest hubs in Charlotte, Chicago, Dallas, Miami, New York JFK, and Philadelphia. The most profitable one is that at Charlotte on a per passenger basis. It is also the hub that experiences the most connecting passenger flight traffic in the US. AA operates over 90% of the flights from the Charlotte airport. According to a 2013 study, the cost per passenger at Charlotte Airport is $2.28, while it’s $6.86 in Dallas and $19.13 in Miami (Schlappig, 2015). One can see the stark difference in being able to maintain a low cost at this hub for AA. Thus, Charlotte hub has created a network effect for AA. The value is commonly shared by both AA and its customers. AA will be able to keep saving money on passenger cost and then eventually pass it on to the consumer by providing a cheaper ticket. The customers get the added advantage of having multiple options to choose from when selecting a flight via Charlotte
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Effects of Covid – 19 on airline industry
Estimated traffic revival
Estimated ASM
Is traveling for business overrated ?

Estimated traffic revival : Will take 5 years to revive
Estimated Average Seat Per Mile : less than 9 cents in Q3 and Q4
Zooms rise to fame on business networking
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What should AA do to come back strong? (1/2)

Reduction in
operational costs
1

3

2
Creation of
Direct routes
Improve customer
trust
Cancelled 19 domestic routes
Asking employees to take buy outs or early retirement settlements.
Take advantage of the fall in crude oil prices by buying more upfront
Leasing of landing slots in Charlotte

Reduction of indirect flights to convert them to direct routes
Stop using the hub spoke model until passengers are back

General needs the government to provide it with interest free loans
Emergency travel preferred airline
wearing masks at all times on the airplane and leaving the middle seat open

This is the strategy that AA has gotten wrong, the efforts should have been more directed and faster

AA has cancelled over 19 routes, received government aid through the payroll protection program and has made changes to the operational costs by asking employees to take buy outs or early retirement settlements. I think all these actions are good to stay afloat. But to get back to be a profitable airline, I would propose that firstly, AA should work on creating more direct routes for the time being. This would mean not using the most profitable hub at Charlotte for connecting flights. There are two reasons that people will travel on an airplane – emergency or any other urgent matter that is not related to health. People will look to save time and exposure on the route, and I believe by providing a direct flight will increase demand. Secondly, the airline industry in general needs the government to provide it with interest free loans both to avoid massive job losses and keep afloat. While the pandemic will not go away unless a vaccine/remedy is created, there will be a day when man’s need to fly will
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What should AA do to come back strong? (2/2)
Stop any chance of merger or takeover
any kind of attempt made in these regards should be thwarted by the government.
Oligopoly should turn in to monopoly
A worse situation for the consumer
Other generic actions
Utilizing passenger planes for cargo movement
Selling/mortgaging aircrafts and engine parts
Defer deliveries of the planes in production
Reduce in-flight espenses

Talk through the reasons why a merger will be bad for the passengers where the buying power of the consumer reduces.

Other plans to revive the airline
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Conclusion
AA has not been the most profitable airliner in the last few years
AA’s demand and supply curves depend on pricing of fuel, income levels, the number of buyers, technology outlook for cleaner fuels and cost efficiency, and peoples’ thinking of the future.
Cost concepts can be discussed via network hubs and law of diminishing returns
The Covid – 19 pandemic will see AA financially strained but a merger/take over should not be a solution

Conclude with details of different points in agenda and end with thanking class for their times.
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References
Cook, G. (1996, August 8). A Review of Hist view of History, Structure , Structure, and Competition in the U.S. Airline e, and Competition in the U.S. Airline Industry. Retrieved from https://doi.org/10.15394/jaaer.1996.1183
Duignan, B. (2013, February 14). American Airlines. Retrieved August 01, 2020, from https://www.britannica.com/topic/American-Airlines

American Airlines. (2017, November 09). Retrieved August 01, 2020, from https://www.cleverism.com/company/american-airlines/

Hopfer, E. (2020, April 15). American Airlines to receive nearly $6B in government aid package. from https://www.bizjournals.com/charlotte/news/2020/04/15/american-airlines-to-receive-nearly-6b-in.html

Impact of COVID-19: Data Updates. (n.d.). Retrieved August 01, 2020, from https://www.airlines.org/dataset/impact-of-covid19-data-updates/
FAA’s major roles and responsibilities. (2019, November 06). Retrieved August 01, 2020, from https://www.faa.gov/about/safety_efficiency/
Hayes, A. (2020, June 14). of Diminishing Marginal Returns. Retrieved August 01, 2020, from https://www.investopedia.com/terms/l/lawofdiminishingmarginalreturn.asp
Grant, J. (2019, August 13). Billion Dollar Route – Jewels in The Network. Retrieved August 01, 2020, from https://www.oag.com/blog/billion-dollar-route-jewels-in-the-network

Banton, C. (2020, January 29). Understanding the Network Effect. Retrieved August 01, 2020, from https://www.investopedia.com/terms/n/network-effect.asp
Schlappig, B. (2015, December 30). You’ll Never Guess American’s Most Profitable Hub. Retrieved August 01, 2020, from https://onemileatatime.com/charlotte-hub-american/