hrm360 2014 summer case 1 1 america west airlines

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Copyright © 2004 Thunderbird, The Garvin School of International Management. All rights reserved. This case wasprepared by Professor Lauranee Buchanan for the purpose of classroom discussion only, and not to indicate either effectiveor ineffective management.

America West Airlines:An Airline in Transition

Edward Beauvais saw an opportunity and made it a reality. As an airline consultant in the1980s, he feltthat southwest markets such as Phoenix, Arizona were overlooked by most of the major carriers. To-gether with his partner Michael Conway, a former Continental executive, they mortgaged their housesto raise cash to start America West Airlines (AWA) in 1981. AWA began with flights from Phoenix tofour U.S. cities; today, AWA is the eighth largest carrier in the U.S., serving 100 designations in theU.S., Canada, Mexico, and Costa Rica. Among 150 startups formed since deregulation in 1978, AWAis the only airline to become a major player.1 But along the way, AWA has flown through its share ofturbulence.

Company History

AWA grew rapidly in the 1980s, establishing hubs in Las Vegas, Nevada, and Columbus, Ohio, buyingroutes from bankrupt Eastern Airlines, and starting international service to Nagoya, Japan via Hawaii.But expansion cost and intense competition from low-cost carrier Southwest Airlines led to losses of$46 million in 1987.2 In 1988, Beauvais and Conway were forced to cut flights, planes, and employees;they sold the Nagoya route to Northwest Airlines. These cuts might have been enough, but the after-math of the first Gulf War left the entire industry reeling with additional losses due to high fuel pricesand reduced demand. In 1991, AWA filed for Chapter 11.

At that point, Beauvais stepped down, and the board brought in financier and turnaround special-ist William Franke. Mr. Franke’s previous experience had been to bring Circle K, a convenience storechain, out of bankruptcy. Making further cuts in staff and planes, AWA made a profit in 1993 andemerged from bankruptcy in 1994. During this time, Franke and Conway were often at odds with oneanother, and in 1994, Conway was fired by the board and replaced by Franke. (When Conway’s lifetimepass on AWA was revoked, he started a rival airline in Las Vegas.3)

On the surface, AWA’s situation seemed to improve as the financial burden lifted, but internallythe picture was quite different. The tension between Franke and AWA employees escalated to the pointof open warfare. A senior executive at a rival airline said he had never seen a carrier whose approach toworkers was “so confrontational.” AWA was “the kind of employer that fires people on Christmas Eve(500 technicians in early December 1995).”4 Flight attendants negotiated for five years to get their firstcontract. Pilots protested their contract by flying extraordinarily fast to burn fuel; arriving early, theywould circle the airport to kill time.

1 Farnham, Alan, (2001), “America’s Worst Airline?” Forbes, June 11, 167, 14: 104.2 Hoover’s Online, (2004), “America West Holding Corporation: History.”http://premium.hoovers.com/subscribe/co/history.xhtml?COID=41891.3 Lacter, Mark, (2000), “Flying Aces,” Forbes, November 13, 166, 13: 54.4 Farnham, “America’s Worst Airline?”

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Cuts in planes and staff also resulted in operational problems. In 1998, the Federal AviationAdministration (the government agency responsible for civil aviation safety) hit AWA with a $5 millionfine for maintenance violations—the largest such fine ever levied against an airline. The FAA chargedAWA with flying 41,000 flights using 17 planes that were overdue for structural inspection.5 AWAsubsequently paid $2.5 million in fines and agreed to a major overhaul of its maintenance and flightoperations, including joint FAA/AWA teams to revamp procedures and oversee outsourced mainte-nance work.6

These internal problems soon spilled over into customer service, and America West soon becameknown among customers as “America Worst.” In June 2001, Forbes magazine reported: “We scouredtons of data on canceled fights, lost luggage, staff rudeness, and more to find which carrier is worst atwhat. And the loser is … America West. Even in an industry rife with screwups, crummy service, anddissembling, America West stands out as a paragon of badness. It ranks worst in customer complaints,worst in lost luggage, worst in cabin comfort, and next-to worst in on-time performance. It has onething going for it: in denied-boardings (bumping ticketed passengers because a flight is oversold), it issomewhat less bad than the average airline.”7

Almost 1500 people filed complaints against AWA with the Department of Transportation in2000—the highest rate in the industry. (Southwest had the lowest rate with 338 complaints.) AarreLaakso, a San Diego consultant, arrived in New York for a business meeting, but his bags didn’t. “I hadto go to the executive suite dressed in torn jeans and a stained shirt.” But Mr. Laako wasn’t really upsetuntil his bags were lost again as he traveled to Boston. That America West claimed to have “the mostsophisticated baggage tracing system in the industry” failed to impress Mr. Laako, since he couldn’t findanyone who knew how to use it. After the second incident, Mr. Laako vowed never to fly America Westagain.8 He wasn’t alone. eComplaints, which collects and analyzes consumer complaint data, reportedthat AWA customers were more likely than other travelers to say they will switch carriers—permanently.It also claims that there may be 20 fliers that are upset with the airline for every one that bothers tocomplain in writing.9

While every airline occasionally disappoints its customers, America West could, at times, seemcompletely insensitive. Sherry Layne, a blind woman traveling with her Seeing Eye dog, was booked infirst class. When her rowmate objected to the dog, AWA stuck Ms. Layne in the last row of coach,instead of asking the discontented rowmate to move. When she complained to CEO Franke, he had anassistant respond: “Our personnel were able to accommodate you on that flight. I’m disappointed youfeel this constitutes a violation of your rights.” Ms. Layne received more sympathy from the Depart-ment of Transportation, who issued AWA a fine (which was later waived).10

New Management Team

On September 1, 2001, amid employee dissatisfaction, customer complaints, and continuing financialproblems, Mr. Franke turned the management of AWA over to a younger generation, lead by W. Dou-glas Parker. Mr. Parker, a financial wizard who first established his credentials as a fare analyst, came upthrough AWA’s management ranks. During his tenure as CFO, Parker had been instrumental in restruc-turing the airline’s schedule to increase business traffic: adding service to business cities such as Boston,Philadelphia, and Cleveland, while cutting back on flights to leisure destinations.11 As President and

5 Ibid.6 McCartney, Scott, (1998), “America West Loses Altitude Just After Its Comeback—No. 9 Airline StrugglesAnew with Reliability, Labor, Depressed Shares,” Wall Street Journal, September 18: 1.7 Farnham, “America’s Worst Airline?”8 Ibid.9 Ibid.10 Ibid.11 McCartney, “America West Loses Altitude.”

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COO, Parker acknowledged the airline’s operational weaknesses and worked to correct them: “The factof the matter is, we did not run a good airline through last summer (2000). When we were growing10% a year in the late 1990s, we did not adequately invest in infrastructure or in preventive mainte-nance. That caught up with us, and by last summer we were not delivering reliable aircraft to the gate atthe time of departure.… Starting last summer we took strong corrective measures, spending a com-bined $20 million to double our number of spare aircraft from four to eight and hire 50% moremechanics. We also spent $40 million on extra spare parts and $5 million to hire new customer servicerepresentatives.”12

To make improvements, Parker sought outside financing. On September 10, only nine days aftertaking control of the company, he received welcomed news that the airline had obtained preliminaryapproval for a $200 million loan. Mr. Parker took his newly installed management team out to cel-ebrate, but there was little time to savor the success. With fleets grounded on 9/11, AWA started bleed-ing $5 million a day. When flights resumed three days later, losses continued and AWA’s financing fellthrough.13

A week later, Parker flew to Washington, D.C., along with the CEOs of the other airlines, to seeka government bailout for the beleaguered industry. After months of lobbying, AWA was the first airlineto secure a government loan. (The $380 million government loan was later supplemented by a $429million loan from a group lead by Citibank.) Getting government help wasn’t easy. Mr. Parker had tobuild a case for why AWA was worth saving, give the government warrants worth one third of theairline’s fully diluted common stock, and wring more than $600 million in concessions from 20 credi-tors including manufacturers, vendors, and leasing firms.14 Among the creditors who were willing tohelp were GE Capital Aviation Services—GE’s aircraft financing arm and AWA’s largest aircraft leaser—and Airbus—the European plane maker.

GE agreed to co-guarantee the Citibank loan, based on the goodwill Mr. Parker had built up innegotiations prior to 9/11. “Typically, airlines arrange several leasing companies in different roomsduring negotiations, and shuttle back and forth playing one against the other. But during a negotiationwith GE just before 9/11, Mr. Parker didn’t do that, and GE took note, says Michael Chen, senior vicepresident at GE Capital Aviation Services. After they struck a deal, Mr. Parker took the GE officials toa down-to-earth neighborhood bar, instead of a fancy restaurant, to celebrate. ‘It was more like he wasone of us, where he could talk about his family and basketball,’ says Mr. Chen. ‘It made it like a morepersonal level where you build trust in the guy.’”15

Henri Courpron, head of Airbus Industrie’s North American unit, concurred, characterizing Mr.Parker as a “hard bargainer who asks nicely.... He’s just going to tell you: ‘Look Henri, this is what Ineed, this is why I need it.’” Airbus agreed to defer delivery of 17 of the 28 aircraft on order fromAWA.16

Even with loans and vendor concessions, AWA had to furlough 1500 employees after 9/11.17 Oneof the promises Mr. Parker made the government was to continue to hold down labor cost. Pre-9/11,America West employees were paid about 45% less than competitors: a pilot with ten years makes anaverage of $126,000 a year compared to $186,000 at other carriers.18 Further concessions would be

12 Turrettini, John, (2001), “A Bad Airline Repents,” Forbes, June 11, 167, 14: 105.13 Trottman, Melanie, (2002), “Credit Lifeline: Still Wobbling a Bit, America West Tests Plan to HelpAirlines,” Wall Street Journal, April 4: A1.14 Ibid.15 Ibid.16 Ibid.17 Alexander, Keith, (2002), “A Climbing America West; Airline, Citing Loan Guarantee, Says It Is Out of‘Survival Mode,’” The Washington Post, June 25: E1.18 Trottman, “Credit Lifeline.”

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needed, but pilots, who had been in contract mediation for over a year, weren’t expected to embrace newcost-cutting measures.

Turnaround for a Troubled Airline

Many argued that troubled airlines like America West should be allowed to go under; not surprisingly,Mr. Parker disagreed. “We’re the nation’s largest, low-cost hub-and-spoke airline. We keep prices downnot just for our customers, but for [those of ] every other airline.”19 But the AWA team needed to makea decision: was AWA a traditional hub-and-spoke airline, or was it a low-cost discount airline? Evenbefore the management team could settle on a long-term strategy, they knew they had to act to improveoperations and get passengers back onboard. Fortunately, with the promise of government loans andnew management working to ensure the future of the airline, employee faith in the company began toreturn. By June 2002, AWA had rehired all 1500 employees furloughed after 9/11, including 179pilots.20 And operations continued to improve.

Douglas Parker and his team began taking bold steps to improve customer relations as well. InMarch 2002, AWA took customers—and competitors—by surprise, announcing they would eliminaterestrictions such as the Saturday-night stay-over requirement for cheaper fares. At the same time, theyslashed expensive, last-minute business fares by as much as two-thirds. To promote these initiatives,AWA aired a low-budget ad during the Phoenix Suns basketball games. The ads opened with the text“The fine print from America West Airlines” as small, white type filled in a black background. As the“fine print” rolled over the screen, the type size increased in four places to publicize AWA’s new, cus-tomer-friendly policies: lower business fares, no additional charge for standby flights on the same day,no required Saturday-night stay, and no penalties on unused tickets. The tagline asked “Lower fares.Fewer restrictions. Is that fine with you?”21 In addition to conveying AWA’s new policies, the ads hadanother purpose: to make fun of competitors who had added new fees for “extras”—such as papertickets and over-sized baggage—in order to generate higher revenues.

With industry revenues down and costs escalating, traditional competitors reacted quickly. Theycut business and leisure fares in AWA’s main markets; a move designed to force America West to retreatfrom its decision. But America West held its ground, and, by the end of 2002, several other airlines,including Delta and American, were testing similarly priced business fares.22

In addition to encouraging customers to fly again, America West looked for ways to increaseprofitability. In May 2003, airline executives decided to experiment with the yield-management pro-gram. As described by Scott Kirby, Executive VP of Sales and Marketing, “…America West sorted the92 days in June, July, and August into 43 peak-travel days and 49 off-peak days, and blacked out salesfares on the peak days. ‘We refused to sell our product at ridiculously low prices,’ said CEO DougParker.” The strategy was “very successful.” “On peak days in June, the airline had flat load factors,much like a year earlier, but big increase in yield—cents per revenue seat mile. On off-peak days thereverse was true; yields were flat, but the load factor was up.”23

In another initiative, referred to as the “First-Rate” program, AWA sought to attract higher rev-enues in first class at lower prices. How? By getting customers to actually pay for their seats! AWA—likemost airlines—was not breaking even on first class. Only six percent of travelers in first class paid fullfare; the remainder used frequent flyer miles to upgrade. With the First-Rate program, AWA offers first-

19 Ibid.20 Alexander, “A Climbing America West.”21 Flass, Rebecca, (2002), “Moses Anshell Spells Out Benefits of America West,” Adweek, December 9, 52, 49:4.22 Setaishi, Sonoko, (2003), “A Galling Idea: Charging for Airline Food—America West to Test Selling In-Flight Meals and Snacks,” Wall Street Journal, January 2: D1.23 Bond, David, (2003), “An ‘Incredible Transformation’ America West Drops ‘Ridiculously Low Prices,’Reaps Reward with Second-Quarter Profit,” Aviation Week & Space Technology, July 28, 159, 4: 41.

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class seats at 50% to 70% off full-price fare, but the ticket is non-refundable. (They continue to offerrefundable tickets at full fare.) “We’re going to redefine what we think first class is, and (we think) firstclass should be affordable,” says Scott Bowers, VP of revenue management.24 The program was designedto attract two segments of customers: budget-conscious business travelers and high-end leisure travelers.In the first few weeks, First-Rate increased revenues $1 million to $2 million a week. Half of the ticketswere sold more than a week—and in some cases, more than 21 days—in advance of departure. Withthis in mind, AWA said that it would not hold back first-class seats for last-minute passengers hoping toupgrade.

Back in economy class, America West took at different tactic. The airline began charging passen-gers for meals: $3 for a snack box, $10 for a Chicken Kiev dinner. While widely ridiculed in the press(the Wall Street Journal headline read: “A Galling Idea: Charging for Airline Food”), other airlines tooknotice and also began experimenting with on-board food sales.25

All the while, AWA continued to invest in IT projects to improve customer interactions andreduce cost. “Online is our lowest-cost distribution channel, and we want to shift as much of ourvolume there as possible,” according to Lloyd Parker, VP of distribution.26 To encourage customer useof the Internet, AWA introduced Low Fare Finder. In one step, customers can find the best possibleprice for the preferred date of travel and compare it to fares on alternative dates. To reduce check-intime, AWA began automating airport check-in throughout its route system with self-service kiosks. Andto reduce boarding delays, AWA began using a “reverse pyramid” process designed by Arizona StateUniversity engineering students, whereby passengers board from back to front and window to aisle atthe same time.27

Controlling costs remains a top priority, forcing America West to reexamine fundamentals—including route structure. In 2003, AWA closed its Columbus, Ohio hub. At the same time, AWAexpanded its point-to-point transcontinental services from Los Angeles International Airport to NewYork’s Kennedy and Boston’s Logan. Service from San Francisco to New York and Boston began in2004. AWA flies two round trips per day: east to west in morning and early evening, west to east inmorning and at noon. To gain a foothold in these markets, AWA dropped prices. Out of JFK, AWA’swalkup or unrestricted tickets were priced at $299 one-way—compared to $900 on American, Delta,or United, and $1200 on US Airways. Consumers flying out of Boston benefited from even biggersavings.28 The expansion into new routes carries risks, but Mr. Parker sees it as the only way to remaincompetitive: “We are seeing a number of other low-cost airlines moving into point-to-point marketsthat we have a competitive advantage over. Rather than find ourselves in a position in a few years ofwishing we had added those markets, we are going to enter them today.”29 In expanding point-to-pointservice, AWA avoids competitors’ hubs, where passengers are more likely to use connecting flights.

America West’s costs—particularly labor cost—continue to be lower than most competitors. Af-ter four years of negotiation, pilots accepted a three-year contract in December 2003. The contractdoesn’t increase salaries, but it increased total compensation and benefits $30 million to $35 million; afigure, Mr. Parker indicated, that’s “comfortable.”30

24 Trottman, Melanie, (2004), “First Class at Coach Prices; America West Adds Class of Nonrefundable Seats;Others Expected to Follow,” Wall Street Journal, February 17: D1.25 Setaishi, “A Galling Idea.”26 Verton, Dan, (2002), “Despite Economy, IT Projects Take Off at America West,” Computerworld, August19, 36, 34: 8.27 Trottman, Melanie, (2003), “America West Tests Low Fares—Despite Broad Retooling, Airline Continuesto Suffer Losses,” Wall Street Journal, June 5: B10.28 Bond, David, (2003), “Low-Fare Transcon America West Will Launch Nonstop Service in Four of the BigThree’s Profitable Markets,” Aviation Week & Space Technology, August 18, 159, 7: 39.29 Josselson, Steve, (2003), “Phoenix Rises,” Airfinance Journal, December: 1.30 Ibid.

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31 Bowen, Brent D. and Dean E. Headley, (1999–2004), “Airline Quality Rating,” April.http://www.unomaha.edu/~unoai/aqr.32 These results included nonoperating gains of $81.3 million related to federal government assistance and$13.1 million from sale of investments; even without these, AWA reported an operating income of $32.9million.33 America West Airlines, (2004), 2004 Chairman’s Message to Shareholders. http://www.americawest.com/aboutawa/publicrelations/aa_2003shmessage.htm.34 Josselson, “Phoenix Rises.”35 America West Airlines, (2004), 2004 Chairman’s Message to Shareholders.36 Josselson, “Phoenix Rises.”37 Ibid.38 Gilbertson, Dawn, (2004), “AmWest CEO Has Strategy for Crisis,” Arizona Republic, August 15: D1.39 Farnham, “America’s Worst Airline?”40 Will, George, F., (2004), “An Industry Ready for Takeoff?” The Washington Post, June 3: A19.

Results

The results have been dramatic. After a three-year effort, AWA has begun to show signs of a consistentoperational turnaround, improving its on-time record and maintenance procedures, as well as curbingthe number of flight cancellations. AWA lost fewer bags and logged fewer customer complaints threeyears in a row. (See Exhibits 1–4.)31

For 2003, AWA reported net income of $57.4 million compared to a net loss of $387.9 millionfor the prior year.32 At year end, AWA had experienced five consecutive quarters of improved earningsand three consecutive quarters of profitability.33 Passenger load factor—the percentage of seats filled—jumped to a record 76.4% in 2003, with business travel accounting for 40% of traffic (up from 34% in2002).34 Other key indicators were also up:

• Revenue passenger mile—one paying passenger flown one mile—increased 7.1% to 21.3 billionwith 3.3% increased capacity.

• Revenue per available seat mile (RASM) increased 6.2% year-over-year (compared to the industryRASM of 2.8%).

• Revenue per passenger mile, or yield, increased 2.3%.35

At the same time, AWA reported one of the lowest costs per available seat mile (CASM) at 7.57cents (Q3, 2003); the only airlines with a lower CASM were Jet Blue, Northwest, and Southwest.36

In December 2003, AWA reported that the government would make more than $200 million ifthey chose to exercise the stock warrants held in exchange for providing the loan guarantee.37

Despite the upturn in America West’s performance, some analysts remain pessimistic. By mid-2004, the stock price was at a 52-week low, just over $5 (compared to its 52-week high of $16). “NoHope” was the headline one investor slapped on an Internet message board, saying he had just soldAWA stock at a loss.38

In large part, this pessimism is a reflection of the state of the industry. Even before 9/11, structuralproblems plagued the airline industry: too few runways, too few airports, too many flights, and out-dated air-traffic control technology.39 Since then, airlines have suffered through one crisis after another:recession, SARS, the war in Iraq. Jet fuel is now at a 15-year high, having escalated more than 70 centsper gallon in the past year; with each penny, industry cost increased by $180 million.40

Several of the major carriers, including United and Delta, are at or near bankruptcy, while mo-mentum has shifted to discount airlines lead by Southwest and Jet Blue. The low-cost, discount airlineshave seized opportunities—hiring furloughed workers, grabbing abandoned airport gates, making deals

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on aircraft canceled by the bigger airlines. As noted by the Wall Street Journal: “Some pilots are sitting inthe same planes but wearing different uniforms...”41 Passenger traffic at the six largest airlines was down2.9 billion revenue passenger miles in June 2004 compared with June 2001 (a decrease of 8%), whilethe six largest discount carriers flew nearly three billion more revenue passenger miles (an increase of38%). Discounters now have a 25% market share, and are expected to capture 40% of the market in thenext year.42

41 McCartney, Scott, (2004), “How Discount Airlines Profited From Their Bigger Rivals’ Woes,” Wall StreetJournal, August 12: A1.42 Will, “An Industry Ready for Takeoff?”

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Exhibit 2 Involuntary Denied Boardings(per 10,000 passengers)

1999 2000 2001 2002 2003Air Tran 1.45Alaska 0.91 1.41 1.36 1.17 0.81America West 1.39 1.12 0.38 0.20 0.40American 0.43 0.42 0.36 0.31 0.59American Eagle 0.43 0.19 0.38ATA 0.89Atlantic Southeast 7.86Continental 0.34 1.80 1.51 0.87 1.06Delta 1.53 0.33 0.77 1.11 1.30Jet Blue 0.00Northwest 0.18 0.57 0.45 0.60 0.70Southwest 1.38 1.89 1.50 1.09 1.02TWA 0.73 2.54 1.83United 0.90 1.43 0.92 0.69 0.65US Airways 0.52 0.65 0.34 0.35 0.34Industry Average 0.88 1.04 0.86 0.72 0.86

Statistics based on data from the Department of Transportation, compiled by Brent D. Bowen andDean E. Headley.

Exhibit 1 On-Time Arrival Percentage



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Exhibit 4 Total Complaints to Department of Transportation(per 100,000 passengers)



Exhibit 3 Mishandled Baggage(per 1,000 passengers)



hrm360 2014 summer case 1 1 america west airlines

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